What Are Accounts Payable?
Accounts payable are a company’s short-term liabilities. Companies that use accrual basis accounting have accounts payable, or money the company owes its vendors and suppliers, and accounts receivables (AR), or money it is owed by its customers.
Accounts payable are represented on the company’s balance sheet, the snapshot of a company’s financial health. They are listed on the right-hand side under “current liabilities.” Liabilities are listed according to when they are due to be paid. Accounts payable are listed first because they typically need to be paid within 30 days.
Importance of the Accounts Payable Department
The second week in October, the Institute of Financial Operations celebrates AP Recognition Week. Everyone would do well to recognize that week by giving the AP clerk one of these mugs—because no business can exist without the AP function.
The accounts payable department is responsible for accurately tracking what’s owed to suppliers, ensuring payments are properly approved and processing payments. Accurate information on accounts payable is essential to producing an accurate balance sheet.
This job is also central to the business because:
- AP departments ensure good relationships with suppliers by making sure suppliers’ information is accurate and up to date in the company’s systems. They make sure suppliers are paid on time and boost relationships to gain favorable payment terms and discounts.
- AP departments keep accurate books to ensure cash forecasts are accurate and working capital can be optimized.
- AP departments help prevent mistakes and fraud.
What Does the AP Department Do?
Companies track accounts payables on their chart of accounts. Depending on the size of the organization, the responsibilities for accounts payable and accounts receivable may be combined. But at larger companies, they are separate functions. Here’s an example of an AP clerk job description:
What Is the AP Process?
The basic AP process goes like this: The AP clerk receives the invoice. The clerk manually enters the data and checks the invoice against the purchase order and relevant general ledger (GL) account. The clerk routes the invoice for approval. Once approved, the clerk schedules payment against the invoice.
In the AP process, it’s important to understand double-entry bookkeeping and the concept of debits and credits. Double-entry bookkeeping helps eliminate accounting errors by logging every financial transaction twice: as a debit in one account and a credit in another.
For instance, say Bob’s Balloons purchases $500 in balloon inventory in August from its supplier Balloonys, which sends the invoice in August due net 30 days in September. The bookkeeper will create an account payable journal entry for Ballooneys and credit that account $500. It will debit $500 from its inventory asset account.
In general, when a company receives a bill, it credits accounts payable and debits an asset account (or expense) in the GL. When Bob’s Balloons pays the bill from Balloonys, it debits the AP account and credits the inventory asset account.
Accounts payable are recorded on the company’s balance sheet as a summarized total of all accounts payable. In the balance sheet equation, Assets = Liabilities + Equity. Using the example above, the balloons are assets, and the bill for them is a liability.
7 Ways to Organize Your Accounts Payable Department
- Get the right documentation. Always require a purchase order for goods and services. Keep a vendor master file, a hub of all vendor information that includes W-9s and tax identification numbers.
- Centralize all records. Enter invoices into the system promptly if using software; a best practice is to do so the day they arrive. When processed, include a date stamp. Record all accounts payable in the journal. Keep all records in one place.
- Reconcile accounts every day. Confirm if invoices match purchase orders. Keep track of disputes and resolutions.
- Segregate duties. Accounting is one of the departments in which unwitting mistakes and outright fraud is most likely to happen. Have different people in charge of approving and processing payments.
- Include electronic payment methods. Automated clearing house (ACH) transfers encrypt payment data to ensure security and allow the company to take advantage of discounts borne of expedited payments.
- Consider electronic data interchange (EDI). Paperless processes save time and ensure more accurate invoice processing. This can also help a company take advantage of discounts and favorable payment terms. Companies that adopt supplier relationship management systems for procurement functions can automate purchase orders and invoice receipt and approval. They can also better track and pay for inventory and services received.
- Automate accounts payable. AP automation can save time and money while protecting your business from costly errors. AP automation can reduce days payable outstanding (DPO) by an average 5.55 days, according to the Aberdeen Group.
How AP Automation Software Improves AP Department Efficiency
Accounts payable is the “most time-consuming, laborious and paper-intensive finance and administrative function,” according to controllers surveyed by the Institute of Finance and Management.
AP automation software digitizes the entire process so that most invoices can be processed without manual intervention, while the AP department deals with exceptions and outliers. This saves time and makes the entire process more accurate.
In this system, invoices are scanned or emailed to a specific address and read by accounting automation software. For instance, a software’s accounts payable management function allows businesses to manage vendor lists, track bills and payables, and make payment without needing to enter detailed debits and credits. The invoice is routed for approval according to the rules and workflow built in the system. Payment posts to the general ledger as an expense, and the amount of payment is automatically deducted from accounts payable. Invoices are stored in a central database to ensure regulatory and tax compliance. What’s more, businesses have a real-time picture of payables.
Automated accounts payable processes embed payment controls as simple and repeatable processes. AP automation designates separate roles by creating separate login credentials and dashboards, as well as dual-factor authentication for logging in. This makes it hard to forge approvals and keeps a log of all approvals in a central location for easy auditing. AP automation matches invoices to purchase orders and flags anything that doesn’t match.
Accounting becomes more strategic to the business—and moves away from being viewed strictly as a cost center—when the department takes steps to ensure greater accuracy and faster invoice processing, while offering business insights with which to optimize payment timing and terms with suppliers.