Accounts payable for small businesses is essential for instilling and retaining trust with vendors and creditors. A stellar accounts payable process may even lead to some discounts for your business down the road.
Keep reading to find out everything you need to know about accounts payable, from what it is, why it matters, and how to do it right. Spoiler alert: Many, many businesses aren’t optimizing accounts payable in ways that can save valuable time.
If you’re new to accounting, read our glossary of accounting term definitions for this article before diving in.
Quick note: The accounts payable process applies to both external vendors and internal processes such as petty cash and expense accounts. This article will cover the external accounts payable process.
Table of contents
- What are accounts payable?
- What’s the difference between accounts payable and receivable?
- What is the accounts payable process?
- What are some examples of accounts payable?
- Why does accounts payable matter?
- How does accounts payable impact cash flow?
- What should an SMB look for in accounts payable?
- How should SMBs/management use accounts payable?
- 5 tips for accounts payable
- Glossary and definitions of accounting terms related to accounts payable
What are accounts payable?
Accounts payable is the money your company owes to vendors and creditors.
On a basic level, your total accounts payables are two things: your short-term debt to creditors and invoices you have yet to pay suppliers who have provided your business with goods or services.
Accounts payable is considered a liability on your balance sheet because it’s cash that will soon flow out of your business within a certain period of time, depending on your payment terms with creditors and vendors.
What’s the difference between accounts payable and receivable?
Accounts payable represents the cash that will soon flow out of your company to your vendors and creditors. Accounts payable is listed as a liability on your balance sheet, because it’s an amount that’s going to counteract any assets and revenue.
Accounts receivable represents the cash that will soon flow into your company from clients who have received goods or services on credit. On your balance sheet, accounts receivable is listed as an asset because it’s money your company will have in the bank within a certain period of time.
What is the accounts payable process?
Depending on the size of your small business, the owner may be in charge of handling the accounts payable process. If your business is larger, there may be another person or department handling accounts payable.
3 Steps your business should do before an accounts payable process
Before your actual accounts payable process, your business will:
Step 1: Create a purchase order
Create a purchase order for the goods or services provided by vendors.
Step 2: Create a receiving report
Create a receiving report to verify the receipt of those goods and services when they’re fulfilled.
Step 3: Verify the goods or services received
Verify the goods or services received against the purchase order, receiving report, and the invoice from the vendor. This process is called the three-way match.
4 Steps in an accounts payable process for businesses
After these three steps, your accounts payable process should look something like this:
Step 1: Set up vendors and their payment terms
When you sign a contract with a vendor, you’ll need to transfer some of the information from that contract into your accounting system. Software like Quickbooks or Xero lets you set up records with payment terms (most commonly net 30, 60, or 90 days from invoice receipt) with vendors to keep track of basic contact information and payment schedules.
Step 2: Receive and enter invoices
When you receive an invoice, or bill, from a vendor, you’ll need to enter all of the information into your accounting system. Some accounting software solutions use OCR technology that scans a hard copy of the invoice and populates your records automatically.
Step 3: Make payments
After you receive an invoice, it’s time to keep your end of the bargain and pay your vendor. Options to pay will include credit card, EFT payments, ACH payments, e-transfers, etc.
Use a payment integration with your accounting software to make faster payments to your vendors. If your payments require multiple levels of approval, get sign off from one centralized place that auto-reconciles with your accounting software to keep your records updated.
Automated payments with accounting software integrations save companies an average of 20-40 hours per week.
Step 4: Track accounts payable data
Some finance departments use an accounts payable aging schedule to keep track of all payment schedules to vendors.
Traditional accounts payable schedules are obsolete with payment integrations, however. Payments software keeps track of when you’re supposed to pay your vendors in one place, then auto-reconciles that data back to your accounting software every day.
What are some examples of accounts payable?
Your accounts payable covers many types of purchases on credit for your business. You can apply accounts payable processes to:
- Purchase of raw materials
- Travel expenses
- Other expense accounts
- Petty cash
- Subcontracting work
- Transportation and logistics
- Software licensing
- Equipment purchases
- Office leases
- Other vendor payments
When you owe vendors money, your accounts payable entry will have a credit balance that shows a current liability (more on that later). When you pay what you owe, your credit balance will show up as a debit of the same amount.
Accounts payable account
Accounts payable account
Why does accounts payable matter?
Accounts payable matters because it can save you money.
Many vendors offer discounts for accounts that pay early. When you keep track of your accounts payable in one place, you’re looking at opportunities to save money. Small discounts spread across many vendors can save thousands of dollars as your business grows.
Accounts payable is another opportunity for maintaining good relationships with vendors. When your vendors know they can trust you to pay on time, you may also get early or special access to goods and services you wouldn’t have otherwise known about.
On the flip side, accounts payable prevents your business from making late payments — which can affect your credit rating.
How does accounts payable impact cash flow?
Did you know accounts payable is considered cash on hand for your business?
In accrual accounting, accounts payable represents a lag time between receiving goods or services and actually paying for those goods and services. The longer you put off paying your vendors, the more cash on hand you’ll have to grow your business.
Some companies choose to make payments on their accounts payables as close to their due date as possible to better manage cash flow.
Unless you have an incentive, such as a discount, to pay an invoice early, don’t. The time could mean the difference between business growth and stagnation.
If you have a good relationship with a vendor, you can also renegotiate your payment terms to lengthen the amount of time you have to pay your bills. This gives you more time to make more revenue, which means your business will “feel” the impact of those bills less each time because it has more cash on hand to operate.
When your business is handling a lot of accounts payables at the same time, economies of scale kick in and save your company thousands of dollars every year.
What should an SMB look for in accounts payable?
Small to mid-sized businesses have enough on their plates without the added stress of an onerous accounts payable process. Automation can help business owners avoid a lot of this stress.
But “automation” is an umbrella term that covers several components of a complete accounts payable process. Here are the specific features of an automation system that helps business owners save time:
Paperless recordsYour vendors may still send hard copy invoices, but your accounting system should make it easy to digitize any paper records in one centralized place. This digital centralization will make everything else easier when you’re reconciling your accounts and generating reports on the overall health of your business.
Auto-reconciliationYour financial software ecosystem will likely include accounting software with a payment integration. When you make a change to one, it should be reflected in the records of the other. With auto-reconciliation, you’ll dramatically cut down on data entry errors that can cause headaches later.
Generated financial reportingAutomated record keeping features like auto-reconciliation lead to faster, more accurate financial reporting, either for yourself as a business owner or for any leaders on the finance team.
Automated remindersYou shouldn’t need to remember to pay your bills. When you automate your accounts payable process, you’re also outsourcing the act of remembering to a software solution. Never make a late payment with automated reminders, and maintain good relationships with vendors in the process.
Fast paymentIf you do run into a late payment, the last thing you want to do is add more waiting time with slow payment processing. Look for payment solutions that can cut down on the amount of time it takes for your vendors or contractors to get paid (they may just thank you with their best work). And the faster you manage payments, the better you can grow your business with accurate books.
Bonus: Look for a payment solution that can get your payment in your vendors’ accounts by the next day.
How should SMBs/management use accounts payable?
Business owners should think of accounts payable as a mechanism to improve their business. Accounts payable can help with this in three ways:
1. Manage vendor relationships
Accounts payable offers two main opportunities to touch base with your vendors and contractors: payment term negotiation and every subsequent payment.
When you negotiate payment terms, it’s a chance to find out about possible discounts, opportunities for longer terms, and start your relationship on the right note.
With every payment made thereafter, you get another opportunity to show your vendors respect when you pay them on time.
2. Manage cash flow
A good accounts payable process manages the operating cash flow for your business.
First, with three-way matching between your purchase order, receiving report, and invoice, you’re verifying that you’ve actually received what you ordered to be able to run your business.
But even more than that, accounts payables that haven’t yet been paid are still cash on hand. The longer the payment terms, the more cash you have to run your business — especially important when times get tough and every penny counts to get you through the next month.
3. Get future discounts on goods and services
Accounts payable is a point of negotiation. Many vendors offer discounts as incentives for early payment, so if your cash flow is healthy and can withstand shorter payment terms, negotiate to save some money.
5 Tips for accounts payable
As your business grows, your accounts payable process will become more complicated with more vendors, creditors, and subcontractors. When accounts payable becomes unruly, missed payments may happen.
Here are some tips to handle the growing complexity of your accounts payable process to avoid mistakes:
1. Establish good security measures and payment approval to avoid fraud.
When you hire staff to handle your accounts payable, you’ll need to start establishing security measures to avoid fraud. Make sure you get or assign appropriate approval measures for payments, and try to avoid having the same person create new vendors and make payments.
2. Don’t be afraid to renegotiate payment terms in tough times.
You don’t get what you never ask for. If you foresee rough times ahead, be proactive and contact your vendors to request a renegotiation of payment terms. They may be more willing than you think. After all, if you go out of business, they’ll have a much harder time getting payment from you as opposed to granting your request to lengthen payment terms.
3. Review financial data regularly.
Take the time to sit down and review your financial data at least once a month. Take stock of:
- Signs of fraud, such as double payments or double vendor entries
- Cash flow planning
- Opportunities for discounts
- Audit trails
You’ll never be able to improve what you don’t measure, so never become complacent about reviewing monthly, quarterly, and annual trends in your data.
4. Wait until the last minute to pay invoices.
This may sound counterintuitive to maintaining good relationships with your vendors, but most businesses wait until the final day to pay their bills to keep cash flow healthy. You want your cash in the bank as long as possible so you can grow, and as long as you’re budgeting properly and aren’t missing out on any discounts for paying early, it’s smart to wait.
5. Resolve disputes with vendors and contractors right away.
If there’s a dispute on payment between a vendor or contractor, always address it right away. Your relationships are the lifeblood of your business, and most late payments are a result of miscommunication rather than malice. A simple phone call and a plan on how to solve the issue can mean the difference between losing an ally and salvaging an important relationship.
There is nothing more pressing than preventing a bad relationship from becoming associated with your business.
Glossary and definitions of accounting terms related to accounts payable
The money your company owes, but hasn’t yet paid, to vendors for goods or services.
Accounts payable aging schedule
A chart that keeps track of when your company needs to pay vendors and creditors.
Accounts payable turnover ratio
A formula that shows how fast a business it paying its bills.
The money owed, but not yet paid, to your company for goods or services.
An accounting method where revenue and expenses are recorded at the point of transaction, not when payments are received or made. See “cash basis accounting” for alternative.
Assets, or asset account
Line items that show the value of what your company owns, whether cash, accounts receivables, investments, etc.
A financial statement that shows your company's assets, liabilities, and shareholder equity during a specific time period.
Cash basis accounting
An accounting method that records transactions only when payment is exchanged. See “accrual accounting” for alternative.
The movement of money in and out of your company.
A bookkeeping system that requires a credit entry to one account and a corresponding debit entry to another account.
Liability, or liability account
Line items within your books that show how much your company owes.
Assets earned by your company's goods or services.
Take your business to the next level of growth and financial stability
The right accounts payable system and procedures in place can save you time and money, while helping you build better relations with your vendors and creditors. Implemented properly, accounts payable frees you up to spend more time strategizing, growing your business, innovating new products — and less on managing payments.
Think of your accounts payable system as a powerful tool that can provide you with a clearer picture of your business today—and where it’s heading. It can help you make better decisions, contributing to a more successful and sustainable business.
Plooto — Our story
Plooto’s accounts payable and receivable software offers the fastest way to manage your business payments. Plooto’s platform helps both businesses and their financial advisors build scalable workflows and eliminate complexities. Our goal is to help our customers achieve their visions as quickly as possible.