Account Payable Process

The accounts payable process or function is immensely important since it involves nearly all of a company’s payments outside of payroll. The accounts payable process might be carried out by an accounts payable department in a large corporation, by a small staff in a medium-sized company, or by a bookkeeper or perhaps the owner in a small business. The accounts payable cycle refers to the complete sequence of steps from invoice receipt to payment, ensuring all obligations are met accurately and on time.

The accounts payable process is important for financial management and compliance, as it helps maintain strong vendor relationships, supports cash flow management, and ensures accurate financial reporting.

Regardless of the company’s size, the mission of accounts payable is to pay only the company’s bills and invoices that are legitimate and accurate. This means that before a vendor’s invoice is entered into the accounting records and scheduled for payment, the invoice must reflect:

• what the company had ordered

• what the company has received

• the proper unit costs, calculations, totals, terms, etc.

To safeguard a company's cash and other assets, the accounts payable process should have internal controls. A few reasons for internal controls are to:

• prevent paying a fraudulent invoice

• prevent paying an inaccurate invoice

• prevent paying a vendor invoice twice

• be certain that all vendor invoices are accounted for

Periodically companies should seek professional assistance to improve its internal controls. Accounts payable staff play a key role in maintaining the integrity of these processes and ensuring compliance.

The accounts payable process must also be efficient and accurate in order for the company’s financial statements to be accurate and complete. Because of double-entry accounting an omission of a vendor invoice will actually cause two accounts to report incorrect amounts. For example, if a repair expense is not recorded in a timely manner:

1. the liability will be omitted from the balance sheet, and

2. the repair expense will be omitted from the income statement.

A manual accounts payable process can lead to errors, delays, and lack of visibility, making it difficult to ensure accuracy and efficiency.

1. the liabilities will be overstated, and

2. repairs expense will be overstated.

Inefficiencies in the accounts payable process can negatively impact the company's financial health and result in inaccuracies in the company's financial statements.

In other words, without the accounts payable process being up-to-date and well run, the company’s management and other users of the financial statements will be receiving inaccurate feedback on the company’s performance and financial position. Optimizing the AP process is essential for reducing errors, improving workflow, and supporting overall financial management.

A poorly run accounts payable process can also mean missing a discount for paying some bills early. If vendor invoices are not paid when they become due, supplier relationships could be strained. Managing accounts payable efficiently is crucial to avoid missed discounts and maintain positive supplier relationships. This may lead to some vendors demanding cash on delivery. If that were to occur it could have extreme consequences for a cash-strapped company.

Just as delays in paying bills can cause problems, so could paying bills too soon. If vendor invoices are paid earlier than necessary, there may not be cash available to pay some other bills by their due dates.

Accounts payable represents the amount a business owes to suppliers for goods and services purchased on credit, and effective management of these liabilities is vital for maintaining financial stability.

Maintaining the entire accounts payable process is essential for accurate financial reporting and smooth business operations.

Purchase order

A purchase order or PO is prepared by a company to communicate and document precisely what the company is ordering from a vendor. The paper version of a purchase order is a multi-copy form with copies distributed to several people. The people or departments receiving a copy of the PO include:

• the person requesting that a PO be issued for the goods or services

• the accounts payable department

• the receiving department

• the vendor

• the person preparing the purchase order

The purchase order will indicate a PO number, date prepared, company name, vendor name, Purchase orders also help the company prepare for incoming bills and invoices from vendors, ensuring that all subsequent documents can be matched and processed efficiently.

The purchase order will indicate a PO number, date prepared, company name, vendor name, name and phone number of a contact person, a description of the items being purchased, the quantity, unit prices, shipping method, date needed, and other pertinent information.

One copy of the purchase order will be used in the three-way match, which we will discuss later.

Receiving report

A receiving report is a company's documentation of the goods it has received. The receiving report may be a paper form or it may be a computer entry. The quantity and description of the goods shown on the receiving report should be compared to the information on the company's purchase order.

After the receiving report and purchase order information are reconciled, they need to be compared to the vendor invoice. Hence, the receiving report is the second of the three documents in the three-way match (which will be discussed shortly).

Vendor Invoice

The supplier or vendor will send an invoice to the company that had received the goods and/or services on credit. These are also known as supplier invoices and represent outstanding bills for goods and services. When the invoice or bill is received, the customer will refer to it as a vendor invoice. Each vendor invoice is routed to accounts payable for processing. As part of the approval process, the vendor's invoice must be cross-referenced with purchase orders and receiving reports. After the invoice is verified and approved, invoice approval is a crucial step before payment is scheduled, ensuring all necessary internal checks are completed. The amount will then be credited to the company’s Accounts Payable account and will also be debited to another account (often as an expense or asset).

Three-way match

The accounts payable process often uses a technique known as the three-way match to assure that only valid and accurate vendor invoices are recorded and paid. The three-way match involves the following:

Only when the details in the three documents are in agreement will a vendor’s invoice be entered into the Accounts Payable account and scheduled for payment. This process helps prevent payment errors by ensuring all documents are reconciled before payment.

Good internal control of a company’s resources is enhanced when the company assigns a separate employee with a specific, limited responsibility. The following chart illustrates the concept of the separation (or segregation) of duties involving accounts payable:

When the duties are separated, it will require more than one dishonest person to steal from the company. Hence, small companies without sufficient staff to separate employees’ responsibilities will have a greater risk of theft.

To illustrate the three-way match, let’s assume that BuyerCo needs 10 cartridges of toner for its printers. BuyerCo issues a purchase order to SupplierCorp for 10 cartridges at $60 per cartridge that are to be delivered in 10 days. One copy of the PO is sent to SupplierCorp, one copy goes to the person requisitioning the cartridges, one copy goes to the receiving department, one copy goes to accounts payable, and one copy is retained by the person preparing the PO. When BuyerCo receives the cartridges, a receiving report is prepared.

The three-way match involves comparing the following information:

1. The description, quantity, cost and terms on the company's purchase order.

2. The description and quantity of goods shown on the receiving report.

3. The description, quantity, cost, terms, and math on the vendor invoice.

After determining that the information reconciles, the vendor invoice can be entered into the liability account Accounts Payable. The information entered into the accounting software will include invoice reference information (vendor name or code, invoice number and date, etc.), the amount to be credited to Accounts Payable, the amount(s) and account(s) to be debited and the date that the payment is to be made. The payment date is based on the terms shown on the invoice and the company’s policy for making payments. Before the payment is executed, payment authorisation and payment authorization are required steps to ensure compliance with company policies.

Lastly, the documents should be stamped or perforated to indicate they have been entered into the accounting system thus avoiding a duplicate payment.

Vouchers

Some companies use a voucher in order to document or “vouch for” the completeness of the approval process. You can visualize a voucher as a cover sheet for attaching the supporting documents (purchase order, receiving report, vendor’s invoice, etc.) and for noting the approvals, account numbers, and other information for each vendor invoice or bill. Handling paper invoices in this process can increase administrative burden and the risk of errors, which is why some companies are moving toward digital solutions.

When the vendor invoice is paid, the voucher and its attachments (including a copy of the check that was issued) will be stored in a paid voucher/invoice file. The voucher file serves as a record of the final payment made for each invoice, ensuring accurate reconciliation and supporting financial accuracy. If paper documents are involved, an office machine could perforate the word “PAID” through the voucher and its attachments. This is done to assure that a duplicate payment will not occur.

The unpaid invoices and vouchers will be held in an open file.

Vendor invoices without purchase orders or receiving reports

Not all vendor invoices will have purchase orders or receiving reports. Hence, the three-way match is not always possible. For example, a company does not issue a purchase order to its electric utility for a pre-established amount of electricity for the following month. The same is true for the telephone, natural gas, sewer and water, freight-in, and so on.

There are also payments that are required every month in order to fulfill lease agreements or other contracts. Examples include the monthly rent for a storage facility, office rent, automobile payments, equipment leases, maintenance agreements, etc. Invoice payments for these obligations are often scheduled in advance to ensure timely payment. Payment scheduling helps manage these recurring expenses efficiently. Many companies use the automated clearing house (ACH) network to process these payments electronically, streamlining the payment process. Even though these obligations will not have purchase orders, the responsibility is unchanged: Pay only the amounts that are legitimate and accurate.

Statements from vendors

Vendors often send statements to their customers to indicate the amounts (listed by invoice number) that remain unpaid. When a vendor statement is received the details on the statement should be compared to the company’s records.

The fact that a company can be receiving both invoices and statements from a vendor means there is the potential of a duplicate payment. In order to avoid making a duplicate payment, companies often establish the following rule: Pay only from vendor invoices; never pay from vendor statements. Companies should pay invoices directly to ensure accuracy and avoid duplicate payments. This practice helps maintain accurate vendor payments and supports strong vendor relationships.

Automation and Technology in Accounts Payable

The adoption of automation and technology has transformed the accounts payable process, making it more efficient and less prone to human error. AP automation solutions can capture invoice data electronically, automate approval workflows, and streamline payment processing, significantly reducing the need for manual tasks. These systems provide real-time visibility into cash flows, enabling better financial management and more informed decision-making. By leveraging AP automation, accounts payable teams can focus on higher-value activities such as vendor management and financial analysis, rather than spending time on repetitive data entry. Automation not only enhances the accuracy and speed of the payable process but also helps organizations stay agile and competitive in today’s fast-paced business environment.

Best Practices and Optimization

Optimizing the accounts payable process requires the implementation of best practices that promote efficiency, accuracy, and transparency. Key strategies include timely invoice capture, precise data entry, thorough reconciliation, and prompt payment execution. Regular training ensures that the accounts payable team remains knowledgeable about the latest technologies and industry standards, while ongoing monitoring and evaluation help identify opportunities for process improvement. By adopting a proactive approach to accounts payable management, businesses can minimize errors, reduce operational costs, and enhance their overall financial performance. A commitment to continuous improvement in the payable process ensures that the organization remains adaptable and competitive.

Common Challenges and Solutions

Despite its importance, the accounts payable process can present several challenges, such as duplicate payments, late payments, manual data entry errors, and ineffective vendor management. These issues can negatively impact a company’s financial health and disrupt operations. To address these challenges, businesses can implement AP automation software, establish robust invoice processing workflows, and utilize vendor portals for better communication and transparency. Regular audits and process reviews are also essential for identifying and correcting inefficiencies or errors. By proactively tackling these common obstacles, organizations can optimize their accounts payable process, strengthen financial management, and achieve greater efficiency and productivity.

View Our Services here!

Call Irvine Bookkeeping today if you have any questions regarding statement of cashflows. You reach us at 949-545-9980 or visit us at www.irvinebookkeeping.com