What Does Accounts Payable Mean? - Example, Best Practices, and More

Making sales is not the only part of running a business; paying the suppliers on time is part of it. If a company buys something or services on credit, then the money that they owe is written down as accounts payable until they pay it back. Effective management of account payable will help a business ensure good cash flow, develop a good relationship with the vendor, and maintain accurate financial records. 

So, let’s dive deep into the concept of accounts payable and learn how it works in this blog. 

What is Accounts Payable?

Accounts payable is the money that a business owes to suppliers or vendors for goods or services bought on credit. The payment is to be made in the future, which is why it is listed as a current liability on the company’s balance sheet. 

Whenever a business is supplied with products or services without paying them immediately, the supplier will issue an invoice that specifies a due date for payment. Until the invoice is paid, the money is referred to as accounts payable. 

Suppose a retailer buys merchandise of $7500 on credit for 30 days. The delivery of the goods is agreed upon, and the payment is agreed to be made next month, so the $7500 will be written in the accounts payable section in the accounting records for the 30 days. 

Key characteristics of accounts payable: 

• It represents money owed to suppliers or vendors. 
• Occurs when buying something on credit. 
• Written as a current liability account. 
• Helps businesses to operate their cash flow efficiently. 

Why is Accounts Payable Important?

The significance of accounts payable is that it is helpful in managing the cash flows, keeping supplier relationships intact, and maintaining financial records of the business. An efficient accounts payable process will also minimize payment mistakes and ensure timely payment of bills. 

These are the advantages: 

• Improves Cash Flow Management: Businesses can make payments to the accounts according to their due dates instead of paying the bills at the time of receipt. This enables them to keep a reasonable level of working capital and pay their debts. 
• Strengthens Supplier Relationships: Timely payments to vendors are a sign of reliability and professionalism. The suppliers might offer a better price, longer payment terms, and access to stock to loyal customers. 
• Ensures Good Financial Reporting: Correctly record accounts payable to make sure that the accounts payable on the balance sheet are complete and accurate. This enables the business owners and investors to know the financial standing of the businesses. 
• Helps with Budgeting: By keeping tabs on upcoming payments, companies can make more accurate budgets and anticipate future spending requirements.

What is the Accounts Payable Workflow?

The accounts payable process can be defined as a sequence of steps businesses take to receive, verify, approve, record, and pay supplier invoices. It is a structured process that minimizes the risk of errors, fraud, and late payments by vendors. 

Here are the steps that are followed: 

Accept Invoice 

The process starts when the supplier sends an invoice for goods or services delivered. The invoice usually contains the following information: 

• Supplier details 
• Invoice number 
• Number of products or services being offered. 
• Quantity 
• Price 
• Taxes 
• Payment terms 
• Due date 

The AP team checks the invoice to make sure that all the necessary information is provided and goes to the next step.

Invoice is Verified 

The invoices are carefully reviewed for accuracy before approving payment. 

The finance team looks after: 

• The supplier is genuine.
• The product or service received. 
• The purchase price is in line with the purchase agreement. 
• Taxes and calculations are correct. 
• An invoice with this invoice number does not exist. 

Discrepancies will be addressed with the supplier before payment is made.

Match the Purchase Order 

Many businesses conduct a three-way match that compares: 

• Purchase Order (PO)
• Goods Receipt Note (GRN)
• Supplier Invoice 

This verification confirms that only goods or services that have been ordered and received are being paid for by the company. 

Invoice Approval 

After the invoice is verified in the accounts payable process, it’s matched with the PO and goods received note, and then it is sent for approval. The approval can be given by the department manager, finance manager, or a designated person as per the internal policy of the company. 

The approval verifies that: 

• Purchase has been approved. 
• The amount shown on the invoice is correct. 
• The payment is in accordance with the company policies. 
• Costs are within the planned budget. 

An invoice can only be entered in the payment stage after it has been approved. 

Record the Invoice 

Once approved, the invoice will be added to the company’s billing database. The accounts payable balance is adjusted, and the expense is entered into the general ledger in the applicable fixed expense account. 

Businesses can help by recording the invoice so they can: 

• Keep proper books of account. 
• Track outstanding liabilities. 
• Prepare financial statements. 
• Keep track of cash flow commitments. 

Make the Payment 

The finance team makes the payment as per the payment terms agreed. Payment can be made via: 

• Bank transfer 
• Check 
• Online payment gateway
• ACH transfer 
• UPI or e-payment 

Once paid, the accounts payable are adjusted. 

Keep Paying Records 

The last thing to do is to record the completed payment. Invoices, payment receipts, and approval records are kept for future reference, audit, and tax purposes by businesses. 

Keeping appropriate records is helpful: 

• Resolve supplier disputes. 
• Support tax filings.
• Improve financial transparency. 
• Make sure that accountancy standards are obeyed. 

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Accounts Payable Example 

It helps to have a real-life example to get a better grasp of accounts payable. 

Assume that ABC Furniture buys office chairs from a supplier for $5000 with payment terms of 30 days net. 

Here’s what happens: 

• The supplier sends the chair and sends the invoice. 
• If the payment is made later, the amount is recorded by ABC Furniture as a liability in accounts payable of $5000. 
• If a period of 30 days has elapsed, ABC will pay the supplier. 
• The accounts payable account is cleared of the bill. 

The liability is recorded at the time of purchase, and it’s cleared/removed when payment is made

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Is Accounts Payable a Debit or Credit?

The accounts payable is a credit account because it is a liability. Liabilities will typically have a credit balance. 

When a business buys something or a service on credit: 

• Accounts payable is credited (liability will go up). 
• The expenses and the asset account are debited. 

When the payment is recorded: 

• Accounts payable will be debited (reduced). 
• Cash or bank will be credited. 

Best Practices for Accounts Payable 

These are some of the best practices in order to enhance businesses’ accountable processes: 

• Automate invoice processing using accounting software. 
• Restrict the approval process to a well-defined workflow. 
• Make payments on time. 
• Regularly review supplier statements to reconcile. 
• Keep a close watch on cash flow at all times. 
• Maintain up-to-date electronic records of invoices. 
• Preventing double or fraudulent payments by verifying. 
• Regularly review outstanding payables. 

These practices aid in enhancing efficiency and minimizing manual errors and delays in payments.

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Final Words 

Accounts payable is an important part of any company’s financial processes. It is the amount of money that a business is liable to suppliers for goods and services that were bought on credit and is a useful way to keep track of financial records. An efficient accounts payable process can help you to manage your cash flow, improve your relationship with your vendors, and minimize the risk of errors or late fees. 

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