What is Accounts Payable? Definition, Process & Examples

This post was originally published in December 2021 and was updated in October 2024, with more information about the accounts payable process, including how automation can streamline workflows, reduce manual errors, and more.

Accounts payable (AP) are debts owed to a business or individual, which can be in the form of money, goods or services. "Accounts payable" also refers to the list of vendors who have yet to be paid for goods or services they have provided, and this list includes a wide range of different categories. This term derives from the account maintained by a business that lists these credits and debits and includes adjustments for cash discounts and other transactions.

Below are examples of accounts payable activities:

• Filing invoices
• Verifying that invoices are complete and accurate with supporting documentation
• Approving invoices
• Paying invoices
• Reconciling accounts payable records with supplier records

The accounts payable process is primarily concerned with properly recording payments to suppliers per generally accepted accounting principles. Accounts payable are usually paid by the company’s bank account, credit card, debit card or other B2B payment methods.

How to record accounts payable

Recording accounts payable is essential for managing your business's financials accurately. It involves keeping track of money you owe to suppliers or creditors for goods and services received but not yet paid for. Here’s how to do it:

1. Invoice receipt: The process begins once you receive an invoice from a supplier. Check the details such as the amount, terms, and due date for accuracy.
2. Entry into the accounting system: Enter the invoice into your accounting system as a payable under the supplier's name. This entry should include the invoice number, date, amount, and a brief description of the purchase.
3. Categorization: Allocate the expense to the appropriate expense account to keep your financial statements accurate. This categorization helps in understanding how much is spent on different areas of your business.
4. Acknowledgement of liability: By recording an account payable, you acknowledge a liability on your company’s balance sheet. This is crucial for maintaining the accuracy of your financial records.
5. Payment scheduling: Manage cash flow effectively by scheduling payments based on the invoice terms and your cash position.

How to calculate accounts payable

Calculating accounts payable within an accounting period helps businesses manage their cash flow and understand their financial health. Follow these steps:

1.  Start with the beginning balance: Take the opening balance of accounts payable from the start of the accounting period.
2. Add purchases made on credit: Total all purchases made on credit during the period. This does not include cash transactions.
3. Subtract payments made: Deduct all payments made towards vendors or suppliers from the total accounts payable.
4. Adjust for credits and returns: Subtract any credits received or returns made during the period, as these decrease the amount you owe to suppliers.
5. Resulting balance: The resulting figure after following the above steps gives you the ending balance of accounts payable for the period.

How is accounts payable different from accounts receivable?

Though both accounts payable and accounts receivable deal with transactions not immediately settled in cash, they serve opposite functions in the financial ecosystem of a business.

Accounts Payable represents the amount a company owes to its suppliers or creditors for goods and services received. It is considered a liability on the balance sheet because it's money the business needs to pay out.

Accounts Receivable, on the other hand, is the money owed to the company by its customers for goods or services delivered. It represents an asset because it's money the business expects to receive.

Understanding this distinction is crucial for effective cash flow management and maintaining accurate financial records.

Understanding cash flow and accounts payable

The relationship between cash flow and accounts payable is critical to a business’s financial health and operational efficiency. Accounts payable represents the money that a business owes to its suppliers or creditors for goods and services received, but not yet paid for. How a company manages its accounts payable can significantly impact its cash flow, which is the net amount of cash being transferred into and out of a business.

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Accounts payable is a type of account that deals with debts that have been incurred but not yet paid. Business accounts payable can be divided into two types: salaries and expenses. They are typically in the form of supplier invoices, however, accounts payable can also include bills, invoices and checks. Salaries are payable to employees, while expenses are paid to suppliers and government agencies.

Accounts payable examples include:

• Utilities
• Salaries
• Employee wages
• The cost of acquiring goods from suppliers to be sold in store
• Rent for the company’s office space

An organization’s accounting department will send invoices to clients or vendors, then receive payment (cashier’s check, wire transfer, checks, credit cards). Depending on the type, it needs to be categorized as vendor invoices or customer invoices. This way, it can be paid with the corresponding funds.

An accounts payable two-way match refers to when both parties match the amount that they owe each other which completes the transaction. This process is used to record the value of transactions involving more than one account. This process helps accountants find mistakes in the books quicker and with less effort by matching payments to invoices.

Two-way matching is typically done by assigning a code to both the invoice and the payment. The code on the invoice must match that of the payment or the system will reject it.

Typically, there are three methods for implementing a two-way match:

1. Matching payments to invoices on their face value (cash/check/credit card)
2. Matching payments to invoices based on their GL account number (e.g., Accounts Receivable, Inventory Control)
3. Matching payments to invoices based on some other identifier (e.g., customer name, invoice number)

While a two-way match in accounts payable can be complicated, it's worth it as both parties need to ensure that their debts are paid off. When a two-way match exists, it means the accounting of one account impacts the accounting for another account.

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Accounts payable are an essential component of any organization but are also one of the most significant types of liabilities. As accounts payable are an obligation to pay a supplier for goods delivered or work performed on credit terms, they help with the process of managing cash flow. Accounts payable liabilities arise when a company has bought something and has not yet paid the vendor for it, pays too soon, or the company’s accounts payable process fails to meet U.S. GAAP standards.

For example:

• If a company is paying suppliers too soon, they are running the risk of having to pay penalties. It is important to establish a good payment schedule with all vendors and ensure that payments are made on time.
• If a company's accounts payable process does not comply with U.S. GAAP accounting standards, then that company will have to report this as an error in the footnotes of their financial statements and provide an explanation for why it happened and how it will be resolved going forward.

Accounts payable can represent a financial risk to a company because any business has to reimburse its suppliers. They might be a minor liability, but they're still a liability. When an account payable becomes too large, it can become difficult for a company to pay its current obligations and lead to bankruptcy or defaulting on loans.

The accounts payable process

The accounts payable (AP) process is a fundamental aspect of financial management for businesses of all sizes. Operating efficiently, it ensures that a company's obligations to its suppliers and creditors are met on time, without incurring unnecessary costs. Here’s a step-by-step breakdown of the typical accounts payable process:

1. Receiving the invoice: The process starts when the company receives an invoice from a supplier or vendor for goods or services provided. The invoice details what was purchased, the amount due, and the payment deadline.
2. Invoice verification: Upon receipt, the invoice undergoes verification to ensure its accuracy. This involves matching the invoice details with purchase orders and delivery receipts. It's crucial to catch any discrepancies early to prevent payment errors.
3. Approval for payment: Once verified, the invoice must be approved for payment. Depending on the company's internal policies, this might require approval from the department that initiated the purchase or from a higher management level.
4. Updating financial records: The approved invoice is then recorded in the accounting system as an account payable, which helps in tracking how much the company owes and to whom.
5. Scheduling and making payment: Payments are then scheduled according to the payment terms agreed upon with the supplier. By managing this schedule effectively, companies can optimize their cash flow, sometimes taking advantage of early payment discounts or avoiding late payment penalties.
6. Reconciliation: After payment has been made, the accounts payable team will reconcile the payment, ensuring that the amount paid matches the invoice and that the supplier's account balance is updated accordingly.
7. Archiving records: Finally, all relevant documents, including the purchase order, invoice, payment records, and correspondence, are archived for future reference and compliance purposes.

By following these steps, businesses can maintain a smooth and efficient accounts payable process, which is crucial for effective financial management.

The importance of having an effective accounts payable process

An effective accounts payable process is not just about paying bills; it's a critical component of a company’s financial health and operational efficiency. Here are key reasons why it matters:

1. Cash flow management: Efficient AP processes help businesses optimize their cash flow by ensuring that payments are made only when due, thereby retaining cash in the business for as long as possible without incurring late fees. It can also highlight opportunities for early payment discounts.
2. Cost savings: By avoiding late payment penalties and leveraging discounts for early payments, companies can achieve significant cost savings. Moreover, an efficient AP process reduces the likelihood of duplicate payments and overpayments, saving money and the hassle of seeking refunds.
3. Supplier relationship: Timely and accurate payments contribute to healthy relationships with suppliers, which can be advantageous in negotiating better terms, securing discounts, or in time-sensitive supply chain situations.
4. Regulatory compliance: An effective AP process includes maintaining detailed records of all transactions, which is crucial for compliance with tax laws and financial reporting standards. It also helps in audit readiness, significantly reducing the risk of errors and fraud.
5. Strategic financial decisions: A streamlined AP process provides accurate and timely financial data, enabling better forecasting, budgeting, and strategic decision-making. It gives a clear view of the company's liabilities and helps in assessing the company's financial health.

The importance of having an efficiently managed accounts payable process cannot be overstated. It touches upon every aspect of a business’s financial operations and directly influences its bottom line, relationships with suppliers, regulatory compliance, and the ability to make informed, strategic decisions.

The accounts payable process is a vital part of any organization’s financial system. It is how companies pay for the goods and services they purchase.

When optimizing the accounts payable process, there are a few simple steps you can follow to ensure that you’re making the most of your AP department:

• Ensure that no errors are made in accounts payable transactions.
• Automate many of the tasks that are repetitive and low-level onerous. This frees employees to focus on higher-level tasks that require innovation and creativity that are more difficult to automate.
• Communicate with suppliers so that they can provide more accurate delivery times and invoicing formats.
• Share any issues early on or before they arise to shorten payment lag time.

The benefits of AP optimization and AP platform management are numerous: it reduces time spent on processing, increases visibility across the entire process, enhances accountability for all parties involved, and improves accuracy in reporting leading to improved cash flow management.

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