What is Accounts Payable? Process, Best Practices, Challenges and More!

Accounts Payable may initially sound like some serious accounting jargon but it’s really simple. The term itself should clue you in on its meaning. Accounts payable(AP) is the money(accounts) that your business owes(to be paid) to its vendors or suppliers. When your business buys goods on credit, you end up with accounts payable on your balance sheet. Sometimes, AP also refers to the department that manages vendor invoices or bills.

So, what does Accounts Payable mean?

AP is the amount that gets recorded on the balance sheet of the organization in the form of a liability. It records as the short-term debts in the general ledger (GL). As many say, the accounts payable section is more like “bills due to be paid” column for businesses.

The Accounts Payable Process

We will take you step by step to understand the complete accounts payable process:

Step 1: Purchase of Goods or Services

The Accounts Payable process begins when a business buys goods or services from a vendor on credit.

Step 2: Generating Invoice

The supplier sends an invoice to the respective business after the delivery of goods or services. This invoice will outline the due amount, a brief of delivery details, payment terms and all other relevant information.

Step 3: Verifying Invoice

Both businesses must verify whether the invoice matches the purchase order and the goods or services received before making any payments.

Step 4: Ledger Record

The invoice amount is recorded in the Account Payable ledger after completing the verification. This step keeps businesses in loop about all the amounts they owe to different suppliers.

Step 5: Approval of Payment

Based on your company’s internal working procedures, approval can be considered an important step before any payment is processed. Usually, you (top management) or your finance department should take a closer look at the details to approve of any expenditure.

Step 6: Payment of the Invoice

In this step, your business finally settles the invoice by paying the vendor after approval.

Step 7: Recording the Payment

The Accounts Payable ledger is updated to show the reduced liability after all payments are made. Your business should also record the payment in its Bank ledger or cash, which reflects the reduction in cash or bank balance.

Is Accounts Payable an Asset or Liability?

Accounts Payable (AP) is actually a liability. It shows the amounts the company owes its vendors or suppliers for items or services purchased on credit. It is recorded under the “current liabilities” section. This is the money that your business has to pay, which simply makes it a liability rather than an asset.

Now, accounts payable can be categorized as:

1. Trade payables: These are the payables for the purchase of physical goods which are recorded in the inventory.
2. Expense payables: These are the payables for the purchase of goods or services expensed.

Accounts Payable vs. Accounts Receivable

Accounts Payable and Accounts Receivable are actually two different sides of the same coin. AP is the money a company owes to its suppliers and vendors. Whereas, AR is the money customers owe to a business.

Accounts Payable is a current liability, while Accounts Receivable is an asset.

Businesses usually gauge their profitability by determining the total assets and

liabilities. In simple terms, AP reflects cash outflow, while AR generates revenue.

Other factors to consider:

Accounts Payable:

1. Flow: It reduces company cash or increases liability after a payment has been made to a vendor.
2. Documents: The common documents for AP are invoices, payment Records and PO.
3. Example: Considering that a company has ordered office supplies but still hasn’t cleared its payment, the amount owed will reflect in the accounts

Accounts Receivable:

1. Flow: It increases company cash or decreases its assets after a payment has been made by a customer.
2. Documents: The common documents for AR are sales invoices, collection records and delivery notes.
3. Example: Considering that an organization offers consulting services to clients and sends an invoice, the amount billed and the payment awaiting would be reflected in accounts receivable.

Key Components and Processes Involved

The key components of AP are:

1. Invoice
2. Purchase Order
3. Goods Received Note (GRN)
4. Vendor Information
5. Payment Records
6. Credit Notes

Now that you know the components, have a clear idea about the processes involved. They are:

1. Invoice Processing
2. Approval of Invoice
3. Scheduling of Payment
4. Payment Execution
5. Matching of Payments
6. Vendor Communication
7. Record Keeping
8. Periodic Review

8 Best Practices for Managing Accounts Payable

Besides the bookish information, you should know the best practices to manage AP. Here it goes:

1. Simplify the workflow of Accounts Payable (get a system to track AP processes)
2. Limit access and get control
3. Show importance to invoices
4. Use technology (Try paperless Automation Solutions)
5. Prioritize KPIs for measuring AP efficiency [metrics to look at: Cost per Invoice, Payment Accuracy rate, Days Payable Outstanding (DPO), etc]

6. Get a reliable fraud detection solution
7. Have a safety net for duplicate payments
8. Keep supplier information updated every time