Accounts payable refers to short-term debts and obligations that have not yet been paid. When a company has outstanding accounts payable, the sum of those amounts is listed on a company’s balance sheet. It’s the opposite of accounts receivable, which is the money owed to the business.
Tracking your accounts payable helps keep track of cash flow and avoid incurring penalties or debt. This guide to accounts payable is designed to provide a general overview of the process, with a handy guide and examples.
What does accounts payable mean?
Think of accounts payable as short-term debts you owe to vendors and suppliers. This is in contrast to long-term debt, such as mortgages or loan repayments. Accounts payable is the sum of what you owe to another company or individual on a short-term basis to avoid default.
Accounts payable shows up on your balance sheet, and it’s important to monitor changes. For example, if you notice that your accounts payable decreases over time, this indicates you’re paying obligations faster than you’re purchasing them on credit. In contrast, increasing accounts payable means that you’re purchasing new goods or services on credit instead of using cash. Monitoring your accounts payable is the key to managing your company’s cash flow.
Once you understand the basics of accounts payable, you can make strategic decisions regarding cash flow. A company might decide that they need increased cash reserves over a certain period, so they use the maximum amount of time allowed before paying their outstanding short-term debts. This can free up more cash for immediate needs, which is often important for seasonal businesses or companies otherwise expecting a lull in income.
Ultimately, accounts payable is considered a liability account. If you use double-entry accounting methods, increases are posted as credits to the accounts payable account, with a corresponding debit to the expense account. Once accounts payable bills are paid, you’ll debit the accounts payable account and credit the cash account.
Guide to the accounts payable process
Creating your own accounts payable workflow might seem challenging at first, but it gets easier as you go along. Here are the basic steps to setting up and managing accounts payable.
Confirm and set up vendor details
First, set up or confirm vendor details. This ensures that you know the status and sum of all outstanding payments. This might include setting up vendor profiles within your accounting software and describing the terms and conditions of the credit cycle, like due date, potential fees and penalties, and more. Track or create your current purchase orders for an overview of all your outstanding short-term debts. It’s also helpful to note the frequency of the goods and services you purchase, for better cash flow planning.
Receive invoice and update records
Next, whenever you receive an invoice, you should compare it to the purchase order to make sure the invoiced amount is the same as in the purchase order. Check to see if the vendor honored agreed-upon terms, such as concessions or discounts. If the records match, you’ll update the invoice to indicate it should be paid before the end of the specific credit term.
Pay debts and reconcile records
Before the credit term ends, your company will pay the outstanding debts. Then each debt goes through the reconciliation process again. The purchase order, approved invoice, and payment receipt are all compared to each other. This ensures that you pay the appropriate amount to the correct account.
If there are discrepancies, however, you’ll need to go back and find the error. Once it’s identified, you can update the records accordingly and document the process.
Repeat weekly or monthly
Finally, you should repeat the accounts payable process on a regular basis. Companies typically review and reconcile accounts payable on either a weekly or monthly basis. This not only spreads the work out over time, but it decreases the chance that one small error throws off your entire accounts payable process and disrupts cash flow management. In turn, you’ll build better relationships with your vendors and have up-to-date records of short-term debts.
Accounts payable examples
This simple accounts payable example demonstrates how the process works in practice. Depending on the size of your business, the process may be significantly more complex. Maintaining accurate and up-to-date records is the key to a clear financial picture.
Imagine you are a widget retailer, who regularly purchases widgets and office supplies for your business. Every month, you purchase $10,000 worth of widgets on credit from Acme Widgetmaker. You also spend around $500 on office supplies, which are purchased on the company credit card. You have already created vendor profiles for Acme and your credit card company in your accounting records.
Upon receiving your purchase order, Acme Widgetmaker will send an invoice for $10,000 and give you 60 days to make a payment. When you receive the invoice, you can compare it to the original purchase order to ensure the amount owed is the same. Then you would enter the invoiced amount along with the payment due date.
The same process is repeated with your credit card statement, which is due on the 20th of every month. Once you receive your monthly statement, you compare the amounts to your records and ensure that they are accurate. Update the invoice with the due date.
If your cash flow is good, you might choose to pay these debts immediately. If, however, you’re waiting on your own payments to come in, you might push the payments back within their respective terms. For example, if you’re expecting two clients to pay you $5,000 in three weeks, that gives you some financial leeway. As long as you pay the credit card by the 20th of the month and Acme before 60 days are up, you will not incur any penalties.
Accounts payable best practices
When you’re setting up and managing an accounts payable system, keep these best practices in mind:
- Use good accounting software: Accounting software can take a lot of work out of the accounts payable process. Some software allows you to automatically schedule and track payments, which makes the management process much faster.
- Keep accurate, detailed records: Accounts payable relies on detailed records—otherwise, you risk missing due dates, entering inaccurate amounts, and cash flow problems. Never estimate dates or round off numbers. Keep the original invoices filed along with purchase orders to make it easier to cross-reference, and always file invoices individually.
- Standardize your naming conventions: It’s important to stay consistent. Choose an invoice naming system and stick with it for easier organization and reconciliation.
While the accounts payable process can become complex, following these tips can save you time and money in the long run.
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