Accounts Payable is a financial obligation that arises out of a transaction between the vendor and the company for acquiring goods and services on credit. The entry appears as a current liability in the balance sheet and comprises the total of unsettled invoices from suppliers. Timely settlement of these outstanding invoices is crucial for companies to evade any potential defaults.
The accounts payable of a company provide an insight into its short-term financial responsibilities and their implications on the cash flow. An escalation in payables signifies the mounting credit-based acquisitions by the company. Conversely, a reduction in payables suggests that the company is discharging its obligations earnestly.
To enable businesses and companies to procure goods and services without upfront payment, banks provide a short-term credit facility through ‘Account Payable Service’. The payment for these goods and services can be made within a fixed time frame, normally, 6 months. This facility enables smooth business operations as well as proper management of cash flow.
What is Accounts Payable?
It is crucial for a business to procure the required goods and services regularly for seamless and hassle-free operations. The cash flow of a business may not be conducive to obtaining these goods and services with upfront payment at all times. At such times, vendors provide these goods and services on credit by defining a time frame for the payment. This financial obligation between the vendor and the buyer is the Accounts Payable meaning. It appears as ‘Accounts Payable’ or creditors in the balance sheet of the company.
Banks now provide ‘Accounts Payable Services’ wherein the company can avail of the goods and services without making upfront payments to the vendors. The company is given a short-term credit facility which has to be repaid within the period stipulated by the bank.
Individuals can also make use of the ‘Accounts Payable’ facility to pay utility bills within the due date for uninterrupted service.
How does Accounts Payable Work?
A short-term financial obligation of a company is reflected in the company’s balance sheet under ‘Accounts Payable’. It refers to a credit arrangement between the seller and the buyer for the exchange of goods and services.
The Accounts Payable System enables the company to acquire specific goods and services without immediate payment. The vendor and the company agree mutually upon a time frame to settle the payment and complete the transaction. These transactions related to accounts payable are orchestrated by banks. In this process, the purchasing company reimburses the bank instead of directly settling the payment with the selling company.
The company will be allotted a time frame by the bank to settle the dues, normally, 6 months. Till such time, the credit transaction will be shown under ‘Accounts Payable’ in the balance sheet of the company. 100% of the value of the goods and services will be funded by the banks.
For all practical purposes, the sale transaction will be considered complete though it does not involve direct money exchange between the vendor and the buyer. While availing of the ‘Accounts Payable’ facility, the company has to provide accurate details of the supplier to the bank. The settlement to the bank should be done within the time frame stipulated.
A limit will be provided under the ‘Accounts Payable’ service which varies with the bank. The time frame as well as the interest charged for the short-term debt also vary with the bank.
What is the Accounts Payable Process?
The Accounts Payable Process revolves around effectively managing a company’s financial commitments to its vendors. The comprehensive process comprises 4 distinct steps.
Capturing the Invoice: Generally, the invoice capture phase entails manual entry of invoice information such as the specifics of the vendor, line item details, amounts and GL coding into a designated record-keeping system. However, this approach carries inherent risks related to accuracy and the possibility of human errors.
Approval of Invoice: This step involves the meticulous evaluation and endorsement of supplier invoices. It’s not uncommon for a member of the accounts payable team to physically transport the paper invoice around the office to gather the necessary approvals. This action takes place prior to recording the expense in the ERP system and initiating the payment process.
Authorisation: Once an invoice is prepared for payment, the authorization to proceed with the payment needs to be obtained. This involves determining the payment submission date, selecting the payment method, and confirming the payment amount.
Payment: After obtaining payment authorization, the invoice is settled, and comprehensive payment details are communicated to the vendor. This often entails tasks like printing, signing, and mailing checks, initiating Automated Clearing House (ACH) transactions with the bank, or conducting credit card payments. With this completed, the invoice can be officially marked as resolved within the system and stored across various repositories.
Difference between Accounts Payable & Accounts Receivable
Accounts Payable and Accounts Receivable are two financial terms that represent distinct aspects of a company’s financial transaction. The difference between Accounts Payable and Accounts Receivable are:
Accounts Payable | Accounts Receivable |
Represents the financial obligation of a company towards its suppliers or creditors for goods and services received on credit | Represents the money that the customers and clients of the company owe to the company for the goods and services received. |
It refers to the company’s short-term liability | It refers to the company’s short-term asset |
It is listed under current liability on the balance sheet | It is listed under current assets on the balance sheet |
Money flowing out of the company | Money coming into the company |
Accounts Payable FAQ:-
Proper management of ‘Accounts Payable’ is required:
For building a good relationship with the suppliers/vendors
For uninterrupted supply of goods and services
To avoid duplicate payments, proper tracking of invoices is necessary
For managing the cash flow of the company
To minimise the risk of fraud
To make the accounts payable process manageable the following are required
Automating the invoice capture process
Insist on digital invoices to reduce paper-work
Set up reminders for payments to ensure timely payments to vendors
Conduct monthly reconciliation
The risks involved in Accounts Payable are:
Errors in data entry
Missing out payment deadlines
Disputes with suppliers
Harming the relationship with suppliers owing to missed payments
Inaccuracies in recording can hamper the creditworthiness of the company
Mounting accounts payable increases, the current liability of the company. It will have a direct impact on the company’s working capital and liquidity position. It reflects the inability of the company in managing short-term financial commitments.
Some suppliers offer early payment discounts to promote prompt payment. The company can reduce the outstanding accounts payable by taking advantage of the discount. However, this will have an impact on the cash on hand of the business. Businesses should consider the cash flow needs and then determine if the early payment has any benefit.