How The Accounts Payable Process Works

How The Accounts Payable Process Works | Accounting Smarts
Charles Hall

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Charles Hall

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June 24, 2021

The accounts payable process is one of the most integral parts of a company’s accounting cycle. As a business owner, it is important to understand.

The accounts payable process is one of the most integral parts of a company’s accounting cycle. As a business owner, it is important to understand.

The Account Payable process starts with a P.O. to the vendor for a good or service, it is then verified if it can be provided, invoice is input in the accounting system, approval of invoice for control, match P.O. with packing slips and invoice, post for payment, make payment.

Accounts Payable is a broad department in a business that encompassess all of your business’s expenses except for payroll. In this article, we will be going over the Accounts Payable process and how we can help you be more efficient with your business. As well, having internal control put in place. For example, a three-way match system where you need a purchase order, order receipt and a vendor invoice in order to post and pay vendors; will eliminate inaccuracy. The accounts payable process should gracefully be complete and accurate for financial statement purposes. Implementing an accounts payable process will help your business with accurate financial information during month end close and when auditors come knocking at your company’s door.

My experience as an accounting professional performing accounts payable tasks throughout multiple industries has given me this insight of How The Accounts Payable Process Works.

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What are Accounts Payable?

When you purchase an item for your business on credit, the price of what you purchase is added to your accounts payable. Accounts payable refers to the amount owed for goods or services purchased from your vendors on credit before a payment due date. If you do not pay your bill within the agreed payment due date, then there may be a late fee and penalty assessed.

Accounts payable belongs to the liability account of a balance  sheet. To account for this we use double-entry accounting. First we increase accounts payable would be posted as a credit with an expense being debited. This is when accounts payable receives the invoice from the vendor.

Date Account Debit Credit $37.50
5/27/2021 Maintenance and Repair Expense 250.00 $85.00
5/27/2021 Accounts Payable 250.00 $99.00

A bill was received for maintenance and repair for an asset on credit.

Secondly, when the bill post for payment accounts payable is debited and cash being credited.

Date Account Debit Credit $37.50
5/27/2021 Accounts Payable 250.00 $85.00
5/27/2021 Cash 250.00 $99.00

Payment made to the vendor.

The Accounts Payable Flow Chart

The account payable process begins with a good chart of accounts. When you define your accounts in the chart of accounts this will allow for you to post your expenses to the correct account. The process is finalized when you issue a check to the vendor by check or ACH before the due date.

As well, it is also common practice to set up vendors prior to entering invoices in the system. If you recently started your business it more than likely you will have to set up your vendors information. There are two ways to track your vendor information using spreadsheet or accounting software. We are going over the accounting software for this article.

Accounting softwares gives you the capacity to set up vendor details directly in the accounts payable module. Here you will be able to enter the vendor's business information and payment terms. These accounting terms refer to how long your vendor or supplier gives you to pay the bill. Common practice terms include:

  • Due on Receipt
  • Net 10
  • 2/10 Net 30 (2% discount paid within 10 days)
  • Net 30
  • Net 60

For example, if you receive an invoice with payment terms of Net 10, and the invoice is dated May 15, 2021. Payment should be made by May 24, 2021 in order for you to not  assess a late bill.

Step 1: Submit Purchase Order

Not all businesses use P.O. But in general it is good practice to keep accounts payable organized.

In today’s world because of technology communication happens quickly and at times orders can fall through the cracks in regards to formal processes taking effect. Purchasers usually make orders through phone conversation, via email, and through text messaging. As a business owner you want to be aware of the item(s) the company is procuring and purchase orders allow for documentation of the process. You use these measures for internal control purposes. In some cases you will not need a purchase order. As a business owner, I would make clear to management and employees on the company policy on how to place a purchase order.

Step 2 : Vendor Verifies Purchase Order

Furthermore, the vendor will review the purchase order to make sure the item is in stock or if service(s) are available, quantities, prices, and terms agree with the system. Once approved by the vendor an email is sent to the purchaser. This email contains the order details and delivery date. If by chance the vendor does not hold the item(s) or service(s) is not avaialble a backorder is usually placed.

Step 3: Invoice Is Entered In Accounting System

After the item(s) or service(s) have been received from the vendor a member of accounts payable must review the invoice for accuracy.

First step to take with any invoice received is to verify all products on the invoice have been received. If a service(s) was rendered ensure all described services on the invoice were provided. It is important to make sure all item(s) or service(s) on the invoice have been received.

Step 4: Invoice Approval

Second when the invoice has been entered the company should have controls in place with guidelines on invoice approval process. Here you would also set a dollar limit for each department for approval.

Another practice is to have Accounts Payable clerk code invoice with account number and cost center. Then have a high level manager approve the invoice.

The account payable manager should review accounts payable aging report on a weekly basis. By reviewing the accounts payable aging report you can view the upcoming due date. Giving you leverage on making sure all payments are due on time in order to avoid paying late fees or penalties.

Step 5: Three-way Match

Before you cut the check and send the check for signature. You want to make sure that there is a three-way match for the invoice sent for payment.

This three-way match consists of the purchase order, invoice, and packing slip or receipt of service.

From my professional experience with serving as an Accountant. CFO’s like to have checks come with documation for them to complete their signature on the check.

Step 6: Post Payment

Once the three-way match has been completed you can post the invoice for payment. This is just another step internal in the accounting system.

Step 7: Make Payment

There are many options on how you can pay invoices. First, you can process checks from the accounting software. Another method is by paying with a business credit card or also with electronic payment such as ACH.

If making payment by check, you should make sure to include the invoice number in the check remittance. This will ensure your payment is properly processed.

If using a credit card or ACH as a form of payment. Advise the vendor on the process to make this type of payment.

Repeating the Accounts Payable Process Weekly

Implementing an accounts payable schedule for when invoice will be entered, as well when check runs will be performed is a major key. Incorporating a weekly schedule will reduce the workload during month end closing. Reviewing the Accounts Payable Aging Report weekly will help avoid late payments and the extra fees. Maintaining accounts payable organized will help you leverage cash flow.

Optimizing Accounts Payable with an Accounting Software

Accounting software can add value for any business. It will maintain and keep records safe guarded for years. You will be able to track your business growth with the accumulation of historical data.

Vendor Records Maintenance

Accounting software aims to make the life of a business owner easier. Using accounting software you can easily manage all of your vendors records in one location. Always, knowing who to contact for each vendor, also making sure with this individual all payments are received and processed.

Lastly, using accounting software will let you see on a high level what has been paid to each vendor. This can help with managing the business budget for expenses.

Automatic Payment to Vendors

Utilizing an accounting software, you can record payments and invoices easily. Recording invoices with the amount and due date of the bill to make a payment on or before the due date.

Accounting software enables a variety of payment forms. Enabling you to make payments by check, credit card payment, or ACH transfers.

Properly recording Expenses

Having your accounts payable clerk code the invoice to the proper expense account can save your company time and money. For example, if you’re figuring out the year to date  for a certain type of expense you will just have to open the expense account pertaining to that vendor's account.

On-time Payments

An accounting software will provide accounts payable aging-report. Reviewing this report weekly will help you flag upcoming due dates. As for my experience as an accountant and dealing with accounting software there is usually a notification which alerts you when due dates are arriving.

Accounting Software for Reporting Purposes

You never want to be audited, but if you are, accounting software will make sure things go as smoothly as possible. It’ll help you keep an extensive audit trail of the process from initial approval and all the way through final payment and that means more accurate financial statements.

Why use Accounting Software for Accounts Payable?

One of the most important tasks for any business is to collect and pay their debts on time. By implementing an effective accounts payable system, you can avoid costly late fees that would otherwise accumulate as well as build valuable relationships with your vendors by ensuring they are paid promptly. In addition, using a good accounting software ensures accurate bookkeeping so all expenses throughout the company's financial year get properly accounted for in order to better manage your budgets!

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall