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.
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.
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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.
Read more about the difference between accounts payable and accounts receivable here.
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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.
Before your actual accounts payable process, your business will:
Learn more about invoice management here.
After these three steps, your accounts payable process should look something like this:
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.
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.
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.
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.
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Your accounts payable covers many types of purchases on credit for your business. You can apply accounts payable processes to:
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.
Date |
Account |
Debit |
Credit |
9/13/2021 |
Purchases account |
$1,000 |
|
Accounts payable account |
$1,000 |
||
10/13/2021 |
Accounts payable account |
$1,000 |
|
Cash account |
$1,000 |
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.
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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.
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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:
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Business owners should think of accounts payable as a mechanism to improve their business. Accounts payable can help with this in three ways:
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.
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.
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.
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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:
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.
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.
Take the time to sit down and review your financial data at least once a month. Take stock of:
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.
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.
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.
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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.
Accounts receivable
The money owed, but not yet paid, to your company for goods or services.
Accrual accounting
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.
Balance sheet
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.
Cash flow
The movement of money in and out of your company.
Double-entry accounting
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.
Revenue
Assets earned by your company's goods or services.
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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’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.