Accounts payable: Definition, how it works, with examples

Running a business is exciting—but between sales, marketing, and keeping your customers happy, keeping track of bills can feel overwhelming. Have you ever wondered what happens to invoices you owe to suppliers?

That's where accounts payable come in. It's a term for the money your business owes to vendors for things you've already bought, like office supplies, inventory, or marketing materials. Think of it like a short-term loan from the supplier, but instead of paying interest, you might have a specific timeframe to settle the bill.

In this post, we'll explain what accounts payable is in simple terms, why it's important, and how managing it effectively can improve your cash flow.

What is the role of the accounts payable department? 

Every business, regardless of size, relies on a smooth-running accounts payable (AP) department. This department is the backbone of your financial operations, which is critical in managing your cash flow and ensuring timely payments to vendors. Here's a closer look at the key responsibilities of an accounts payable department:

• Processing invoices: The AP department receives and reviews invoices from vendors, ensuring they align with purchase orders and reflect accurate pricing and quantities.
• Verification and approval: They verify the legitimacy of invoices before routing them for approval within your organization.
• Payment processing: Once approved, the AP department handles disbursing payments to vendors on time via the correct payment methods, ensuring adherence to agreed-upon payment terms.
• Recordkeeping and reporting: They maintain accurate records of all accounts payable transactions and generate reports to provide valuable insights into your cash flow and vendor relationships.

Overall, the AP department is a key driver in supporting your organization as a whole when it comes to vendor payments, approvals, and reconciliations.

Skills needed in the accounts payable role

An effective accounts payable (AP) professional requires a blend of skills to achieve smooth operations and optimal cash flow management within your business. Here are some of the most important qualities to excel in this role:

• Strong attention to detail: Accuracy is crucial in accounts payable. A keen eye for detail ensures accurate invoice reviews, data verification, and the ability to catch any discrepancies.
• Organizational skills: Juggling multiple invoices, due dates, and vendor inquiries requires exceptional organizational abilities. The ability to prioritize tasks, manage deadlines, and maintain accurate records is crucial.
• Understanding of the accounting cycle: A basic understanding of accounting concepts like debits and credits ensures proper classification of transactions and accurate financial reporting.
• Communication skills: Clear and concise communication is essential for interacting with vendors, resolving any issues, and fostering positive relationships.

By possessing this combination of skills, you can contribute significantly to a company's financial health.

While all of these skills are needed and highly valued in the AP department, many companies choose to automate using tools like QuickBooks Online, where they can digitize, organize, and streamline their AP process.

Accounts payable vs. accounts receivable

Accounts payable and accounts receivable represent opposite ends of your business's cash flow cycle. As mentioned, accounts payable refers to the money your business owes to vendors for goods or services you've already received but haven't paid for yet. It functions similarly to a short-term loan from a vendor—it's a liability on your balance sheet and requires careful management to avoid late payment penalties.  

Alternatively, accounts receivable represent the money owed to your business by customers who haven't settled their payments for goods or services you've delivered. This is an asset on your balance sheet, and efficiently collecting these outstanding payments is crucial for maintaining a healthy cash flow. In simpler terms, accounts payable is money flowing out, while accounts receivable is money flowing in.

Accounts payable vs. trade payables 

Accounts payable and trade payables are often used interchangeably, but there's a slight difference between them. 

Accounts payable is the broader term, encompassing all short-term obligations your business owes to suppliers for goods or services you’ve purchased. This includes various expenses, from office supplies and marketing materials to operating costs, like utility bills and rent. In simpler terms, it's any outstanding payment you owe to a vendor. 

On the other hand, trade payables are a more specific subset of accounts payable. They focus solely on debts incurred for goods purchased on credit that are directly related to your inventory or used to deliver your services. This could include raw materials, manufacturing supplies, or finished goods you purchase for resale. Essentially, trade payables represent the money you owe for the things you sell or use to create what you sell.

Managing accounts payable and trade payables effectively is crucial for maintaining a healthy cash flow and optimizing business finances. Understanding their differences can help you gain a clearer picture of your financial obligations and how they impact different aspects of your business.

Accounts payable example

Any good or service that your business purchases should be listed as accounts payable on the balance sheet. Understanding accounts payable with a concrete example can solidify its role in your business. For this example, imagine you run a bakery.

• You place an order with a flour supplier for 100 pounds of flour at $2 per pound on credit, with payment due in 30 days. 
• Upon receiving the flour, you don't immediately pay the supplier. Instead, this creates an account payable of $200 (100 pounds x $2 per pound) on your books.
• The AP department receives the invoice from the flour supplier and verifies its accuracy. Once approved, they schedule the payment to ensure it reaches the supplier within the 30-day term.
• This $200 account payable represents a short-term liability on your bakery's balance sheet. It reflects the money you owe the supplier and impacts your cash flow when the payment becomes due.

In the example above, we can see how everyday business purchases create accounts payable.

3 tips to simplify AP management

Now that you understand the core principles of accounts payable, here are three valuable metrics for accounts payable management. 

Increase accounts payable turnover

Purchases on credit increase the accounts payable balance. Accounts payable turnover is the total purchases on credit divided by the average accounts payable balance. The period measured is typically a month or year.

Let’s assume that a business buys a large dollar amount on credit in March and pays the invoices right away. The March purchase balance is high, but the average accounts payable balance may only be a few days. Increasing the accounts payable turnover ratio means you’re paying for credit purchases faster.

Another great tool for managing payables is the accounts payable aging schedule.

Decrease the accounts payable aging schedule

An aging schedule separates accounts payable balances based on the number of days since the invoice was issued. Acme Manufacturing, for example, has $100,000 in payables from zero to 30 days old and $15,000 due in the 31-to-60-days-old category.

The aging schedule helps you decide when invoices must be paid. The vast amount of your payables should be in the 0-to-30-days-old category. Since most invoices are due within 30 days, you don’t want many outstanding invoices unpaid beyond 30 days.

Streamline the AP workflow

Streamlining your accounts payable process can help you create more efficiency in your business. The following tips can help you smooth out your AP operations: 

• Embrace automation: Leverage technology to automate repetitive tasks like data entry, invoice routing, and approval workflows. This frees up valuable time for your AP team to focus on more strategic tasks.
• Standardize processes: Establish clear and consistent procedures for receiving, reviewing, and approving invoices. By ensuring everyone in the process follows the same steps, you can minimize errors and delays.
• Leverage e-invoicing: Encourage vendors to submit invoices electronically. E-invoicing eliminates manual data entry, reduces errors, and speeds up the processing time.
• Invest in accounting help: Consider using live expert assistant bookkeeping like QuickBooks Live to automate tasks, improve data accuracy, and gain valuable insights into your vendor spending.

By incorporating these tips, you can better streamline your AP workflow and minimize manual work. 

Spend more time growing your business 

Understanding accounts payable and implementing effective management strategies are essential for any business. By streamlining your processes, leveraging technology like accounting software, and prioritizing efficient cash flow management, you can unlock new levels of control over your finances.