The Ultimate Guide to Accounts Payable
Taylor Pettis November 26th, 2020
You’ve probably heard the term “accounts payable” before and know that it’s an integral measure of a business’s financial health. But do you know what accounts payable actually means or the true impact accounts payable can have on your business?
This guide will explain just what accounts payable is, why it’s crucial to businesses, how to simplify the process, and more.
What is Accounts Payable?
Accounts payable represents the money a company owes to vendors for products or services that the company has not yet paid, i.e., goods that the company has paid for “on credit” or “on account.”
Take a hospital, for instance. At any given moment, there could be needs for medical equipment, sanitizing supplies, new waiting room furniture, or even parking lot plowing services. However, the hospital may not have the funds on hand to pay these hefty bills immediately, so it pays on credit and logs those transactions and subsequent invoices in its accounts payable.
In larger companies, there are entire accounts payable teams to track invoices and ensure vendors are paid on time. The accounts payable department is also responsible for reflecting the total outstanding amount owed on the company balance sheet so investors and leadership have a good sense of cash flow.
What is the Difference Between Accounts Payable and Accounts Receivable?
Accounts receivable is usually mentioned in tandem with accounts payable. That’s because they both handle invoices, but they’re on opposite ends of the accounting spectrum. While accounts payable represents liabilities of debts that a company owes, accounts receivable represents assets in the form of money owed to the company.
So when your business pays a vendor on credit, your accounts payable team will record an entry on their books, whereas the vendor will add your payment as an entry to their accounts receivable ledger. Find out more about how accounts payable and accounts receivable are different.
Why Accounts Payable Matters
There are countless reasons why accounts payable is critical to your company.
An organized AP department prevents costly errors like paying invoices twice or failing to pay on time—errors that not only cost your business money but negatively affect the company’s credit rating.
Externally, maintaining an efficient accounts payable department that issues timely payments promotes a steady financial reputation, as well. Investors and suppliers are more inclined to work with a company that doesn’t have severe liabilities. Some vendors even offer discounts to buyers who resolve accounts payable ahead of a deadline.
How Accounts Payable Impacts Cash Flow
Perhaps the most important function of accounts payable is that it allows companies to better assess the state of their financial affairs and ultimately spot opportunities to save or free up money.
Using what’s called an accounts payable balance, you can see how many products or services your company is purchasing on credit versus paying in cash. You can use this information to strategically prioritize which balances should be paid first and which payments can wait. This methodical repayment helps the company keep enough cash on hand to stay afloat without incurring more debt or to tackle large, costly projects.
For example, say a state transportation department is set to design and build an urban interchange to create more efficient traffic flows. Such an initiative would require a whole suite of new staff. In this case, postponing other bills can buy the agency time and money to get that new team off the ground.
By the same token, putting off payments can be dangerous. It increases the risk of missing payments in the future or incurring fines for late payments. This could cost your company more in both dollars and reputation in the end. It all depends on the level of risk you want to take and the skill and foresight of your accounts payable department.
6 Tips for Your Accounts Payable Process
Staying on top of accounts payable is paramount to running a successful and sustainable business. Below, we outline six steps to reduce friction in your accounts payable processes.
1. Ensure you’re recording accounts payable accurately in your books
Accurate records are everything in the world of accounts payable. One number or decimal out of place can quickly spiral into a costly mess. The first step is to record accounts payable data accurately and comprehensively. You should import every bill into your accounting software in near-real-time, with the vendor’s name and point of contact also readily accessible. Without taking these precautions, leadership and other stakeholders who rely on your company’s financial statements will be basing their decisions on inaccurate depictions of the company’s financial position.
2. Add reminders of due dates in your calendar
Another way to optimize accounts payable is to record the due date of each invoice as a reminder in a shared calendar. Ideally, there will be multiple reminders for each invoice, staggered well ahead of the due date to account for any lag in processing on the vendor’s end. In addition to basic information like the vendor, payment due, and invoice number, those reminders should also list who is responsible for ensuring the payment goes through. Setting up these reminders helps avoid repeated late payments, which, on top of late fees, may lead to vendors either demanding cash up front or terminating their relationship with you altogether.
3. Keep a cash cushion
Just like a personal bank account, a company’s bank account should always have a cushion. Be sure to keep several months’ worth of planned expenses on hand, just in case. Aside from putting aside a small portion of profits regularly, waiting to pay bills, so long as it isn’t detrimental, can be another way to add to the cushion. If margins are tight, paying an invoice early might mean there isn’t enough liquid cash to pay for unexpected expenses.
4. Rely on purchase orders
A purchase order, or PO, is a document that summarizes what a company ordered from a merchant. It should include information like the date it was prepared, a unique reference number, the vendor’s name and point of contact, the company’s name and point of contact, descriptions and quantities of purchased items, and the shipping method. Given the level of detail they include, POs are excellent paper trails that can be useful for auditing purposes, to have for reference in case of future disputes, and for generally tracking purchases on a large scale.
5. Operate on a paperless system
Paper is both easy to lose and hard on the environment. Consequently, many vendors offer electronic invoicing. Unlike paper invoices, electronic invoices are easy to search for, don’t require additional physical storage, and can be effortlessly imported into your accounting software. Plus, payments are easier to schedule and send electronically, and they come with an automatic receipt. If a vendor still insists on using paper, scan each invoice and log it appropriately in your accounting system. This makes it much less likely that you accidentally recycle or misplace it.
6. Find ways to automate your accounts payable workflow
Though the above tips support a robust workflow, there’s still potential for human error. While everyone makes mistakes, mistakes in accounts payable can be particularly costly. Failing to account for bills creates problems for financial forecasting teams, misguides leadership, and harms supplier relationships. Luckily, there are some fantastic tools that can automate accounts payable processes. Look for tools that streamline your most tedious or error-prone processes, like invoice data entry and approvals. And be sure that these tools can integrate into legacy systems that might be costly to replace, like your ERP.
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Start Modernizing Your AP Process Today
When accounts payable acts as a well-oiled machine, companies have sufficient cash to pay for exciting projects while still paying the bills on time. However, it can take time to get to a stage where things are running smoothly.
Fortunately, MHC offers accounts payable solutions that modernize documentation and easily facilitate transactions. From automated invoice processing and approvals to easy document tracking and self-service document access for vendors, MHC saves accounts payable teams time and money, all while increasing visibility. Discover what MHC NorthStar can do for your AP department!