How to manage accounts payable for improved cash flow

When considering effective cash management for small businesses, the initial focus often revolves around enhancing collections from accounts receivable. However, it's crucial to recognise that accounts payable (AP) plays a significant role in cash management as well. 

Here, we explore the benefits of accounts payable management for small businesses, defining the meaning of accounts payable and providing insights into establishing an efficient process to enhance overall cash flow.

What is the meaning of accounts payable?

Accounts payable (AP) encompasses the short-term debts and financial obligations that a business incurs when purchasing goods or services on credit from vendors or suppliers. It serves as a comprehensive list of outstanding payments yet to be settled with external parties.

This aspect of financial management involves the recording and processing of invoices, commonly handled by the accounts payable department. When a business makes credit-based purchases, the corresponding amounts are reflected in accounts payable, distinguishing it from transactions completed with cash. 

In essence, accounts payable represents the bills and payables that a business is obligated to settle, forming a vital component of the company's liabilities on the balance sheet. 

As a component of the liabilities balance in the balance sheet equation, AP can be represented as: 

Asset - liabilities = equity 

Balance sheet accounts are separated into current and non-current accounts.

Current liabilities

Accounts payable is a component of current liabilities, which are obligations that must be paid within the next 12 months. Current liabilities also include: 

• Trade payables: Some firms use trade payables to record bills received from suppliers. Other companies post the supplier invoices to accounts payable and don’t use the trades payable account.

• Short-term debt: The principal and interest due on a loan are posted to current liabilities. If a firm owes £4,500 in principal and interest over the next 12 months, the balance is a current liability.

• Credit card balances: Amounts due on credit cards are posted to current liabilities.

Non-current liabilities

Non-current liabilities are debts that are due in a year or longer. Most of the balance on a five-year loan, for example, is categorised as a long-term (non-current) liability.

Financial statements also include current assets, which include cash and balances that will be paid within 12 months. Accounts receivable and inventory are current assets. A fixed asset, such as machinery, is a non-current asset account.

The AP balance impacts your firm’s cash flow.

Small business accounts payable example 

Imagine a small bakery that sources ingredients on credit from a local supplier for their daily baking operations. The supplier provides a monthly invoice, and the bakery agrees to settle the invoice within 15 days.

Purchase on Credit:

The bakery places an order for 50 kilograms of flour and 20 kilograms of sugar from a local supplier.

The supplier delivers the goods and issues an invoice for £400, detailing the quantity and cost of each item.

Record in Accounts Payable:

The bakery records the transaction in its accounts payable as a liability.

The accounts payable entry on the balance sheet now shows a £400 obligation to the supplier.

Payment Terms:

The supplier's invoice specifies a net 15 payment term, indicating that the bakery has 15 days to pay the £400 without incurring any additional charges.

Payment Process:

Within the next 15 days, the bakery processes the payment and sends £400 to the supplier.

Update Accounts Payable:

Once the payment is made, the bakery updates its accounts payable, reducing the liability by £400.

The transaction is reflected in the financial records, showcasing the settlement of the supplier's invoice.

Impact of cash flow on AP

A company’s cash position is important, because every firm needs a minimum cash balance to operate. Owners must consider the timing of cash inflows from accounts receivable and the cash outflows required for AP. 

To manage cash flow, create a monthly cash flow rollforward, using these line items:

• Beginning cash balance

• Cash inflows from accounts receivable, other sources

• Cash outflows for accounts payable, inventory purchases, and payroll

• Ending cash balance

The ending cash balance in March is the beginning cash balance in April. Review your company’s balance sheet, and analyse each asset and liability account to determine the impact on cash flow. 

To work productively, you need to design an efficient system to manage the payment process.

What is the accounts payable process?

The accounts payable process involves recording credit-based transactions through the accrual basis of accounting, starting with the creation of a purchase order (PO). Vendor invoices are then recorded in the accounts payable department, detailing due dates, payment terms, and contract information.

Upon receiving goods, a Goods Received Note (GRN) ensures alignment with the purchase order. General ledger entries are posted, and when invoices are paid, journal entries are recorded.

To effectively manage AP, you must post transactions using the accrual basis of accounting.

Let’s explore the accounts payable process in more detail:

Accrual accounting

Accrual accounting requires firms to post revenue when earned and expenses when incurred to generate revenue. Businesses using accounts payable should use accrual accounting so that revenue can be matched with expenses, regardless of the timing of cash flows. 

This is in contrast to cash accounting, which records revenue and expenses only when cash is received or paid out. This means revenue is recognised when payment is received, and expenses are recognised when bills are paid.

Cash accounting does not consider revenue and expenses that have been incurred but not yet paid or received.

The accounts payable department should use accrual accounting to post transactions and for financial reporting. To set up a clearly defined process, meet with your AP department. If your firm is smaller, a bookkeeping employee may handle AP.

Your payable system should include these components:

Purchase order

Most spending decisions must require a purchase order, or PO. Assume, for example, that Best Manufacturing needs to order a £10,000 piece of machinery. Before the order is placed, the plant manager must complete a PO, which lists the machinery’s price and other details.

The owner, or someone else with financial responsibility (CFO), approves the PO. At this point, the order can be placed. Small purchases, such as £40 in office supplies, don’t need a PO. Purchase orders help a business control spending.

Vendor invoices

When the order is placed, the vendor will send an invoice. The person responsible for account payable tasks should record the following information in the accounting system:

• Due date

• Payment terms: Some vendors offer a discount, if the invoice is paid within 5–10 days. If a discount is offered, you may decide to pay the invoice in a shorter period of time.

• Contract information: Name, address, email, client’s invoice number. If the vendor takes electronic payments, include that information with the invoicing data.

• Purpose: If you need to plan the payment for machinery, include a description of the purchase. 

When the item is received, the vendor should include a shipping receipt.

Goods received note

The goods received note (GRN) details what the vendor sold to the customer. The GRN includes a description and the number of items included in the shipment.

The data on the purchase order, invoice, and GRN should be the same. Reviewing these documents ensures that the order was approved and if you received the goods that were ordered.

If the data matches, the accounting department can generate a cheque. The owner should review all of the documents before signing the cheque and paying the invoice.

Automate the payable process to save time and to reduce the rate of error. You can purchase accounting systems that can scan GRN and invoices, so they can be electronically linked to a particular transaction.

In addition to managing paperwork, you need to post accounting entries.

General ledger entries

The accounts payable department posts journal entries into general ledger. A journal entry contains all of the information needed to record a transaction. Here are two common journal entries for AP.

Purchase on credit

When Best Manufacturing places the order for the £10,000 piece of machinery on 5 March, it posts this journal entry:

Debit #3100 machinery (asset account) £10,000

Credit #5000 accounts payable £10,000

(To record the 5 March purchase of machinery on credit)

Best posts a debit to increase the machinery asset account (#3100), and posts a credit to increase accounts payable (#5000).

The journal entry includes the date, accounts, dollar amounts, debit and credit entries, and a description of the transaction.

When the invoice is paid, the AP balance is decreased.

Invoice paid in cash

Best Manufacturing pays the invoice on April 6th, and posts this journal entry:

Debit #5000 accounts payable £10,000 

Credit #1000 cash £10,000

(To record the 6 April invoice payment) 

Best posts a debit to decrease accounts payable (#5000), and a credit to reduce cash (#1000).

Whether you are venturing down the accrual accounting or cash accounting route, QuickBooks Online can support you. With our intuitive accounting software, you can see how your business is performing in less than 30 seconds. 

Take control of your cash flow and gain valuable insights into where your money is going, all from one convenient location.

5 actionable tips for accounts payable management

For small businesses, effective management of accounts payable is crucial for maintaining financial health and fostering positive relationships with vendors. By implementing strategic approaches, businesses can optimise their accounts payable processes, ensuring timely payments and efficient cash flow. 

Here are five actionable tips to enhance your accounts payable management:

1) Optimise AP turnover

Calculate your accounts payable turnover ratio regularly by dividing total credit purchases by the average accounts payable balance. Increasing the AP turnover ratio enables faster payment for credit purchases, but consider your cash flow needs before paying invoices promptly. 

Evaluate payment terms and, if feasible, strategically delay payments to suppliers, especially if invoices have a 30-day timeframe, allowing better alignment with customer collections.

2) Utilise an accounts payable ageing schedule

Implement an accounts payable ageing schedule to categorise payables based on the number of days since invoice issuance. Focus on maintaining the majority of payables in the 0 to 30 days category, as most invoices are typically due within 30 days. 

Prioritise timely payments for invoices in the 0 to 30 days range to uphold positive vendor relationships and avoid damaging supplier rapport.

3) Regularly review and monitor payables

Conduct frequent reviews of your accounts payable to identify any discrepancies, errors, or outstanding invoices. 

Stay proactive in managing payables, addressing issues promptly to ensure accurate financial records and avoid potential disputes with vendors.

4) Boost efficiency with automation

Explore accounts payable automation tools and software to streamline the payable process, reduce manual errors, and save time. 

Using automated tasks such as scanning invoices, linking documents electronically, and generating reports, enhancing overall efficiency in managing accounts payable.

5) Prioritise timely payments to maintain vendor relationships

Take proactive steps to pay invoices on time, especially for reliable vendors who contribute to the success of your business. Timely payments strengthen vendor relationships, ensuring continued trust and reliability in the supply chain. 

Avoid delayed payments that could strain relationships and potentially lead to unfavourable terms or conditions in the future.

Manage accounts payable seamlessly with Quickbooks

Optimise your accounts payable (AP) management with QuickBooks accounting software. Streamline your invoicing process and effortlessly post payables to your accounting system. 

Leverage the power of QuickBooks to enhance efficiency, conserve cash using recommended ratios, and strengthen relationships with your vendors.  Take charge of the accounts payable process to improve your business results.

Accounts payable FAQs

Are accounts payable business expenses?

Accounts payable (AP) is not a business expense but a liability. It represents money a company owes to creditors and is listed on the balance sheet. AP reflects short-term debts yet to be paid, and its analysis helps companies understand working capital.

Is accounts payable a credit or debit?

Accounts payable is a credit account. It is a liability account that represents the money a company owes to its vendors or suppliers for goods or services purchased on credit. When goods or services are obtained on credit, the amount owed is recorded as a credit in the accounts payable account, increasing the company's liability. Payments made to vendors are then recorded as debits to the accounts payable account, reducing the liability. However, in cases of early payments or overpayments, the account may be recorded as a credit.

What is the difference between accounts payable and accounts receivable?

Accounts receivable represent amounts owed to a company by customers for credit sales, classified as current assets. On the other hand, accounts payable represent the company's obligations to suppliers for credit-based purchases, classified as current liabilities. 

Accounts receivable may involve offsets like allowances for doubtful accounts, while accounts payable typically lack such offsets. The complexity of accounts payable extends to various components like trade payables, sales taxes payable, and others. 

Is accounts payable a current liability?

Yes, accounts payable is considered a current liability. When a business purchases goods or services on credit, the corresponding amount owed is recorded in accounts payable. Accounts payable represents a list of current debts that must be paid to external parties.

We hope you’ve found this article useful. QuickBooks can help you monitor your cash flow efficiently. Get a quick snapshot of the financial health of your business with just a few clicks.

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