An efficient accounts payable (AP) process is a must for any business, as it ensures that vendors and suppliers are paid on time and reduces waste by eliminating late fees and duplicate payments.
This article will explain how the accounts payable process works and the differences between accounts payable and accounts receivable. We’ll also show you how to set up your own AP process.
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Accounts payable are the payments due for goods or services purchased from a vendor or supplier. You can track these liabilities on a balance sheet to monitor outstanding payments and ensure no overdue balances.
Payment due dates vary, so check individual invoices to verify the dates. If payments aren’t made on time, your company could get hit with late fees.
An accounts payable term you may hear frequently is “days payable outstanding” (DPO). This financial ratio measures the average number of days a company takes to pay its vendors or suppliers. The longer it takes you to pay your suppliers, the higher your DPO.
It’s easy to confuse accounts payable with accounts receivable, the latter of which involves collecting unpaid invoices. While there’s some overlap, accounts payable and accounts receivable aren’t the same.
Accounts payable are the money your business owes its vendors and suppliers for goods and services purchased. In contrast, accounts receivable are the money owed to your company, usually by its customers. And while accounts payable are considered liabilities, accounts receivable are assets.
Both accounts payable and accounts receivable are crucial aspects of the accounting cycle and work together to ensure your business functions smoothly. Both should be recorded to ensure accuracy and to track when outgoing and incoming payments are due. Without bringing in a profit, your company will be unable to meet its financial obligations.
Here are a few examples of accounts payable:
There are two types of payables in business accounting: trade payables and expense payables. Trade payables represent the purchase of physical goods, while expense payables refer to the purchase of expensed services, such as travel or supplies.
It’s essential to record all purchases as soon as they’re made. Once you pay the accounts, the balances will no longer appear in accounts payable.
Here’s a step-by-step guide for setting up an accounts payable process:
First, you must create a chart of accounts to track your transactions. You can easily make one in Excel or accounting software. A chart of accounts should include the following information for each transaction:
Next, create a spreadsheet with a list of your vendors. Here, you can detail exactly how each vendor is paid and when the payment is due. Maintaining a solid relationship with vendors will help your business in the long run and ensure no hiccups arise when you’re buying their goods or services.
Make sure you enter the correct payment terms. Some vendors offer discounts if the invoice is paid in full before a specific date. This is referred to as Net D, with the “D” indicating the number of days. The terms will change depending on your agreement with the vendor.
For example, a 2 percent net 30 provides a company with a 2 percent discount if the invoice is paid within 30 days. If your vendors don’t offer this currently, see if it’s an option. It’s an incentive for the company and vendor to ensure smooth, on-time payments.
Once you receive an invoice, review the bill to ensure there are no errors and confirm that all goods have been accounted for. Then, enter the invoice information. The only exception would be if a vendor provided a service instead of a product.
Match the invoice to the purchase order to double-check that everything is correct. Once the invoice is paid, you may be unable to correct the order.
Check your AP at least once weekly to ensure there are no unpaid invoices. You want to stay on top of payments to avoid penalties on unpaid invoices, such as interest and late fees. There are many ways to pay your invoices, so it’s always best to see which method a specific vendor prefers.
Accounting software can help you avoid oversights in making payments. You can also set up payment alerts to ensure you have no outstanding invoices. Any extra step you can take to pay on time is highly recommended.
Accounting software provides numerous advantages to streamline your accounts payable process.
Many excellent accounting software programs are available. Here’s a look at three of the best accounting and invoicing software solutions that small businesses should consider.
QuickBooks Online is a well-known accounting solution that’s an excellent option for businesses of all sizes with unique needs.
For example, if your business relies on contractors, QuickBooks helps you easily manage and pay your team. When you onboard a new contractor, you can invite them to set up a free account, where they’ll fill out a W-9 and enter their banking information. From there, you can set up next-day direct deposit so they’re always paid quickly and on time. Your payments will automatically sync to QuickBooks Online, so your banking information will always be accurate.
The QuickBooks dashboard is a central management hub where you can see a breakdown of the bills you owe and check if any are overdue. You can also pay vendors directly through QuickBooks, thus simplifying the accounts payable process.
Learn more in our detailed QuickBooks Online review.
FreshBooks is a great accounting software option for freelancers and small business owners. While it’s known for top-notch invoicing features, the software also makes financial tracking and expense tracking effortless. FreshBooks relies on double-entry accounting, so you’ll always know that your financial information is accurate and up to date. FreshBooks lets you create profiles for each vendor. After adding a new profile, you’ll see what you owe the vendor and if any bills are overdue or outstanding.
Our in-depth FreshBooks review explains more features and pricing information.
Xero offers a cloud-based monthly subscription service, making it an excellent option for growing businesses as they scale. The software helps you monitor your business’s cash flow and easily track and pay bills from one easy-to-use dashboard.
When you receive new bills, you can store them in folders so they’re organized but easily accessible, as well as schedule upcoming payments to multiple vendors simultaneously. If you struggle to make on-time vendor payments, Xero can help you run an aged payables report to stay on top of unpaid bills.
Read our comprehensive Xero review to discover more of this platform’s features and functionality.
All businesses, regardless of their size or industry, should be familiar with the accounts payable process. You must know when outstanding invoices are due to avoid late fees or strained supplier relationships. If you’re creating your own AP process, using the right feature-rich accounting software can help you prevent many common mishaps.