When you’re running a business, an efficient accounts payable (AP) process is a must. It ensures that vendors and suppliers are paid on time and reduces waste by eliminating late fees or duplicate payments.
This article will explain how accounts payable works and how it differs from accounts receivable. We’ll also show you how to set up your own AP process.
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What is accounts payable?
The accounts payable department manages the company’s payments 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 there are no overdue balances.
Your AP department oversees all outgoing payments and is usually the first point of contact for suppliers. Payment due dates can vary, so check individual invoices to ensure you’re aware of payment 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 it takes a company to pay its vendors or suppliers. The longer it takes you to pay your suppliers, the higher your DPO.
Accounts payable vs. accounts receivable
It’s easy to confuse accounts payable with accounts receivable, which involves collecting your unpaid invoices. While there are some overlaps, accounts payable and accounts receivable aren’t the same.
Accounts payable deals with the money your business owes to its vendors and suppliers for goods and services purchased. In comparison, accounts receivable is the money owed to your company, usually by its customers. And while accounts payable is considered a liability, accounts receivable is considered an existing asset.
Both accounts payable and accounts receivable are crucial aspects of the accounting process, 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.
Bottom line: Accounts payable deals with the money your business owes, while accounts receivable is the money owed to your business.
Examples of accounts payable
Here are a few examples of accounts payable:
- Subcontracting services
- Raw materials
Did you know? There are two types of payables: 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.
How to set up an accounts payable process
It’s important to record any purchases to your AP department as soon as they’re made. Once you pay the accounts, the balances will no longer show up in accounts payable.
Let’s look at a step-by-step guide for setting up an accounts payable process.
1. Create a chart of accounts.
Before you do anything else, you must create a chart of accounts to track your transactions. You can easily make one in Excel or a similar program.
A chart of accounts should include the following information:
- Vendor names
- Account and invoice numbers
- Invoice date
- Expense type
- Payment deadline and status
2. Set up your vendors.
Next, create a spreadsheet with a list of your vendors. Here, you can detail exactly how each vendor is paid and when payment is due.
Maintaining a solid relationship with vendors will help your business in the long run. It will also ensure no hiccups arise when you’re buying their goods or services.
Make sure you enter the correct payment terms. Some vendors will offer a discount if the invoice is paid in full before a certain date. This is referred to as Net D. The terms will change depending on your agreement with the vendor.
For example, a 2% net 30 would provide a company with a 2% discount if the invoice is paid within 30 days. If your vendors don’t offer this currently, check with them and see if it’s an option. It’s an incentive to both the company and vendor to ensure smooth, on-time payments.
3. Receive invoices from suppliers.
Once you receive an invoice, review the bill to ensure there are no errors. Enter the invoice information after you confirm that all goods have been accounted for. 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 not be able to turn around and make any corrections to the order.
4. Process payments for outstanding invoices.
Check your AP at least once a week to ensure there are no unpaid invoices. You want to stay on top of payments to avoid penalties, such as interest and late fees, on unpaid invoices.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 avoid any oversights in making payments. You can also set up payment alerts to ensure there are no outstanding invoices. Any extra step you can take to pay on time is highly recommended.
How accounting software can help manage the accounts payables process
There are many advantages to using accounting software for your accounts payables process. Online accounting software makes it easy to pay invoices electronically and avoid any past-due penalties.
Plus, having everything in one place makes it easier to track and manage your accounts. Handling everything manually leaves way too much room for human error.
By using accounting software, you can automate your accounts payable process to avoid any late payments. You can also link bank and credit card accounts so you won’t have to input that information manually. Additionally, accounting software provides a virtual paper trail in case there are any discrepancies. Overall, the appropriate software will save you time and energy.
There are many popular accounting software programs to choose from. Here’s a look at three of the top accounting software programs you’ll encounter as you begin your search.
Tip: For more information, read our comprehensive reviews of all the best accounting and invoicing software so you can choose a solution that best meets your needs.
QuickBooks is one of the most well-known accounting software packages, and for good reason. QuickBooks provides options for businesses of all sizes, and it’s easy to get started. While there will be a learning curve if you don’t have any prior experience with QuickBooks, the company provides video tutorials to make the process easier.
You’ll need to decide whether you want the QuickBooks online or desktop version. With an online account, you can access your information from anywhere. With the desktop version, you can access your data only on your computer. Sharing options are limited, which can be problematic if you need to share information with your accountant. Learn more in our complete QuickBooks review.
Wave is a frequently overlooked option for accounting software, but it’s an excellent choice for small businesses and freelancers. The company offers cloud-based accounting software, and there are no monthly charges, setup costs or hidden fees.
While Wave is an outstanding option for new business owners or anyone on a tight budget, it’s not going to be the right software for everyone.
Wave has limited tracking and inventory, so it may not have the functionality larger businesses and enterprise companies need. Its app integrations are also limited compared to some of its largest competitors. Read our Wave review for more information.
Xero offers a cloud-based monthly subscription service, and it’s our pick as the best option for growing businesses. The company provides a wide range of services, including the below:
- Accounts payable
- Purchase orders
- Expense claims
Xero integrates with more than 700 different apps, like Bill.com and ADP. Plus, Xero offers flexible pricing for businesses at different stages of growth.
Xero’s Early Plan starts at just $11 per month and is a great option for solopreneurs, freelancers and new business owners. The company offers a free 30-day trial, so you can ensure Xero is the right fit for you. Our full Xero review has more information.
FYI: The best accounting software allows you to process payments automatically and avoid late fees and other common business accounting mistakes.
An AP process streamlines accounting
All businesses, regardless of their size or industry, should be familiar with the accounts payable process. You need to know when outstanding invoices are due to avoid late fees or strained relationships with your suppliers. If you’re creating your own AP process, using the right feature-rich accounting software can help you avoid many common mishaps.