It is hypothesized that the writing system evolved among humans to record financial transactions; the earliest clay tablets dating back to 3000 BCE are accounts of financial records – the “Accounts Payable” of the Mesopotamian and Egyptian civilizations, so to speak.
From then on, the system of tracking financial interactions between vendors and clients has evolved through Contrugli’s double-entry accounting system, Pacioli’s legendary ledger system, the US transportation industry’s streamline of the Account Payable process in the 1960’s, to the current digitally enhanced Accounts Payable Processes adopted worldwide.
Let’s learn more about Accounts Payable best practices and the Accounts Payable Process.
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What is the Accounts Payable Process?
The Accounts Payable Process is the management and execution of the company’s short-term payment obligations to vendors/suppliers. The full cycle of the accounts payable process includes capturing invoice data, GL coding, a 3 way match, flagging errors and approving payments.
It is part of the P2P (procure-to-pay) process that covers all activities from procurement to invoice processing & vendor payments.
All businesses run on interconnected cycles of revenue and expenditure. Accounts Receivable (AR) falls under the revenue cycle while Accounts Payable falls under the expenditure and associated purchase cycles. The Accounts Payable or Account Payable (AP) is the amount of money that a business entity owes to vendors/suppliers for availing their goods/services.
In layman terms, the Accounts Payable Processing is the process that is responsible for paying suppliers and vendors for goods and services availed of by any business. The goal of the AP process is to ensure legitimacy and accuracy of any payment originating from the business.
Most businesses have a separate AP department that handles incoming bills/invoices and the payments made to vendors. The responsibilities of the department may vary depending on the nature and size of the enterprise.
The Basic AP Workflow Process
The scale of Accounts Payable Processing of any organization depends on:
- the number of vendors/service providers that cater to its needs
- the quantum of payment expected to be made over a short period of time
- the types documentation required to validate the purchase process
The AP department may also interface with other departments such as the purchase department in its operations.
For example, a small mom-and-pop store would require only a basic Account Payable procedure. A single ledger can record bills and invoices, in two columns – one for invoices received and the other for payments made. Here the purchase department doubles up as the AP department.
Accounts Payable Processing departments of larger enterprises with more stakeholders cannot function on this single ledger system. They would need procedures involving multiple steps: receiving the Purchase Order (PO) from the purchase department, receiving invoices from the vendor, matching the details on the PO and invoice, validation, approval, and bill payments to the vendor.
In such cases, a more elaborate workflow becomes essential to efficiently manage the high value and volume of transactions.
A simple workflow of the AP process includes the following steps:
At the end of the process, the amount that was “payable” at the first step, would no longer be a liability. There may be intervening processes involving purchase orders, verifications, and approvals, but the basic five steps are essential to avoid errors and fraud in expenditure.
Documents Associated with the AP Process
Depending on the scale of operations, the accounts payable procedures of a company may include many or all of the following documents:
Purchase Order – the PO: The PO is a legally binding agreement issued by the company to the vendor, informing of the type of product/service ordered and the quantity and prices agreed upon. For large companies, multiple entities are involved in the PO process, including, the person/department requesting the goods/services, the purchase department, the accounts payable department, the receiving department, and the vendor.
Receiving report: The receipt of goods/services report is a confirmation of the acquisition of the ordered product/service from the vendor. The details on the receipt report must match those on the PO issued earlier.
Vendor Invoice: Concurrent to or after the receipt of the ordered goods, the business would receive the invoice/bill for the product from the supplier of the goods/services. At the business end, it is called the vendor invoice. The processing of the vendor invoice is the sole responsibility of the AP department, which verifies the details on the invoice by a three-way match among the PO, receipt report and vendor invoice and schedules payments after approval.
Vouchers: Vouchers are sometimes used to “vouch for” the completeness of the approval process – it is like an index to the supporting documents like PO, Receipt report, vendor invoice etc. and contains information on approvals, case numbers and other information related to that particular purchase.
These documents are kept on an “open” file until the payment has been fully processed, after which it is labelled “closed”.
To illustrate, suppose that a buyer, Buyer Inc., requires 10 pen drives for the company. It issues a purchase order to its supplier, Supplier Inc., for the ten items, at a price of, say, $15 per pen drive, to be delivered in five days. The PO is generated by the purchase department, one copy of which is sent to Supplier Inc., one to the AP department, one to the beneficiary department and one to be retained by the purchase department. When Supplier Inc. supplies the pen drives, a receiving report (or a receipt report) is prepared by ABC Inc., by the purchase department and the vendor invoice is filed by the AP department. At this point, the AP department does a three-way match among the PO, receipt report and the purchase invoice to check if the description, quantity, cost, and terms match in all three documents. Once the match is verified by the AP department, the payment is initiated. Not all companies may have the three-way match, but a two-way match between the PO and the invoice is necessary to prevent mismanagement of funds.
The Importance of AP Management and accounts payable workflow
The management of accounts payable processes is critical to the efficient and error-free functioning of a business establishment. Its importance arises because:
- It helps prompt payment of bills, which is important for the creditworthiness of the company and helps establish healthy relationships between the vendor and the company.
- Prompt payments also prevent overdue charges, penalties, or late fees.
- Accounts Payable Processing keeps overspending in check, and prevents multiple/duplicate payments for the same product/service.
- It keeps track of the company’s needs and purchases, which helps avoid delays and interruption in the day-to-day functioning of the company.
- It consolidates all purchase actions for easy retrieval.
- AP processing eliminates fraud through stringent follow-up and checks at every stage of the process.
- It helps better management of cash flow by enabling payments only when due, using the credit facility offered by vendors etc.
The Breadth of the AP Process
The Accounts Payable process encompasses almost all payments made by a business for goods and services; payroll, however, is not part of the AP process, but comes under the class of HR management. The AP maintains records of all financial aspects of purchases made by the company, which is crucial for auditing and tax purposes.
The main goals of the AP are:
- To ensure that payments are legitimate and accurate
- To leverage early payments or dynamic discounts.
The integration of internal controls in the AP process, especially in automated processes eliminates fraudulent or inaccurate payments while ensuring that all invoices are accounted for.
Challenges to the AP Process
Some common challenges to AP processing are:
- Time delays: This is particularly true with manual AP processing because paper documents must be moved across tables and departments. This can cause delays in processing an invoice and paying the vendor. Delays along the account payable cycle can snowball into late receipts of ordered items, poor credit rating, poor relationships with vendors and fees/fines.
- Matching errors: The three-way match is necessary to ensure that all vendor invoices are paid correctly. Discrepancies can occur when there are data entry errors or incorrect billing information, which may take time to identify or fix.
- Exception management: The account payable departments must deal with exceptions such as incomplete and nonmatching information in invoices, which can lead to costly delays.
- Unnecessary purchases: The absence of adequate controls and checkpoints in the accounts payable cycle can result in unnecessary or unauthorized purchases.
- Fraud and theft: AP teams must constantly be vigilant against fraud and theft, both from within the company and without.
- Missing documents: Paperwork can result in misplacement and loss of important documents like invoices. This can lead to a plethora of issues across the accounting payable cycle, starting with friction with the vendor to delayed operations.
- Double payment: Inconsistencies and inefficiencies in documentation can cause a single invoice being paid twice. Double payments can also occur if multiple financial software are used, instead of a single integrated system.
- Blind spots: Paper and manual processes are associated with opacity that prevents AP teams from tracking the cash flow of the company in real time.
- Outsourcing accounts payable activities vs Automating AP responsibilities
Streamlining the Account Payable Cycle
Accounts Payable Processing can be streamlined by centralizing all the relevant AP documents and filing them for easy access. Such streamlining can be enabled by automation. Automating serves the following purposes:
- Eliminates paper clutter, thereby reducing processing time and error rates
- Links POs and invoices with electronics payments, which presents the full picture of the accounts payable cycle
- Helps better vendor management & prevent vendor fraud
- Enables hassle-free three-way matching
- Allows integration of the Accounts Payable process with other core business systems such as ERP and CRM
- Allows setting up of multiple checkpoints in the accounting payable cycle to avoid overspending or unnecessary purchases
- Warnings and alarms can be set when discrepancies are detected at any stage of the accounts payable workflow
- Allows for setting up payment deadlines
- Enables generation of periodic reports to understand the spending patterns of the company and prepare for audits and taxation
Automating the AP Management Process
The digitally enhanced accounts payable workflow is believed to have started in 1978, with Visical, the first spreadsheet software that could be used for accounts management. This was followed by similar software that could help companies computerize their accounting. Today, the digital Accounts Payable Process includes invoice data capture, coding invoices with the correct account and cost center, approving invoices, matching invoices to purchase orders, and posting them for payments.
A variety of accounts payable workflow software use features such as Optical character recognition (OCR) and intelligent data capture (IDC) to automatically capture key bits of data such as the PO number, amount and date. They also use pre-set templates to convert all documents associated with AP management into digital versions.
More recently, all accounting tasks, including the Accounts Payable, are being automated using AI-based technologies. Machine Learning allows the AP system to learn from usual elements of the process and make meaningful suggestions on how to handle these elements in the future. Such AI automation of the AP processes can give the AP team more time to devote to the analytical and administrative functions that benefit the company.