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It’s estimated that over 60% of American businesses process more than 1,000 invoices per month—with a remarkable 23% processing over 10,000. With so much volume, keeping track of every bill and where every dollar goes is no easy task. 

That’s why having a solid process to manage your payments is critical as it can ensure your business accounts are well kept, your cash flow is optimal, and that your vendor relationships are as strong as ever—that’s where the Accounts Payable (AP) process comes in.

In this thorough guide, we’ll break down what accounts payable is, how the process works, and why automation is changing the game for businesses all over the United States. Whether you’re looking to improve accuracy, prevent fraud, or streamline your payment workflow, this guide has everything you need to know.

What Is Accounts Payable (AP)?

Accounts payable (AP) is a standard accounting process that refers to the amount a business owes to a third party for goods or services received but not paid for. It serves as a way to track these obligations, which are recorded as liabilities on the company’s balance sheet. You can think of it like a credit card bill—something you’ve already bought but can pay for later.

Business-to-business transaction typically allows for a repayment grace period called a payment term. The terms of payment can vary from vendor to vendor, but they generally range between net-10 and net-90. This allows customers between 10 and 90 days to pay the bill without penalty.

Because accounts payable represent money your organization owes, it’s recorded as a liability on the balance sheet. Once an invoice is received and approved, the line item needs to be added to your online ERP system, which increases your balance sheet’s total liabilities.

Example of an Accounts Payable Transaction

Let’s assume your organization contracts a cleaning service for your office space on March 5, with an agreed fee of $2,500.

The cleaning company provides the service and issues an invoice stating that payment is due within 45 days (net 45). At this point, your bookkeeper would create an accounts payable journal entry, increasing your balance sheet’s total liabilities by $2,500.

Once the invoice is reviewed and approved, your organization will process the $2,500 payment for the cleaning service on or before the due date—April 19.

After the payment is completed, the transaction will need to be closed on your ledger. When it does, the liability will be settled.

Distinguishing Accounts Payable from Other Liabilities

The term “payable” is generally used in accounting for an amount owed, which can be easily confused with accounts payable. However, while accounts payable is considered a liability, not all liabilities are accounts payable. 

To determine if a liability belongs to the AP category, it must meet well-defined criteria:

• An invoice for the liability must have been received.
• The invoice should be expected to be paid within one year at the most.
• It must be paid through the company’s AP system. 
• The invoice must not be merged with any other expense.

Types of Accounts Payable

1. Trade Payables

Trade payables are incurred when businesses receive goods or services from suppliers or manufacturers on credit that is used for business operations. This broad definition means trade payables are one of the most common types of AP.

2. Non-trade Payables

Non-trade payables are obligations similar to trade payables but are not directly tied to inventory or operational production. Instead, they cover general business expenses such as utilities, office supplies, rent, and other non-vendor costs.

3. Wages Payable

Wages payable refer to liabilities incurred by an organization for wages earned but not yet paid to employees.  

For example, if an employee works throughout January but receives their paycheck in February, the unpaid amount is recorded as wages payable in January’s financial records.

4. Taxes Payable

Taxes payable is a type of account payable that represents the amount of money that an organization owes in taxes. These could include income tax, payroll tax, sales tax, or value-added tax (VAT).

For example, if your business collects VAT on products sold, the amount of VAT collected during a quarter, until the bill is due, would be recorded as a tax payable liability on your balance sheet.

What Is The Accounts Payable Process?

The accounts payable process is a series of standardized steps that involve tracking, verifying, and paying suppliers. By following the accounts payable process, companies can ensure they always pay the right amount to the right person at the right time.

The cycle of AP begins with the creation of a Purchase Order (PO) and its acknowledgment by the supplier and ends with the payment and recording of such payment in the accounting system.

Why Is it Important to Have an Efficient Accounts Payable Process?

Operating a business without an AP process is like running a household without a budget—before you know it, you’ll be dealing with all sorts of financial problems.

Implementing a well-structured accounts payable process is the first step towards gaining control over your business finances. It can ensure your bills are paid on time and that your cash flow is managed effectively, and more.

These are some of the key reasons why it is important to have an efficient accounts payable process:

• It Improves Cash Flow Management

By having an efficient accounts payable process, businesses can have a clear, data-driven view of their financial obligations and forecast for the future. Doing so can help you and your business track payments, allocate capital wisely, and avoid cash shortages.

• Avoid Penalties and Late Fees

Knowing when every bill is due is the first step toward ensuring all bills are paid on time. This can protect your business from costly penalties and/or late fees while ensuring the lights stay on, so to speak.

• Prevents Unauthorized Payments

Losses caused by fraudulent activity increased by $1.2 billion to $10.0 billion in 2023, according to the FTC. With financial fraud on the rise, it is not uncommon for bad actors to attempt to complete unauthorized payments to your business.

When you implement an accounts payable process, your payment information is stored in your accounting system or ERP. This helps prevent unauthorized payments and validates POs before confirming a payment. 

• Better Supplier Relationships:

Ensuring your business is always paying suppliers accurately and on time builds trust and strong business relations between the suppliers and your company. It may also lead to better payment terms and discounts, which benefit your bottom line.

• Provides Actionable Insights

Tracking your payments and financial data with an accounts payable process can enable your business to analyze spending patterns, track financial trends, and optimize cash flow strategies.

The Accounts Payable Process: Step-by-Step

The Accounts Payable Process: Step-by-Step

Every process follows a set of standardized steps, and the accounts payable process is no different.

1. Sending a Purchase Order (PO)

Every AP process begins with the issuance of a Purchase Order (PO) to a vendor. A purchase order is a legal document used to place an order with a supplier. It typically specifies the desired items, quantities, prices, and credit terms for a purchase.

2. Receipt of Goods or Services

After a PO is sent over to a supplier, the ball is in their court, and it’s now their responsibility to fill the order and deliver the requested goods or services. 

As a buyer, your role now is to closely monitor this part of the process by tracking its progress and ensuring the items you receive are aligned with the PO. 

3. Receiving and Verifying The Invoice

Once the goods or services are delivered, the vendor will share an invoice with the buyer as part of the process. This is where the team in charge of the accounts payable process gets to step in and verify that the invoice matches the purchase order and what was received. 

4. Match The PO With The Invoice

It is essential to match invoices, purchase orders, goods received notes (GRN), and inspection reports before payment is made.

This can be done in several ways, depending on the system that best fits your organization:

• Two-Way Matching: A comparison between a purchase order and an invoice.
• Three-Way Matching: A comparison between the purchase order, the delivery receipt, and the invoice.
• Four-Way Matching: A comparison between invoices, purchase orders, goods received notes (GRN), and inspection reports (for quality tolerance) before payment. 

5. Authorize and Process the Payment

This final step of the accounts payable process may also involve several subtasks, which include:

• Coding the invoice: To ensure that expenses are accurately categorized for financial reporting
• Routing for Approval: By sharing the invoice with the appropriate department for approval.
• Submitting Payment: Processing the payment on time after all approvals are obtained from the appropriate departments

• Record The Transaction

Last but not least, you’ll want to make sure that the payment is properly recorded in the general ledger and that the transaction is properly documented and reconciled.

In the final step, the accounts payable process closes the loop, keeping financial records up to date.

How To Improve The Accounts Payable Process

Tracking accounts payable (AP) processes can be challenging, particularly for large organizations, as manual workflows are often complex and prone to human error.

According to a survey, the main issues caused by processing invoice challenges include: 

• Stress to the AP teams (30%)
• Damaged relationships with vendors and suppliers (21%)
• Delays in the delivery of goods and services (20%)

While top processing challenges for AP teams include: 

• Time spent processing invoice exceptions (22%)
• Too much manual data entry (21%)

Fortunately for AP teams, there’s a tool that’s changing that—Enterprise Resource Planning Systems (ERPs).

ERP is business software used to manage, track, automate, and integrate core business processes essential to their operation. The software collects and manages data from several departments, including accounting, supply chain, manufacturing, sales, marketing, and human resources.

There is no better way to streamline the accounts payable process than through automation and using ERP. Implementing an ERP system for AP management can help you streamline operations, improve accuracy, and reduce errors.

Automate up to 75% of accounting and financial tasks with Xledger.