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Accounts Payable

Accounts Payable Explained – The Process, Definition & Examples

Companies often deal with debtors and creditors on a daily basis for the sale or purchase of goods. Accounts payable and receivables must be accurately recorded to provide a better picture about the company’s financials and its outstanding short-term debt to vendors. 

What is Accounts Payable (AP)?

Accounts payable is generally the department that handles vendor invoicing or billing. All invoices sent by vendors are routed to the accounts payable (AP) department, which verifies them against purchase orders to ensure that goods were delivered by the vendors and received before releasing payment.

Accounts Payable – An Accounting Term 

Accounts payable is an accounting term that refers to a short-term liability on the balance sheet. It indicates the amount of money a company owes to different vendors that have supplied goods or services to the company on credit. Accounts Payable (AP) is also an account that’s prepared in the general ledger. 

It highlights the company’s short-term obligations, and is managed by the accounts payable function within the company. The sum of all outstanding liabilities is shown on the balance sheet under short-term liabilities. 

What is the Role of the Accounts Payable Department? 

The accounts payable (AP) department is responsible for performing several functions, including administrative, financial, and clerical functions. These are critical for the smooth functioning of the organization, and play a critical role in managing the company’s accounts payables. 

Their primary roles include coding, seeking approvals, reconciling vendor balances, and issuing payments on time. The AP department is also responsible for documenting and storing vendor contracts. 

The accounts payable team also helps in  refining and improving the company’s invoice payment process, and to ensure that payments are only released to legitimate vendors that have submitted accurate invoices with corresponding purchase orders. 

The AP department is also responsible for fulfilling other functions in the company apart from issuing vendor payments. Other examples include:

Examples of AP Expenses

Common examples of AP expenses include:

The Accounts Payable Process – Explained

There are 4 key steps involved in the entire accounts payable process, as defined below:

1. Invoice Capture

The first step involves invoice capture. This is the process where data from the invoice is manually or automatically entered into the system. Key information, including vendor details, coding, line items, and corresponding amounts are entered into the financial system. 

Manual invoice capture often increases the risk of errors and can cause significant loss to the company. It also reduces the accounts payable department’s job roles to performing repetitive and menial tasks. Accounts payable (AP) automation is fast becoming the standard amongst most organizations. 

2. Invoice Approval

When an invoice is received from a vendor, it must be reviewed and approved before payment is issued. An AP executive often has to go in-person to seek approvals from authorized individuals. This usually happens before the cost is recorded in the financial system and the invoice is sent for payment.

Again, with AP automation, the invoice could be automatically sent for approvals, making it easy for authorized individuals to approve or reject the invoice with a single tap. 

3. Authorizing Payment

The AP department is responsible for authorizing payment once an invoice has been approved. This includes the payment method, the date when the payment will be posted, and the amount to transfer to the vendor. Prompt payments can help businesses improve vendor relationships and improve their negotiation powers. 

4. Releasing Payments

Once the payment is authorized, the AP department releases the payment and sends the confirmation or details to the vendor. In manual AP departments, this often means printing and signing checks, before mailing them to the vendor. In some cases, companies also use credit cards to clear payments before closing the invoice and filing it. 

Why is Manual AP Processing a Problem?

Paper-based AP processing can often lead to inaccurate financial reporting and increases the risks of human errors. Moreover, it prevents the AP department from focusing on more impactful activities that benefit the business as a whole and improve profitability. 

It also introduces inefficiencies in the system, which often result in additional costs or surcharges due to late payments, or an inability to claim discounts. In some cases, there’s also the risk of invoice fraud. 3-way matching is often the preferred method for verifying and executing payments. Here’s how it works:

  1. The first step is verifying the purchase order (PO), which is an internal document confirming that an order was placed by the purchasing department with a specific vendor. The purchase order includes specifications of the order itself, including the price. 
  2. The Goods Received Note (GRN) confirms whether the ordered goods were received by the organization. The shipment is carefully documented, including the quantity of goods received, and the condition in which goods were received. 
  3. Once the company receives the vendor’s invoice, they then compare it with both the purchase order and the goods received note. 

As you can imagine, manually matching invoices is often cumbersome and takes time. There’s also a risk of fraud due to the quality, or lack of, internal controls. Manual AP processing also causes issues during audits, where it’s often hard to confirm audit trails. 

Using AP Automation Software to Turn AP Departments into a Profit Center

Historically, AP departments have been viewed as cost centers by most organizations. However, using AP automation software can streamline most of these operations, allowing AP departments to automate workflows and focus more on high-level activities that directly improve the company’s profitability. 

SoftCo’s AP automation solution offers a complete paperless solution to fully automate the invoice data capture, matching, and approval process. It also offers greater visibility in the accounts payable process, providing AI analytics and offering greater transparency by reporting spend, accruals, budgets, and KPIs.