All About Accounts Payable
Many businesses focus solely on managing accounts receivables. While that obviously is essential, accounts payable is also something you don’t want to ignore. Both AP and AR affect cash flow, which we all know, fuels a business. If you’re wondering what accounts payable mean, its processes, and how it affects a company, then this article is for you.
What is Accounts Payable?
Accounts payable (AP) is the combined amount of short-term debt a company owes to its suppliers and vendors for purchasing their goods or services on credit. AP typically has a lifespan ranging from 30 days to a few months. To avoid incurring penalties or interests, companies must pay these short-term debts within the agreed-upon payment term.
Think of it as essentially the exact opposite of accounts receivable. While AR is the amount a business must collect from others, AP is the amount others must collect from a business. Similar to AR, you can find accounts payable on the balance sheet. But, while AR records under current assets, AP is a current liability. Later we’ll go over how companies record accounts payable with examples from a general ledger.
Accounts payable may also mean a finance team department that supervises vendor invoices, payments, and records all transactions affecting payables on the company’s books. Many teams utilize automation to streamline workflows, save time, and cut costs. If you haven’t yet, check out Peakflo and learn how we can put your AP on autopilot.
How Does it Work?
Companies often buy goods or services on credit, in which they don’t pay actual money straight away. Instead, they’ll promise to pay the purchased amount sometime in the future. The accounts payable cycle starts as soon as the business orders goods from its supplier. Here’s how it goes during vendor transactions.
The Accounts Payable Cycle
The process begins when a company sends out a purchase order (PO) to its supplier. A PO outlines all the information about the goods or services the company wants to purchase, like order fulfillment date, quantities and qualities of deliverables, and prices. The PO serves as an agreement that the buyer will compensate the seller with cash later.
Receipt & Inspection of Purchase
The business receives the goods or services defined in the purchase order. It then creates a receipt report after examining if the delivered items meet all the criteria and requests indicated in the PO. The business notifies the supplier of missing or damaged items for replacement or account crediting.
Invoice Receipt & Payment
After receiving the goods or service, the firm takes an invoice detailing all the vital information about the purchase from the vendor. The business’s accounts payable team then approves and records the invoice before prepping it for payment. Automation becomes critical for workflow efficiency and circumventing human error during this step.
Double-Entry Accounts Payable With Example
Many companies use double-entry bookkeeping. Under this method, the purchasing company records two entries of the invoice amount in a general ledger. Accounts payable either gets recorded as debit or credit depending on where it is in the accounts payable cycle.
Accounts Payable Example:
On 22-February, 2022, Company XYZ purchased inventory amounting to $30,800 from one of its long-time vendors. The vendor allows the company to pay after 60 days.
Here’s how it will look on a double-entry ledger:
Accounts Payable/Current Liability
The company debits $30,800 under inventory, which is an asset, and credits the same amount in accounts payable, which is a liability.
After 60 days, Company XYZ pays the vendor in full. This payment settles the AP recorded 60 days prior.
Here are the necessary journal entries:
Accounts Payable/Current Liability
This time around, Company XYZ debits accounts payable, removing the amount previously under this account. It then credits the cash account $30,800, signifying its removal from this asset account.
Job Description & Required Skills
The larger the organization, the more likely it will have dedicated teams in charge of separate accounting and finance functions. One such team is Accounts Payable, which focuses exclusively on accounts payable management.
Generally, accounts payable is responsible for every activity involving vendor purchases and payments, managing each payable account throughout the AP process. Here are the essential day-to-day functions an AP team will perform to ensure a good AP process:
- Generate PO and deliver them to the appropriate vendors.
- Ensure PO accuracy and clarity to avoid misunderstandings and order delays.
- Maintain a good relationship with suppliers through clear communication and information exchanges.
- Evaluate and approve essential vendor documents like vendor statements and credit memos.
- Review, approve, and record invoices (preferably using cash management software).
- Manage and prioritize which invoices to pay first to ensure timely payments
- Check and approve payment checks or wire transfers to assure the company makes correct payments.
- Record and reconcile all AP transactions on the company’s books of accounts.
- Produce and analyze reports regarding AP performance.
What Skills are Required?
For an AP department to work effectively, its team members must possess the following soft and hard skills:
- Communication skills
- Basic accounting know-how
- Problem solving skills
- Data analysis
- Critical thinking
- Teamwork, and collaboration
- Attention to detail
- Strong work ethic
- Project management skills
How to Effectively Lead An AP Team?
Like all finance team leaders, an AP department lead must ensure their team contributes as much as it can to the company’s overall financial performance.
Since cash flow is the ultimate measure of financial health and performance, an AP team manager sees that every process and activity within their department aligns with cash flow objectives and goals. Efficient team leaders also embrace automation to ensure that workflows happen as efficiently as possible.
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How Does AP Affect Cash Flow?
Like changes in AR, changes in accounts payable affect the company’s overall cash flow. But, it does so discreetly. Take, for example, when you buy on credit. You might not notice it, but purchasing on credit and increasing your AP can lead to a positive cash flow.
If you’re wondering how this happens, remember that you’re buying without paying cash right away. Money remains in the company’s accounts. Think of it as a loan without interest, which your business can “borrow” to cover for its day-to-day needs.
Now, as you might have guessed, the opposite goes if there’s a decrease in your accounts payable. Slashing off your AP means you’re also paying in cash, resulting in a cash outflow. The general rule requires businesses to have more inflows than outflows. Depending on how much money you’re spending, you might lean towards a negative cash flow.
Should You Use AP Software?
While it might not require as many administrative tasks as AR management, if you want to make the most out of your AP process, software can be the way to go. These platforms often come alongside a general cash management software that allows your team to automate and streamline repetitive functions to improve efficiency and collection rate.
How to Optimize Your AP Process
If you’re still using manual AP processing, you might be no stranger to errors. Starting with PO generation and invoice receipt all the way to payments, the traditional way of doing things consumes massive amounts of time and resources and is highly prone to errors.
With AP automation, your organization can improve every critical AP function. Automated tasks on accounts payable mean a lot of cost and time savings – as much as 80%
Benefits of Accounts Payable Software
An effective AP automation platform supports every accounts payable function and scenarios your team may encounter. You can also easily connect one to any major accounting software. Here are the core benefits of automation:
Cost & Time Savings
With automation, companies can drastically improve the inefficiencies involved in traditional AP management like manual invoicing and spreadsheet entries. This integration results in lower-cost invoicing and data recording. Streamlined workflows eliminate countless hours of monotonous tasks, saving you time and, ultimately, operational expenditures.
Enhanced Accuracy & Reduced Errors
When you don’t have to do too many manual entries, you can expect a reduction in human error. Automation lets you seamlessly capture invoices and execute payments on one single platform. You also don’t have to worry about payment errors like duplicates since invoice data gets automatically authenticated by a built-in recording system.
A robust cash management system always comes with an intuitive dashboard that lets you and your team get a clear view of the entire AP cycle. Using all-in-one dashboarding, you can easily see every payable invoice and its status along with every other vital info. You can also centralize payment approvals and make timely payments in one place.
With the cash management platform’s built-in document capture capabilities, it’s going to be easier to manage and organize documents. This feature results in easier auditing. Since the platform lets you link POs, invoices, emails, and messages together for every single account, you won’t have trouble when it comes to data retrieval, letting you audit with ease.
Get these features and more with Peakflo’s cash management tool that you can easily integrate into your accounting system. With Peakflo integrated, automate not just AP but your overall cash management processes.
Start putting your cash management on auto-pilot. Connect Peakflo to your accounting software today!
FAQs on Accounts Payable
What’s the Difference Between Accounts Receivable and Accounts Payable?
Accounts receivable is the aggregate amount your customers owe to your business. On the other hand, accounts payable is the total amount your business, as a customer, owes to other companies. Your accounts payable account increases when you buy from a vendor on credit. Simultaneously, your vendor’s accounts receivable increases for selling to you on credit.
Is AP a Liability or an Expense?
Accounts payable is a liability that you record in a balance sheet. Expenses, on the other hand, are recorded in a P&L statement. Both AP and accrued expenses resulted from the same activity, which is you purchasing on credit. But, they differ because while all APs are expenses, not all expenses are APs. The expenses account consists of both cash and credit transactions.
Is AP a Debit or a Credit Entry?
In double-entry bookkeeping, accounts payable can both be a credit and debit entry depending on where it is in the AP process. When your business receives an invoice, your team will have to credit accounts payable and debit the necessary account, like inventory or expense. When you make a payment to your vendor, your team debits AP and credits your company’s cash account.
How Is AP Recorded on the Balance Sheet?
Accounts payable have a typical turnover of less than a year, making it a current liability. You can find all liability accounts in the balance sheet, which is one of the three essential financial reports. These financial reports gather their data from your company’s book of accounts, which you update with every transaction.
What is Accounts Payable Automation?
AP automation uses software to automate time and resource-intensive tasks in the accounts payable process. These tasks include vendor invoice processing, recording, and payment executions. The most significant benefits of AP automation for a business are cost reductions, time savings, and human error avoidance. AP software also comes with dashboarding tools that give you a clear view of your entire AP process in one place.