Not every organization gets to pay right away as soon as they buy from a vendor. In most vendor transactions, businesses are allowed specific timeframes before making actual payments. Accounts payable is what accrues every time your business purchases from someone on credit.
Like every other aspect of a company’s financial management, accounts payable management is essential to meeting short and long-term financial goals, particularly those involving cash flow.
In this article, we’ll be going over everything you need to know to effectively manage your accounts payable and ensure that its processes contribute as much as they can to your company’s overall financial health.
Accounts Payable Definition
Accounts payable (AP) is the total value of short-term debts your company owes to vendors for buying goods or services on credit. Essentially, it’s a list of separate obligations your company must pay on a pre-determined date.
Vendor terms typically range from 30 days to a couple of months after purchase. You can find AP on your balance sheet, recorded under current liabilities. Of course, you’ll have to remove them there upon paying your vendors.
What is an Accounts Payable Team?
Accounts payable can also mean your company’s accounts payable department. The larger an organization gets, the more it’ll make sense for them to dedicate entire teams to handling different aspects of financial management.
An accounts payable team ensures that every process and workflow involved in accounts payable runs as smoothly as possible.
Effective AP teams are always on the lookout for ways to make their processes more efficient. If you’re on the hunt for a way to streamline your existing AP functions, give Peakflo a try. We’ll have everything on autopilot for you and your team.
How AP Affects Cash Flow Health
So, what does accounts payable mean for cash flow? The movement of money in and out of a company isn’t the only factor that affects cash flow health. Money that remains still can also benefit cash position. To explain, let’s use an accounts payable example scenario:
Say you purchase raw materials from a supplier amounting to $50,000. The supplier expects you to pay after 60 days. You don’t have to pay any installments, but the supplier wants the total amount at the due date.
What An Increase In Accounts Payable Mean For Cash Flow
Whenever you purchase on credit, your combined AP amount increases. But since you paid no money, you get to keep that $50,000 for as long as 60 days. Think of it as a loan without interest. Instead of giving it right away, you can store it or temporarily use it to fuel other activities. This transaction leads to a positive cash flow.
What A Decrease In Accounts Payable Mean For Cash Flow
After the 60-day timeframe, you’re going to have to pay back the $50,000 invoice to your supplier. As you pay, your accounts payable decreases, but so is your available cash. In this part of the AP process, you’re losing money, which makes you lean towards a negative cash flow.
What is Accounts Payable Management?
AP management encompasses all the processes, activities, and practices a finance team does to manage unpaid trade credit purchases. Any work that involves short-term debt to a vendor falls into this category of accounting and financial management. Here’s the standard AP process many organizations follow:
The AP Management Process
- Generating and delivering POs to vendors
- Maintaining and updating a master vendor file
- Approving and receiving invoices
- Recording vendor invoices into the master record
- Verifying and matching invoices to other relevant documents and messages
- Prioritizing invoice payments
- Getting approval to process payments
- Executing vendor payments
Why is Accounts Payable Management Important?
When it comes to managing business finances, accounts receivable always take the spotlight. That’s for a good reason since AR has a more significant effect on liquidity and available cash. Many organizations even go to great lengths to improve accounts receivables.
Still, that doesn’t mean you should ignore AP altogether. If you want the best results for your business regarding financial stability, you can’t risk leaving any aspects neglected. Remember that AP signifies the obligations your business has to others.
You’d want to ensure the handling team and procedures involved are as efficient as possible. Also, managing and prioritizing invoices to make timely payments are vital to keeping good relationships with suppliers, leading to leaner and better terms. And as you know, better terms lead to favorable cash positions.
Improving any aspect of financial management is not a breeze, especially in today’s challenging and volatile business environment. And it’s not just AP – whether you’re leading AR, capital, investor relations, or the finance team as a whole, modernizing the way you work is essential to get better outcomes. You can check out our latest webinar here to get expert tips on how to do just that.
Or you can jump right in on these eight essential tips on how to improve your AP management:
8 Best Practices to Manage Accounts Payable Effectively
Tip#1 – Refine Vendor Invoicing
Invoice management involves everything from receipt and approval to recording and payment prioritization. Remember that prioritizing invoice payments impacts supplier relationships, so you can’t afford to get this wrong.
But, the more supplier and vendors you have, the harder it gets to keep things organized and accurate. If you have a high volume of invoices coming in or your business goes through seasonal spikes in vendor orders, these tasks can undoubtedly become challenging.
Apart from prioritizing payments, you’ll also have to successfully screen every invoice to ensure it matches the PO before getting them over to your master list, which, as you know, also opens up a lot of other tasks. These activities take a lot of time and effort.
Many businesses also fail to use their vendor’s early payment discount offers because they just simply can’t stay on top of organizing invoices. Luckily, automation software solves all of these problems. It’s best to integrate one into your current system to improve and speed up your vendor invoice processing and avoid inaccuracies.
Tip#2 – Streamline Your Department’s Workflows
The larger a company’s scope of vendor transactions, the more complex an AP system becomes. And the more complex anything gets, the more it becomes prone to error. Now, if you’re processing hundreds or thousands of vendor invoices, and you’re doing them manually, expect to have a lot of a hard time keeping things organized or accurate.
To ensure workflows remain smooth, you’ll have to find ways to streamline. Whether it’s taking a step back and reevaluating current operations to see dents or bottlenecks or finding a way to centralize functions, you’ll have to take time to figure out how to make things more efficient.
Speaking of efficiency, a great way to streamline is to replace outdated processes that slow things down. Automating tasks with software helps you streamline most functions. AP software provides dashboarding tools to track your team and vendor invoices and process your payments.
Tip#3 – Track AP Performance With KPIs
As with measuring other business goals and objectives, it’s a good idea to set KPIs to see if you’re stepping up in AP performance. Some essential KPIs include:
- Cost per invoice
- Payment accuracy rate
- Average time per invoice processed
- Number of invoices processed per day
- Days Payable Outstanding (DPO)
- Number of invoices paid on time
- Early payment discount capture rate.
Now, to ensure you’re setting the proper standards for these KPIs, figure out what your industry standards are. For example, the average accepted days payable outstanding in your industry might be 40. Falling short on that could indicate that you’re not using capital as wisely as your competitors.
These KPIs can also come in handy when implementing new systems and processes into your AP management. Say you’ve opted for automation. Using these KPIs, you can monitor efficiency increases to see how well your new automation integration has helped.
Tip#4 – Make Your Systems Fraud-Free
Cybercriminals aren’t the only ones you should be worried about. Fraud can originate from many sources; it could be an employee or even a vendor. While large organizations with elaborate systems can still be vulnerable, small or mid-sized businesses with outdated methods, seem to take the biggest hit.
While policies and procedures can always lessen the instances of fraudulent activities, there’s no guarantee that you can eliminate them altogether. Apart from the usual cybercriminals that hack their way into organizations, your people inside can pull one on you if you aren’t careful. Employees can create dummy supplier accounts to generate payments they’ll eventually pocket. Employees on the supplier’s end can also do the same.
Traditional invoice and payment processing are prone to fraud since they often lack a meticulous recording and approval system. Automation provides a more streamlined but careful approval while leaving an accurate trail of payment executions for a later audit.
Tip#5 – Always Maintain Accuracy
Effectively managing accounts payable means being accurate throughout the cycle. From order generation to payment processing, every step can impact your company’s overall AP performance. Getting even one step wrong could compromise many aspects, particularly vendor payment activities.
Imagine going through the entire process only to find out that you’d pay the wrong vendor or you’d pay someone too early or too late.
To ensure consistent accuracy, it helps to look over the following:
- Did the invoice and the items themselves match the details on your PO?
- Does the amount on the invoice reflect expected prices, including tax?
- Has the invoice been recorded in the proper account on the master record?
- Did the company actually receive the items for every invoice on record?
- Are the vendor accounts where you send payment all legitimate?
- Which accounts are priorities, and do they come with early payment discounts?
Truth be told, this list goes on. These tasks are essential yet time and resource-intensive. Go for automation if you want to ensure complete accuracy while cutting time and costs.
Tip#6 – Know Who’s Who In Your Processes
A lot of payment errors occur because who’s who regarding payment approval was never clear in the first place. You’ll need to assign the right people or group of people to authorize payment for every client invoice.
Assigning one person in charge of the entire approval process means you’ll only have one pair of eyes for this vital accounts payable step. This can seldom be effective when mitigating errors. On the other hand, assigning too many can cause confusion and uncertainty, which, as you’ve guessed, also leads to inaccuracies.
Depending on the size of your organization and scope of transactions, try to find a middle sweet spot. And remember who’s who when giving people access to payments. Make sure that each fully understands their responsibilities and the company’s policies. If there are inconsistencies, you’ll need to know who signed off the payments.
You can easily manage the approval process using automation. Peakflo centralizes your payment approval in one place, letting you set custom approval workflows that you can easily track.
Tip#7 – Stay on Top of Every Due Payment with Automation
Prioritizing payments is one of the most important aspects of AP management. Ultimately, it lets you get better deals and terms with your vendors, which improves your AP’s bottom line. Staying on top of payments involves knowing who you owe, how much you owe, and when you need to pay.
One of the cool things about automation is that it lets you set up automatic workflows and directives for organizing and prioritizing payments. By replacing your traditional processes, you get to enjoy these benefits when prioritizing your invoices:
- Set up convenient automatic repeat payments for vendors with recurring due dates.
- Automatically prioritize invoices recorded in an intuitive vendor master record.
- Avoid duplicates, untimely payments, or missed opportunities for early discounts.
- Create payment approval workflows and track outgoing payments in a centralized workspace.
- Never pay too late or too early. Cultivate better relationships with vendors and get the most out of your cash flow