Processing accounts payable is part of the accounting cycle. As a small business owner, you will need to pay attention to the accounts payable cycle and learn the accounts payable process flow.
If you’re a very small business, it’s likely you can pay your bills as soon as you get them. However, if you have multiple bills to pay, you’ll likely add them to accounts payable to be paid at a later date.
Overview: What are accounts payable?
Accounts payable refers to what you owe for items purchased on credit. Any time you purchase goods or services, the amount you owe for those goods and services is added to your accounts payable balance.
Because all of these items or services were purchased on credit, with the amount due and payable within a specific timeframe, a late fee or a penalty can be assessed if the amount is not paid within the agreed timeframe.
Accounts payable is a liability account, so if you’re using double-entry accounting, any increase to this account would be posted as a credit, with a corresponding debit made to an expense account.
When accounts payable items are paid, the accounts payable account is debited, with cash credited.
Accounts payable vs. accounts receivable: What’s the difference?
Both accounts payable and accounts receivable are vital parts of the accounting process. Accounts payable, as explained above, are what is owed to suppliers or service providers for products received or services rendered. Accounts payable are considered liabilities, since it is money that is owed.
On the other hand, accounts receivable (A/R) is money owed to you for goods or services you provided to your customers on credit. Accounts receivable balances are considered an asset, as that number indicates how much money is owed to you by your customers.
How the accounts payable process works
The proper accounts payable procedure begins with a good chart of accounts, which enables you to post your expenses to the correct account. The process is complete when you issue a check or electronic payment to the vendor for the amount due on or before the stated due date.
If you’re used to managing your own personal bills, you should have no problem transitioning to the accounts payable process. However, there are a few things you need to do in order to prepare and process accounts payable properly.
Step 1: Create your chart of accounts
Creating a chart of accounts that works with your business is one of the most important things you’ll need to do before you begin to process accounts payable. Your chart of accounts is where all of your accounting transactions reside, and accounts payable is no exception.
While most accounting software applications include a default chart of accounts, be sure to add any additional accounts in order to track your accounts payable expenses properly. You can also set up your chart of accounts on spreadsheet software such as Microsoft Excel.
Step 2: Setting up vendor details
If you’ve just started your business, you’ll likely have to set up your vendors. Whether you’re tracking accounting transactions using spreadsheet software or accounting software, you’ll need to record vendor details.
If you’re using accounting software, you can set up vendor details directly in the application, including accounting or payment terms provided by the vendor. These accounting terms indicate how long the vendor or supplier gives you to pay your bill. Common payment terms include:
- Net 10
- Net 30
- Net 60
For instance, if your vendor sends you an invoice with payment terms of Net 30, and the invoice is dated December 15, you would need to make payment by January 14 at the latest in order for the payment not to be considered late.
Another payment term commonly used, particularly among suppliers, is 2/10 Net 30. Using the same invoice date (December 15), this term means if you pay your invoice by December 24, you can take a 2% discount off of the total amount due. If you don’t pay by December 24, the full amount of the invoice is due by January 14 at the latest.
One other popular payment term is Due on Receipt. If you receive an invoice from a vendor or supplier that indicates Due on Receipt, that means payment is due immediately.
Step 3: Examining and entering bill details
Once you receive an invoice from a vendor or supplier, you or your accounting clerk need to review the bill for accuracy.
If a bill is for products ordered, be sure to verify that the products listed on the invoice have all been received. If the invoice is for services rendered, ensure the services were provided as described on the invoice. It’s important to complete this process for any invoice received.
Once this is complete, you can begin the process of entering the invoice information, either in your ledger accounts or in your software application. If you typically enter all accounts payable for your business, you can approve bills as you review them.
However, if you employ an accounting clerk, you’ll need to provide that person with general guidelines on invoice approval, as well as perhaps a dollar limit the clerk can approve themselves.
Another method you can use is to have your clerk code invoices with the correct account numbers and then send the coded invoices to you for approval. This method allows you to view incoming bills and help to ensure accuracy while avoiding payment errors.
Once this process is completed, your clerk can begin to enter payment details, such as the invoice number, the invoice due date, and the amount due.
Step 4: Review and process payment for any invoices due
The best way to ensure that your vendors are paid on time is to review your accounts payable each week to see what payments are due. Whether you use a manual accounting system or accounting software, you’ll need to review due dates to see which invoices need to be paid.
There are many methods you can use to pay invoices. You can write a check, process checks from your accounting software, pay your vendors and suppliers using a company credit card, or use an electronic payment method such as ACH in order to pay your vendors in a timely fashion.
If you pay your vendors using a check, you should probably include a copy of the invoice in the envelope along with the check. You will also want to make sure that the invoice number is on any type of remittance in order to ensure your payment is posted properly.
If you pay using a credit card or ACH, you should notify the vendor of the payment.
Step 5: Repeat the process weekly
By implementing and following a weekly accounts payable cycle, you can reduce your workload at the end of the month while also avoiding late payments and late fees. Even if you only have a few vendor payments to make, processing the invoices on a regular basis can help with cash flow.
How accounting software helps with the accounts payable process
If you only process two or three vendor invoices a month, processing them manually shouldn’t be difficult. But even the smallest business has recurring invoices that will need to be processed on a regular basis. If that’s the case, using accounting software can be a tremendous help.
Better vendor management
You’ll never have to look up a vendor or supplier address, check on payment terms, or even hand-write checks. Using accounting software, you can easily manage all of your vendors in one central location, know exactly who your contact person is for each vendor, and be assured that your payment is recorded as it is processed.
You’ll also be able to see how much you’ve paid each vendor in any given time frame, which can help tremendously with expense management.
Payments can be made automatically
No more pulling out the checkbook to write checks and then record them for your records. If you use accounting software, you can enter invoice details, the amount due, and the date due, and choose to pay those invoices when the payment is due. You also have a variety of payment options available to you including a standard check run, credit card payment, or ACH transfer.
Expenses will be recorded properly
When you use accounting software, you or your clerk can code the invoice to the proper expense account. This process allows you to better manage your money. For example, if you’re wondering how much you’ve spent on utilities for the year, just access the Utilities Expense account to view the total.
Payments will be made on time
Nobody wants to be late in making a payment. Accounting software will flag payments that are due soon, ensuring you see them with plenty of time to pay them. Using manual systems, you alone are responsible for viewing your manual ledger or spreadsheet to see what payments are due.
Again, if you only have a few vendors to pay, this may not be an issue, but even if you have to pay just five vendors monthly, your life will be much easier if you use accounting software.
Audit and reporting options are better
No one wants to be audited, but if you ever are, you’ll have a solid audit trail using accounting software, from initial approval to the final bill payment process. You’ll also be able to generate more accurate financial statements, a must if you’re applying for credit or looking for investors.
Accounts payable is more than paying bills
Managing your accounts payable is part of properly running your business. By implementing a good accounts payable system from the start, you can eliminate costly late fees, build valuable business relationships, and ensure that your expenses are accurately accounted for.
Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool owns shares of and recommends Intuit and Microsoft. The Motley Fool owns shares of Xero and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.