What is Accounts Payable? – A Complete Guide

what is accounts payable

Whether you are running a small or mid-size business, your business gets a bill in the mail when you purchase required goods for the business. Then, what happens? Do you pay that amount right away? Or do you hold onto that bill for some time? In our knowledge, every business owner holds onto that bill and pays it at the end of every month. There can be a possibility of delay payment when you are waiting for your customers to pay you. In most of the cases, you may have more cash to pay your bills and less flexibility at other times. If so, then there is nothing to worry about. We are here to help you out in such situations and provide a detail explanation of “What is accounts payable”.

Well, you must know that all of these unpaid bills known as “Accounts Payable” or AP.

Account Payable shows up as a liability on your balance sheet in the company’s financial statements. We recommend you to enter your bills to keep your business organized. This doesn’t indicate that you have to pay your bills immediately, however, this assists you to manage your liabilities and what you owe.

In the following post, we will talk about all the important aspects regarding “What is account payable?” such as the role of AP, the importance of AP, terms included in it.

What is Accounts Payable (AP)?

Accounts Payable is an accounting entry that needs to be paid in a short period of time. In other words, it is the total of the invoices that your company has to pay but hasn’t paid yet. This is a short-term liability that includes business rent, and things related to run your business. As your business enhances, you have to spend more on various services and get a bill or invoice in return that you need to pay in a short period of time.

Particularly, when your business is growing at a faster rate, you have to purchase more inventories and invest in business growth than wait for the payments of your customers. This means that you will receive “Accounts Payable” before getting money from your customers.

Important Point: Accounts Payable is a short-term liability, not an expense. In accrual accounting, expenses related to accounts payable and recorded simultaneously.

In order to prevent yourself from such a situation, you have to manage your AP and ensure that you have enough cash on hand to pay your bills.

Benefits of Managing Accounts Payable

Your accounts payable increases with the growth of your business. When you are expending your business, you need to spend more money on various services for your business. This will lead to an increase in your accounts payable.

Below written are the advantages of managing AP:

  • Keeping track of your AP helps you to maintain good relationships with your suppliers.
  • By maintaining your liability and paying them on time helps you to save your money.
  • You must know that many suppliers provide offers to their buyers only for those who pay their accounts payable on time. For instance, a vendor is asked to pay a bill within 30 days. And then, offer you a 2% discount if you pay the bill in 15 days.

What are the Functions of Accounts Payable?

Generally, accounts payable consists of their own department in larger companies. On the other hand, accounts payable and accounts receivable are combined in small-size businesses.

The size of the business determines the role of the accounts payable. Including paying bills, AP performs the three basic functions written below:

  • Vendor Payments

Vendor’s contact information is organized and maintained via accounts payable. Along with this, it also deals with the Internal Revenue Service W-9 information and payment terms manually or via a computer database.

Aging analysis is also handled by the accounts payable department at the end of the month. Moreover, AP either manages pre-approved purchase orders or ensures purchase after purchase has been made according to the internal controls of a company.

  • Internal Payments

Internal payments such as reimbursement payments, controlling and administering petty cash, and sales tax exemption certificates will be managed by accounts payable. All small expenses such as office supplies, company meeting lunch, and miscellaneous postage are considered as petty cash. It manages a supply of sales tax exemption certificates that will issue to managers to make sure that business expenses don’t include sales tax expense.

  • Business Travel Expenses

In order to manage travel expenses, all large businesses have their own accounts payable department. The travel management via the AP department consists of car rental, hotel reservations, and advance airline. Accounts payable may process distributes funds or requests to reduce travel expenses. The duty of managing funds distributions comes under the AP department.

Precautions While Tracking Accounts Payable

Following we have listed some of the precautions when it comes to handling your Accounts Payable (AP). The under-mentioned points will help ensure that money spent by you produces maximum value for your business. Let’s proceed further to understand all of these points:

  • Use Latest Technologies/Software

It will be not difficult staying up-to-date on Accounts Payable and other financial concerns. You can also avail of the modern software equipped with AP automation and artificial intelligence. With the help of this modern software, you can make a streamlined AP process. In addition to this, you can set reminders to take benefit of discounts for early payment, simplify everything from vendor management for approvals, payments, and monitor your cash flow.

  • Make strategies to pay Accounts Payable

You need to negotiate with suppliers for the best probable terms. After regular payments, renegotiate those terms in order to get more favorable early payment discounts, time frames, and lower interest rates. Moreover, you need to plan ahead to apply extra cash on hand to your liability accounts with the highest inertest rates.

As soon as you pay your invoices on time, the less money you will spend on interest.

  • Develop Strong Relationships by investing in Supplier Relationship Management

As we understand, the core of every business is “Human Interaction”. You can expand your business or negotiate better terms for larger businesses only when you have developed strong relationships with your suppliers. This will give you a chance to form important connections. Exchanging cash for services and goods provides you an opportunity to make strategic partnerships with suppliers.

Also Read: What Does an Accountant Do? – A Comprehensive Guide  

What is the Procedure of Managing Accounts Payable?

The organizations which consist of their own department of accounts payable have a set of process that you need to follow to make a vendor payment. The following mentioned process is important to be followed:

Step 1: Receive the bill

When you have purchased the goods, then you get a bill in return. This bill helps you to trace the number of purchase orders. And, you will be able to know the validity of the bill during this time.

Step 2: Go through the bill details

In the second step, you need to review the bill. The bill must contain all the required information such as vendor name, authorization, date, and all the corresponding requirements to the purchase order.

Step 3: Update transactions after receiving the bill

After viewing the bill, you require updating your ledger accounts based on the receiving bills. For this situation, managerial approval will be required along with the hierarchy approval attached to the bill value.

Step 4: Make payments accordingly

You need to pay the bills before or at the due date on a bill. Or, you can process the bill as agreed upon between a purchasing company and a vendor. Moreover, you need to verify and prepare the required documents. Including this, we suggest you to analyze the details mentioned on the invoice, vendor bank account, payment vouchers, the original bill, and purchase order.

Which Status of Accounts Payable will be Better for you?

Generally, it would be better to have a lower accounts payable for you. This shows that you are paying your bills on time and having good relationships with your vendors and suppliers. It is obvious that AP increases with the increase in the profitability ratio of the business. But, there is nothing to be bothered about. Because it is normal to purchase more inventories as the business grows.

Furthermore, you should know how to calculate the accounts payable turnover ratio in the case of enhancing the business. Here is the formula to calculate the AP turnover ratio:

Accounts Payable Turnover Ratio = Total Purchases/ Average Accounts Payable

You can use the aforementioned formula to know how frequently you are paying your bills.

How can you Reduce your Accounts Payable?

In case, your accounts payable is growing with respect to your business. And if you find it difficult to manage your AP or want assistance in paying your bills, the below-mentioned are a few strategies that you can attempt in order to minimize the cost of your accounts payable.

  • Set up a business line of credit:

This is mandatory to establish a business line of credit before having issues in your accounts payable. Because there is less probability that a bank will lend to you in the case of having too much debt. Furthermore, if you try to open a line of credit that can lessen your burden at the time of having less cash on hand than you usually have.

And, one more thing that you should keep in mind “Not to overextend your business”. This will lead you to the highest amount of invoices. Instead of this, you need to set up a line of credit that allows you to pay your bills while waiting for your customers to pay you.

  • Lower your costs

This is one of the appropriate solutions to reduce your accounts payable. When you purchase inventories from various vendors, you may have to reduce your expense. This will help you to lower your bills. We recommend you to look out for better deals for your business and give some time to check your expenses. By doing so, you can see where you have to cut your costs.

  • Motivate your customer to pay quickly

If you get instant payments from your customers, then there can be nothing better than this. As you don’t need to stress about lowering your accounts payable and you can pay your bills faster. So it is advisable to find out the ways to get your customers to pay you faster.

  • Consult with your suppliers

You can simply talk to your suppliers to make a payment plan so that you can ease the pain. Also, this will help you to make a good relationship with your suppliers that will help you to continue your business with them. Hence, this will also help you to reduce your accounts payable.

Final Words…!

Expectantly, you have gained all the required knowledge about “What is accounts payable?” with the help of the above-mentioned article. As you can see, managing accounts payable is one of the difficult things to manage your company’s cash flow. The way to keep good cash position is to make the right strategies for managing accounts payable. If for any reason, you are facing any issues at the time of tracking accounts payable or want to get some additional information, get in touch with us by dialing our toll-free Support Phone Number.

We, at QASolved, also provide you with all types of accounting services. Our team consists of certified and experienced experts who can handle your accounting books effectively. So you can call us without taking stress. We not only provide accounting services but you can also avail of Bookkeeping and Tax Services.

Frequently Asked Questions (FAQ)
Q1: How do you compute accounts payable?

A: The formula to compute AP is given below:
The total of all purchase orders from suppliers during the amount period is divided by the average amount of accounts payable during that period.

Q2: How to calculate the average accounts payable?

A: You need to subtract the balance of the accounts payable at the beginning from the AP balance at the end of the period to calculate the average AP. And then, the result will be divided by 2.

Q3: Is Accounts payable an expense or a liability?

A: AP is a short-term liability, not an expense. You are required to pay accounts payable till the due date of the bill.The total balance of AP is entered in the total expenses.

Q4: Where you should enter accounts payable on the Balance Sheet?

A: Accounts payable is a liability and a default credit side. You should enter accounts payable on the credit side whenever goods purchased on credit. However, when you make a payment goods purchased on credit will be entered on the debit side of the balance sheet.

Q5: What is a four-way matching in Accounts Payable (AP)?

A: It is a procedure used when an operating location is utilizing online inspection and receiving. Under the process of 4way matching, the bill will be matched to the purchase order for receiving, quantity and amount, inspection information.

Q6: What does the “3-way match” indicate in Accounts Payable?

A: Under 3-way match, you will match the three documents: the bill, purchase order, and the receiving report. This has to be done to check that the payment has been made.

Q7: What can be the examples of Accounts Payable?

A: Accounting services, supplies, utilities, and legal services are examples of Accounts Payable.

Q8: What is Accounts Payable Invoice?

A: Basically, the accounts payable invoice is a request for payment that includes the profit and loss statement. You will not be able to change the accounting data on an AP invoice. Because it is a legal document that manages entries in the general ledger.

Q9: Can you consider accounts payable as a debt?

A: Yes, AP can be considered as the amount of short-term debt or money owed to suppliers by a business.

Q10: What is the process to record accounts payable?

A: You need to debit the assets or expenses account to which a purchase-related and accounts payable will be credited under current-liabilities. And, when you pay AP, then enter it in the debit side and credit cash.

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