Complete Guide to Accounts Payable: Simplified for Everyone

Accounts payable (AP) is a key part of a business’s finances. It’s all about the money a company owes to suppliers or vendors for products or services it has received, but hasn’t paid for yet. 

These unpaid amounts are shown as liabilities on the company’s balance sheet and usually get paid through cash or bank transfers.

In this easy-to-understand guide, we’ll break down everything you need to know about accounts payable, its role in business, how it works, and best practices to manage it efficiently. 

We’ll also cover useful concepts like purchase orders, payment terms, invoice management, and more.

What is Accounts Payable?

Accounts payable refers to the money a company owes its suppliers for products or services it has received but hasn’t paid for yet. 

These are short-term debts that usually need to be paid within a certain time frame, like 30 or 60 days. 

Accounts payable is considered a liability on the company’s balance sheet and represents the company’s obligation to pay its debts soon.

Key Points:

• Short-term liability: AP is a short-term debt that must be settled in less than a year.
• AP and cash flow: Managing accounts payable efficiently helps a company maintain good cash flow, preventing liquidity issues.
• Payment terms: AP often follows payment terms agreed upon with suppliers (e.g., Net 30, Net 60).

The Role of Accounts Payable in a Business

The accounts payable department is crucial for the financial health of a company. Its main job is to ensure that the company pays its bills on time, keeps good relationships with suppliers, and avoids late fees. 

Proper management of AP also helps maintain cash flow by scheduling payments in a way that doesn’t leave the company short on cash.

Functions of Accounts Payable:

• Invoice Verification: The AP team checks that invoices match purchase orders and delivery receipts to ensure the company was billed correctly.
• Processing Payments: AP processes payments to suppliers, usually by check, electronic transfer, or another method.
• Maintaining Vendor Relations: Timely payments help keep suppliers happy and maintain smooth business relationships.
• Financial Reporting: AP helps track debts and payments, making it easier to create accurate financial statements and stay compliant with regulations.

Common Types of Accounts Payable Transactions

Here are some of the common transactions handled by accounts payable:

• Vendor Invoices: Bills from suppliers for products or services provided.
• Purchase Orders (PO): A document that a business sends to a supplier to order goods or services.
• Credit Memos: Issued when a business returns goods or is charged too much.
• Payments: The actual transfer of funds to clear the debt.

What is a Purchase Order, and Why is It Important?

A purchase order (PO) is a formal document sent from a buyer to a seller. It lists what the buyer wants to purchase, how much, and at what price. POs are essential in the accounts payable process because they help the AP team match invoices to ensure the company paid for what it ordered at the agreed price.

A purchase order helps:

• Control spending by making expectations clear between the buyer and seller.
• Prevent errors by ensuring the invoice matches the PO and delivery.

What is a Payment Term?

Payment terms are the conditions under which a company agrees to pay its suppliers. Common payment terms include:

• Net 30: Full payment is due within 30 days.
• Net 60: Full payment is due within 60 days.
• 2/10 Net 30: A 2% discount is offered if payment is made within 10 days; otherwise, full payment is due in 30 days.
• Cash on Delivery (COD): Payment is due when the goods are delivered.

Payment terms affect cash flow and must be carefully managed. Companies need to have enough cash on hand to meet these payment deadlines while also considering any early payment discounts.

What is an Aging Report in Accounts Payable?

An aging report helps businesses track how long invoices have been outstanding. It divides invoices into categories based on the amount of time since they were due, such as:

• Current: Invoices not yet due.
• 30-60 Days: Invoices due in the next 30-60 days.
• 60-90 Days: Invoices overdue by 60-90 days.
• 90+ Days: Invoices overdue by more than 90 days.

Regularly checking the aging report helps companies stay on top of overdue bills and avoid late fees.

Early Payment Discounts in Accounts Payable

Many suppliers offer discounts if invoices are paid early, such as a 2% discount for payment within 10 days instead of 30. These discounts can save the company money, but only if there’s enough cash to pay early.

How the Accounts Payable Process Works

Here’s a simple breakdown of the accounts payable process:

• Receiving Goods/Services: The company receives products or services from a supplier, usually with a purchase order.
• Invoice Receipt: The supplier sends an invoice with payment details, which must be checked against the purchase order and delivery receipt.
• Invoice Verification: The AP team compares the invoice, PO, and receiving report to confirm everything matches.
• Approval Process: Once verified, the invoice is approved by the right person in the company.
• Payment: After approval, AP processes the payment, following the agreed-upon payment terms.
• Recording: The payment is recorded in the company’s books, reducing the amount owed.

Improving Accounts Payable Efficiency

To make the accounts payable process more efficient and cost-effective, businesses can:

• Automate Invoice Processing: Use AP automation tools to speed up invoice handling and reduce errors.
• Negotiate Better Payment Terms: Talk to suppliers about longer payment periods to improve cash flow.
• Use Electronic Payments: Switch to electronic payments instead of checks for faster and more secure transactions.
• Review Aging Reports: Regularly check aging reports to identify overdue bills and prioritize payments.
• Create Clear Approval Workflows: Set up a structured system for invoice approvals to avoid delays.

Accounts Payable and Cash Flow Management

Accounts payable directly affects a company’s cash flow. By managing AP effectively—timing payments, using early payment discounts, and controlling payment terms—businesses can ensure they have enough cash to run daily operations and avoid running out of funds.

Accounts Payable and Financial Statements

Accounts payable impacts two important financial statements:

• Balance Sheet: AP is shown as a current liability, representing money the company owes.
• Cash Flow Statement: The payment of accounts payable appears in the operating activities section of the cash flow statement.

Internal Controls for Accounts Payable

Strong internal controls help prevent fraud and ensure that the accounts payable process runs smoothly. Important controls include:

• Segregation of Duties: Different people should handle approval, payment, and recording of transactions to avoid fraud.
• Authorization Protocols: Payments should be approved by authorized personnel.
• Audit Trails: Detailed records should be kept to track approvals and payments.

Mastering accounts payable management is essential for businesses of all sizes. Proper accounts payable processes ensure timely payments, healthy cash flow, and strong vendor relationships.

By using accounts payable automation, following best practices in accounts payable, and setting up strong internal controls, businesses can streamline their AP workflows, cut costs, and reduce risks. 

In the end, effective accounts payable management is key to financial stability and long-term growth.