There are many elements of the accounting process to keep track of beyond crunching numbers and building budgets. The accounts payable process is one of the most important. Accounts payable describes the various amounts your business owes to external vendors for goods and services that you have not yet paid for, kind of like credit card purchases. Some examples of accounts payable expenses include production costs, inventory and repair services.
In this post, we’ll dive deeper into the accounts payable process, its significance, how it works and how you can save time by streamlining your workflow. Use the links below to navigate our guide, or read through for a detailed overview of the accounts payable system.
- What is the accounts payable process?
- Why is the accounts payable process important?
- Who handles accounts payable?
- Common examples of accounts payable debts
- Difference between accounts payable and accounts receivable
- How to manage your accounts payable in five steps
- Automate the accounts payable process with QuickBooks
What is the accounts payable process?
Accounts payable, also known as AP, are the total debts that you owe to other businesses for products and services that they invoiced you for. Where can you find accounts payable? Your company’s accounts payable debts are found within the current liabilities section of your balance sheet. These amounts are treated as short-term debts, rather than long-term debts, like a business loan.
Accounts payable only applies to businesses that use the accrual basis of accounting, not cash-based accounting. This is because the accrual method of accounting records income and expenses when they are invoiced and paid. Accrual accounting uses invoice processing to both procure and offer services on a credit basis, rather than requiring payment to be made in real time. Typically, when a vendor invoices you for a good or service, you’ll have 30 days to pay your bill.
Let’s take a look at an example of the accounts payable process in action. For this example, let’s pretend you own a restaurant and you want to order fresh tomatoes from a local food vendor.
- Your restaurant places a purchase order for 45 kilos of tomatoes, for a total of $100.
- The food supplier sends you an invoice for $100 with a payment due date and payment terms.
- You add the total amount due ($100) to your accounts payable.
- Your restaurant sends payment to the vendor, eliminating the debt from your accounts payable and subtracting $100 from your cash flow.
Why is the accounts payable process important?
There are several ways the accounts payable process plays an important role in your business’s accounting operations.
- Cash flow: by outlining exactly what your debts are and to whom you owe them, you’ll have a better idea of how to manage your business’s finances. With greater insight, you can not only avoid errors but also strategise your spending and saving, while settling your debts with ease.
- Debt management: paying your bills, whether it be in the context of personal or business finances, is important. Plus, recording and making timely payments is a great way to facilitate positive supplier relationships. After all, no one likes a long-standing IOU.
- Savings: some suppliers implement late fees for late payments, while others offer early payment discounts for settling up ahead of time. No matter the case, keeping track of your amounts due can help you save money.
- Historical records: recording invoice data via AP not only gives you organisational peace of mind, but it also creates a clear picture of your transaction history. Having a detailed database of your outgoing payments can help you identify and resolve spending issues more efficiently. Also, a thorough audit trail can make ATO, internal and third-party audits run much more smoothly.
Who handles accounts payable?
There are several ways you can approach how you manage accounts payable depending on the structure of your small business accounting system. You may have a designated accounts payable department that handles AP, it may fall under general bookkeeping and accounting duties, or you may opt for AP automation.
In addition, as a business owner, you may be listed as the approver for invoices. Alternatively, this job could become part of the CFO duties for larger organisations.
Common examples of accounts payable debts
At this point, you have the definition of accounts payable down: money your business owes to other businesses. But what kinds of expenses fall under the accounts payable category?
Some common examples of debts you might find in the accounts payable category include:
- Raw materials
- Repair services.
Keep in mind that this is not an exhaustive list of the line items you might find within your accounts payable. Let’s dig a little deeper into the contents of the accounts payable process.
Accounts payable exclusively refers to short-term debts that your business owes. This means that you expect to pay the amount within one year, contrary to long-term debts like loans, which may take years to pay off. Technically speaking, the amounts are debts, not expenses because the funds never reach your income statement. Instead, accounts payable only appear on your balance sheet as current liabilities.
What happens if you can’t pay off these short-term debts? You’re likely to get a call from your supplier, which could jeopardise your vendor relationships if you’re not careful.
If you’re unable to pay an invoice by the vendor’s deadline, typically within 30 days, they may be able to extend the due date. In accounting, this reclassification is known as a “long-term note”, which is basically a drawn-out IOU. If you do find yourself in this situation, it’s a good idea to be transparent and communicative with vendors. Remember, your payment not only applies to your own finance management, but it also impacts their livelihood as well.
Difference between accounts payable and accounts receivable
Remember the restaurant example we used earlier in this post? As the restaurant owner, the invoice for the fresh tomatoes was added to your accounts payable. It’s money that you must pay to your tomato supplier. But on the vendor’s side, they added that $100 invoice to their accounts receivable because it’s money they plan to—you guessed it—receive.
This process works both ways. Let’s say your chef makes tomato jam with the fresh tomatoes that you ordered. A local market down the road wants to stock their shelves with your product, so they place an order with you for ten jars. You then invoice them for the order amount and send them their ten jars of tomato jam. Because you’re selling the product and expect to receive money from that order, you’ll add the amount to your accounts receivable rather than your accounts payable fund.
Put simply, accounts payable describes the funds that you owe and accounts receivable is the amount you expect to earn.
How to manage your accounts payable in five steps
So, how do you implement the accounts payable process? At its core, the accounts payable workflow can be boiled down to five steps:
- Create your chart of accounts: a chart of accounts is an organisational chart that summarises where your accounting transactions are recorded. Usually, the chart will associate a bank account name with a code, financial statement and category, such as current liabilities.
- Assign supplier details: this step will help you keep track of contact information, orders and deadlines for payment. Using codes like net 10, 30 and 60 will signal when supplier payment is due. Net 10 means payment is due in ten days, net 30 is due in 30 days, and so on.
- Invoice approval: before initiating payment, you’ll want to review your invoice for accuracy and make sure that the product or service request has been fulfilled.
- Process payment for outstanding invoices: after verifying the accuracy of your invoices, you can initiate invoice payment to the appropriate suppliers. Depending on the supplier’s preference and your method of payment, you may need to notify them that payment is on its way.
- Record and repeat: once you’ve completed steps 1–4, it’s time to update your books to reflect the most current information. You can automate the reconciliation process with accounting software. After a supplier payment has gone through, you can remove it from your list of accounts payable. Repeat the process weekly.
Automate the accounts payable process with QuickBooks
There are a lot of things that contribute to your small business’s success—recruiting talent, bringing creative visions to life and generating leads, to name a few. Adding in the accounts payable process is a necessary step in effective business accounting, but with only 24 hours in a day, getting it done can become a big obstacle.
With QuickBooks, you can automate expense management and get back to doing the things that you love about running your business. Whether that’s getting your hands dirty at a job site or dazzling clients and securing contracts, more time means more control over your own trajectory.
With QuickBooks, you can organise and manage your bills online with confidence:
- All of your bills are organised in one place, so you pay them on time, every time.
- Bills paid by cheque or direct credit are automatically recorded and tracked in QuickBooks, helping to minimise errors.
- Pay your bills using the best methods for you and your suppliers. You can pay with free bank transfers or a debit card, while your supplier can receive payments by direct credit or paper cheque.
- You have the option to defer bills to keep cash longer with a credit card, or make partial bill payments.
- Automated, scalable processes set you up for growth and translate to time savings. Online process automation reduces the need for paper invoicing.
- More insight into your business expenses optimises spending efficiency.
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