What is accounts payable? The ultimate guide for SMBs
- Part 1: What is accounts payable?
- Part 2: Understanding the accounts payable process
- Part 3: Grow your business with account payable automation
- Part 4: Accounts payable fraud prevention
- Why accounts payable is so crucial
As a business owner, you’ve probably encountered the term accounts payable (sometimes referred to as “AP”) in one way or another. But what exactly is it?
Accounts payable is a critical component of financial management and can impact a business’s bottom line. That’s why we created this guide, which will help you understand what AP is, its importance, and how to effectively manage it.
Part 1: What is accounts payable?
Accounts payable represents any short-term balance your business owes vendors and suppliers for services or goods you’ve received but have not paid for yet.
In business-to-business (B2B)Business-to-business (B2B)Business-to-business (B2B) refers to operations done between businesses. B2B payments are transactions made between two businesses or companies. transactions, when you buy goods or services, most of the time, the payment is not made on the spot. Your vendor will give you a certain payment term. Once you receive an invoice, you create the AP balance. Only once payment has been made, the debt is removed from your accounts payable balance.
Knowing how much money your business owes and when payment is due it really important. Not only will it help ensure you maintain proper cash flow but it’ll also make sure you avoid getting into debt or late payments.
Here are some examples of bills and payments that are included in your accounts payable:
- Commercial rent
- Utility bills
- Regular payments on loans that the business has taken
- Reimbursements to employees for business-related expenses like travel or training costs
- Payments due based on contractual obligations, such as long-term service agreements
Note that debt is classified as AP only upon receiving invoice or payment terms. Before you receive an invoice, the debt isn’t yet included in your AP.
Common terms and definitions associated with accounts payable
Accounts receivable (AR): Any payment you expect to receive and have already sent an invoice for, is considered AR. Even though AR refers to money that hasn’t been paid yet, it’s listed on the balance sheet as a current asset. Plus, any amount of money owed by customers for purchases made on credit is considered AR.
Assets: Anything the business owns that has monetary value or can produce future economic benefits is referred to as an asset. There are two main types of assets:
- Tangible assets: Physical or quantifiable objects with a clear financial value. They go on your balance sheet and are divided into two main categories: current assets and non-current assets.
- Current assets: Anything tangible that a company expects to produce real cash within a 12-month period is considered a current asset.
- Non-current assets: Tangible assets that aren’t expected to be turned into cash within a year. These are long-term investments that are not directly meant to produce profit any time soon.
- Intangible assets: Assets that are not physical objects you can touch or count are considered intangible assets. While they have monetary value, which affects the company’s worth, it is often difficult to quantify. They are usually not included in the balance sheet.
Balance sheet: A financial statement businesses file annually. It offers a quick view of a business’s financial situation by listing assets, liabilities, and equity, three of the most basic indicators of a business’s financial health.
Capital: This refers to the money available to start operations and invest in growth. Think of capital as the fuel that powers a company’s engine, providing the initial resources to set things in motion and keep them going. This can include the owner’s investments and retained earnings from profitsProfitProfit is the earnings that remain after you deduct expenses from revenues. Net profit is what’s left when all types of expenses are deducted from sales. Gross profit is what’s left after deducting the costs associated with making and selling the products, or the costs associated with providing services..
Cash flow: The total flow of money coming in and going out of your business. Positive cash flow means more money is coming in than going out, which is vital for covering bills and salaries. Negative cash flow, on the other hand, can spell trouble and might require borrowing money or making adjustments.
Expenses: When you own a business, expenses are a part of the deal. Any money you need to spend is an expense and it can include payments for supplies, rent, utility bills, payroll, etc.
Liabilities: Everything a business owes. This can be money, labor, or goods. All liabilities should be included in the balance sheet and divided into two main categories: current and non-current liabilities.
- Any debt a company intends to clear within the next year is listed under current liabilities.
- Any debt that will take longer than 12 months to cover a year is a non-current liability.
Payroll: The total amount of money that a company pays its employees for their work during a specific period is known as payroll. This includes not only their basic salaries or wages but also any bonuses, commissions, overtime pay, employer costs like social security, 401K if relevant, and deductions like taxes. It’s important to note that payroll isn’t a part of your accounts payable and is recorded separately.
What’s the difference between accounts payable and accounts receivable
Accounts receivable and payable are basically two sides of the same coin. While AR is everything your business is owed, AP is everything your business owes. That includes all your business expenses such as rent, taxes, utility bills, supplies, and vendors.
Why is accounts payable important in financial management
Accounts payable plays a pivotal role in a business’s financial operations. That’s because it includes funds owed to various entities like suppliers, service providers, landlords—for the goods, services, and facilities the business utilizes. The proficient management of this financial aspect is integral to the overall well-being of any small business.
Effectively handling accounts payable gives the business control over when payments are made. This is important for keeping enough money available for its day-to-day as well as large or unexpected expenses. It lets the business pay on time, use discounts for early payment, and avoid unnecessary fees. It also helps create good relationships with vendors and suppliers, which can mean better payment terms and smoother deals.
The role of accounts payable in cash flow management
The effective management of accounts payable allows your business to control when payments are made to suppliers. This means that by strategically scheduling payments, you can ensure that you hold onto cash for as long as possible, maximizing its liquidity. Having enough liquidity to meet your short-term obligations means you still have funding for your daily operations or unexpected expenses.
In addition, the accurate management of accounts payable provides a clearer view of future cash outflows. This is crucial for cash forecasting, which allows you to plan for upcoming expenses and ensure that your business has sufficient funds available.
Part 2: Understanding the accounts payable process
By now, you probably understand that there is no business that can do without accounts payable. Like it or not, you will need to pay bills and do it in a timely manner. Since there’s no way around it, let’s dive in and examine how the accounts payable management process works.
The steps involved in the accounts payable process
There are three steps to processing accounts payable:
- Review the bill: Check to see that everything makes sense. Do the details in the bill correspond with the type and amount of goods or services ordered? Were the goods or services received in full? Are the calculations correct?
- Record the bill in your books: Add the bill to your accounting software or bill pay service. Double-check check the details (amount, date, vendor name, etc.) are correct. Whether you’re using QuickBooks Online, FreshBooks, or another accounting software, once you add the bill to your account, it updates your accounts payable entry accordingly.
- Pay the bill on time: When we say on time, we don’t mean before its time. We mean paying the bill as close as reasonably possible to its due date, without risking a late payment. Why? Cash flow. Your business’s lifeline depends on its ability to hold on to its cash reserves for as long as possible. If you’re not getting an early payment discount on your bill, there’s no reason to pay it before it’s due. If you’re worried about missing a payment, you can schedule it in advance using a digital AP tool (like Melio), so it goes out just in time, not a minute too soon.
The role of various stakeholders in the process
Even though the basics are always the same, companies of different sizes have different people involved in the AP process.
If you’re a sole proprietorSole proprietorA sole proprietorship is a simple business structure where there’s only one owner. A sole proprietorship is easy to set up or take apart, due to a lack of government regulation. As such, they are very popular among sole owners of businesses, individual self-contractors, and consultants., it’s most likely you manage the process from A to Z. That means you, as the company’s owner and operator, receive the bill, review it, update the books, and eventually pay the bill. If you work with an external accountant, however, they’re likely the ones taking care of the books. Some accountants pay vendors themselves as well, for an additional cost.
Bigger companies, with 50 employees or more, on the other hand, may have someone who’s in charge of reviewing bills and recording them, someone to actually send the payments, and a signatory that signs on the payments.
Either way, it’s important to make sure anyone involved knows what their part in the process is to guarantee nothing is missed and that payments go out on time.
Best practices for account payable management
If you’re keeping your AP in-house, here are some things you can do to improve the process without investing too much money or resources.
For most small businesses, daily payment handling isn’t necessary. Shifting attention between tasks wastes time, a precious resource for a small business. By being more organized, you can process outgoing payments on set dates, like the first and 15th of each month, streamlining the process.
File invoices immediately
You don’t want to pay too soon. That’s okay. However, paying and filing invoices serve distinct purposes. While the payment can wait, it’s crucial to promptly handle received invoices to prevent oversight. Whether forwarding them to the AP person or scheduling them for the next payment cycle, avoid stashing them until due. Neglecting this risks damaging vendor relationships due to missed payments.
Implement payment approval workflows
Establishing a transparent payment approval system is key to a smooth AP process. It involves rules that dictate who can send payments and which transactions need higher-level authorization.
Determining approvers, whether the owner or a manager, provides oversight and minimizes mistakes and the risk of fraud. New vendors or updated account information demand added scrutiny, necessitating specific rules for such cases.
Negotiate and repeat
Preferable payment terms enhance the flexibility and ease of managing AP. Yet, vendors usually won’t proactively improve terms or provide favorable conditions unless prompted. It’s time to reach out to vendors and:
- Seek bulk concessions or special pricing if you’re a major customer or handle a sizable nonperishable stock.
- Inquire about early bird discounts to benefit both you and your vendor’s cash flow.
Despite the mess and errors of manual paper-based AP processes, many businesses still rely on them due to perceived cost-effectiveness or control. However, embracing a digital platform for AP management offers significant benefits:
- Saving time and letting you focus on revenue generation
- Automating recurring payments like rent and utilities
- Reducing human error and associated costs
- Centralizing payment tracking and preventing oversights
- Cutting labor, supply, bank, postage, and delivery costs
- Supporting environmental goals through paperless operations
Use your credit card
If you have bills due soon and your current cash flow can’t cover them, consider the option of paying with a credit card. This way, your vendor receives immediate payment confirmation, while you can defer the actual cash payment until your next billing cycle, potentially granting you up to 60 extra days before coughing up the funds.
Beware of fraud
While many believe they’re immune, fraud is more prevalent than expected, costing businesses roughly 5% of revenue annually. Small businesses, lacking awareness and resources, are vulnerable targets. However, even with constraints, effective safeguards are achievable. For accounts payable, simply verifying invoice details against records and consulting vendors when uncertain can notably reduce exposure to fraud.
Common challenges in the process and how to overcome them
A smooth AP process is crucial to the proper function of any business. But, there are several challenges that come with the territory—especially when working manually. The good news is, there are solutions to most of the problems. Digitizing the AP process is key.
Late (or early) payments
When it comes to handling your bills, finding the right balance is essential. Delayed payments can strain vendor relationships, leading to late fees or even legal action. Conversely, paying too early can drain your cash reserves, which is particularly impactful for smaller businesses.
A digital bill payment solution allows you to schedule payments in advance, ensuring they’re timed perfectly—not a moment too early. This approach benefits both your cash flow and vendor relationships.
Bookkeeping errors can cost businesses a hefty sum in fines and fees. From miscalculations and typos in mailing addresses or bank information to duplicate payments that drain your account, human error is common when manually managing payments and bills.
Digitizing your accounts payable minimizes these types of mistakes. It also helps by automatically reconciling your invoices, so you don’t mistake the status of a bill and pay twice.
Being caught off guard by money coming out of your account can be daunting. If more than one person on your team handles the bills, this can be an issue. What if, for example, someone on your team decides to pay an unusually high bill, without knowing you were counting on the balance to pay off a more pressing expense.
Digital AP systems offer workflow management options so you can assign roles to team members and accountants and set approval thresholds. This way, you can ensure no funds leave your account without you knowing about it.
You probably know by now how inefficient the AP process can be when done manually. Digital AP tools save time and sweat by automating recurring payments, saving your payment and vendor details for next time, and scheduling all your transactions in advance.
The average cost of processing a single invoice for novice businesses is between $15 and $40. So, if your business has 25 bills to pay each month, the cost of processing them could amount to $12,000 a year. And that’s on top of the sum due.
Changing how you handle payments can eliminate much of this cost. The most important change here is following in the footsteps of small businesses across the country and switching to a digital AP tool. This means saving on staff hours that can be put to better use, avoiding late fees and penalties, reducing the need for physical goods like envelopes, and stamps, and eliminating most risks.
Part 3: Grow your business with account payable automation
Using software to manage your AP is one of the most important tools your business can utilize to maintain cash flow. It automates your bill pay process and lets you do everything digitally and from one place.
The benefits of automating the accounts payable process
- Time savings: Traditional AP management involves manual tasks like collecting invoices and writing checks, which can be time-consuming. Even small businesses spend several hours weekly on these tasks. Automating bill payments can reduce this workload by up to 80%.
- Reduced errors: Accurate accounting is vital for business financial health. Small business owners often need to address human errors in accounting. Automation, including of the bill payment process, can minimize these errors, leading to meticulous accounting.
- Remote accessibility: AP software empowers you to pay vendors remotely using your phone. This not only saves time but also eliminates the need for physical presence or paper checks.
- Enhanced security: Digital payments provide a secure trail and reduce the risk of loss or theft. AP software offers immediate payment confirmations for both you and your vendors. Top-notch security protocols and encryption tools are integrated into online payment services, enhancing data privacy and minimizing fraud risks.
Different types of accounts payable automation solutions
There are several types of services you can use to automate your accounts payable.
- Electronic invoice processing software: This software facilitates the electronic handling of invoices, leading to time and paper savings. Moreover, it plays a pivotal role in error reduction and elevating accuracy levels.
- Bank services: Most banks offer their business clients bill pay solutions that enable the automation of some parts of the payment workflow. Alongside expediting the payment process, it aids in minimizing delayed payments, thus contributing to effective cash flow management.
- Accounts payable software: Software like Melio streamlines the entire accounts payable procedure, encompassing everything from invoice processing to payments. By automating these tasks, not only will you save substantial time and resources but also enhance overall efficiency.
Factors to consider when choosing an accounts payable automation solution
- Flexibility: Some bill pay tools, like Melio, give both you and your vendors payment flexibility. Say you have one vendor who insists on receiving paper checks and another who prefers an ACH bank transfer or wire. You, on the other hand, want to pay both of them with your card, to extend your float. You’ll need to look for AP software that gives both you and your vendors what you want.
- Ease of use: Choose AP software that’s intuitive and easy to use so you and your team can get the hang of it quickly.
- Trackability: One of the most important things when running a business is keeping the books in check at all times. Choose an AP solution that syncs with your accounting software so that every time you make a payment, it’s updated in both systems.
- Cost-effectiveness: AP software can charge subscription fees and transaction fees. But, not all solutions charge for both or have the same pricing mechanism. Check what your most common transactions are and how much you currently spend on them. Then compare the price of various services and pick the option that charges you less.
- Approval workflows: Choose an AP solution that lets you keep control over your finances by assigning roles to people in your organization and setting thresholds for payments requiring authorization.
Part 4: Accounts payable fraud prevention
Manual payment processes create increased risks related to internal fraud exposure. In this section, we’ll take a look at some of the more common AP fraud practices and how to prevent them.
Common types of accounts payable fraud
Fraud by an employee can result in significant financial losses, depending on its duration, frequency, and transaction amounts. This deceptive practice takes on various forms, with the most prevalent ones being:
- Billing schemes: Crafted to appear as legitimate payments, billing schemes involve fraudulent transactions to beneficiaries linked to employees. This can be tough to uncover as scammers may establish shell companies, generating false invoices to mimic real suppliers.
- Employee reimbursement fraud: This challenging-to-detect type of fraud involves employees submitting false expense claims to receive reimbursements.
- Kickback fraud: In kickback schemes, suppliers collaborate with your employees to siphon money from your business. By inflating supplier invoices and sharing the proceeds, the involved employee, often equipped with payment execution authority, facilitates this deceit.
External fraud occurs when entities outside your company attempt to pilfer its funds or sensitive payment data. Familiarize yourself with common fraud types and emerging trends to shield your business.
- Wire transfer scams: Scammers capitalize on wire fraud, posing as familiar contacts or trusted sources, like vendors or business partners. They coerce you into making direct wire transfers to their accounts. Notably, one Dutch company was duped into a 750,000 euro transfer to a purported supplier.
- Phishing attacks: Phishing attacks encompass emails, calls, texts, or malicious websites. Given that 75% of organizations face them, awareness is crucial. These attempts aim to deceive recipients into believing they’re engaging with credible entities.
- Identity theft: Cybercriminals engage in identity theft to exploit your information under false pretenses. The objectives parallel other frauds: gaining unauthorized access to sensitive data or manipulating you and your colleagues to collect illegitimate payments.
- Account takeover: Recognizing account takeovers proves challenging, as external actors gain entry using stolen or misused credentials. Once in, they access account-related information, enabling them to execute fraudulent payments or deceive others into doing so.
How to prevent accounts payable fraud
- Automate the AP workflow: First and foremost, you should implement an automated AP workflow that aligns with cybersecurity protocols. Solutions like Melio enhance security in payment processes, safeguarding against potential fraud issues.
- Invoice verification: Verify bills before payment, confirming products or services received. Restrict invoice authorization to minimize scam risks.
- Secure banking: Maintain separate business and personal bank accounts and credit cards to thwart hackers. If one account is breached, the others remain protected.
- Monitor finances: Review bank statements, payroll records, and balance sheets frequently to catch fraud early. Opt for online bill handling to avoid keeping confidential details in the office.
- Obtain insurance: Fidelity insurance shields your business against internal fraud losses, covering acts like forgery, credit card fraud, and embezzlement.
- Access management: Periodically assess who has account access. Delegate through individual logins but limit permissions to necessary tasks.
- Vendor screening: Obtain recommendations from trusted sources or research businesses online for potential scams before collaborating.
- Password rotation: Change passwords regularly to minimize vulnerability. Reset all passwords annually or biannually, especially if shared among team members.
- Enable Notifications: Activate email and SMS notifications for real-time awareness of account activities.
If you want to learn more about fraud prevention, check out our fraud protection guide.
Why accounts payable is so crucial
Accounts payable is a critical component of financial management for any business. This guide provides a comprehensive overview of accounts payable, including its definition, process, automation, metrics, and fraud prevention. By implementing best practices and leveraging technology, businesses can optimize their accounts payable process, reduce costs, and improve overall financial performance.
Debating whether you should outsource your AP process? Read more