Accounts payable: definition, examples & best practices

Managing accounts payable is a delicate balancing act that includes managing cash flow, maintaining healthy supplier relationships, ensuring accurate financial reporting, and more. In this article, we’ll start to unravel these complexities and give you a clear understanding of accounts payable. We’ll also explore a few strategies to manage accounts payable more effectively.

What is accounts payable?

Accounts payable (AP) refers to the amount a company owes its suppliers, vendors, or other entities for goods and services purchased on credit. These short-term financial obligations are recorded as liabilities on a company's balance sheet and must be paid within a specified time frame, typically ranging from 30 to 90 days.

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AP is an important part of double-entry bookkeeping, which requires that each transaction be recorded twice: once as an asset and once as a liability. When a company purchases goods or services on credit, it records the purchase as an asset in its books while simultaneously recording the debt owed to its supplier as a liability. This ensures that both sides of the transaction are accurately tracked. Unlike cash-basis accounting, accrual recognizes that debts are not necessarily paid immediately but when they are due.

What does accounts payable do?

Accounts payable (AP) manages a company's financial obligations to suppliers, vendors, and creditors. The key functions of accounts payable include:

• Recording transactions: AP ensures that all invoices for goods and services purchased on credit are accurately recorded in the company's accounting system. This involves verifying the accuracy of invoice details, such as amounts, payment terms, and vendor information.
• Tracking due dates: AP keeps track of payment due dates for each invoice, helping the company avoid late payment penalties and maintain good relationships with suppliers.
• Processing payments: Accounts payable is responsible for processing payments to suppliers, vendors, and creditors as per the agreed-upon payment terms. This can involve scheduling and approving electronic transfers, issuing checks, or making other forms of payment.
• Reconciling accounts: AP regularly reconciles the company's payable accounts by comparing outstanding balances with vendor statements and resolving any discrepancies that may arise.
• Maintaining vendor relationships: By ensuring timely and accurate payments, accounts payable maintains positive relationships with vendors and suppliers, essential for smooth business operations.
• Internal controls and compliance: Accounts payable enforces internal controls and adheres to regulatory requirements, such as tax laws and financial reporting standards, to prevent fraud and errors and ensure compliance.
• Cash flow management: By monitoring and managing payment schedules, AP contributes to effective cash flow management, helping the company optimize its working capital and maintain financial stability.

Accounts payable examples

In each of these examples, the company incurs an expense or acquires goods or services on credit, creating an accounts payable obligation:

• Inventory Purchases: A retail store orders products from a wholesaler on credit terms of net 30 days. The amount owed to the wholesaler for this purchase would be filed under accounts payable until paid within the agreed-upon 30-day period.
• Office Supplies: A law firm purchases office supplies, such as paper, pens, and printer cartridges, from a local supplier on credit. The outstanding amount owed to the supplier would be filed under accounts payable until the law firm makes the payment.
• Utilities: A factory receives a monthly water bill but has not yet paid the amount due. This unpaid bill is filed under accounts payable until the factory pays the utility provider.
• Equipment Rental: A construction company rents heavy machinery for a specific project and receives a monthly statement from the equipment rental company. Until it pays the rental invoice, the outstanding balance is filed under accounts payable.
• Advertising Expenses: An e-commerce business runs an advertising campaign with a media agency and receives an invoice for the services provided. The amount due to the media agency is filed under accounts payable until the e-commerce company pays the invoice.

Assets vs. liabilities

Understanding the difference between assets and liabilities will help you manage your financial obligations and maintain a healthy financial position. Accounts payable falls under liabilities, specifically current liabilities, representing short-term debts owed to suppliers, vendors, or creditors.

Assets

Assets are resources owned or controlled by a company that hold economic value and are expected to provide future benefits. Assets are crucial in generating income, supporting business operations, and contributing to the organization's financial health.

Assets are generally classified into the following categories:

• Current Assets: These are short-term assets you can be converted into cash or used up within one year, such as cash, accounts receivable, inventory, and short-term investments.
• Fixed Assets: These assets are a type of tangible resource used to produce goods or services. They are also commonly referred to as non-current or long-term assets. Unlike other assets meant to be sold during business operations, fixed assets are used for internal purposes only. Fixed assets include land, buildings, warehouses, machinery, vehicles, computers, and office furniture.
• Financial Assets: These assets derive value from contractual claims or ownership rights. They represent investments in financial instruments, loans, or other entities and can generate income through interest, dividends, or capital gains. Examples of financial assets include equity investments, bonds, bank deposits, loans receivable, and certificates of deposit.
• Intangible Assets: These are non-physical assets that have value due to their legal rights or competitive advantages. Intangible assets include patents, trademarks, copyrights, and goodwill.

Liabilities

Liabilities are debts or obligations that a company owes to third-party creditors. Liabilities represent a future cash outflow and are usually settled over time. Liabilities fall into two main categories:

• Current Liabilities: These are short-term financial obligations or debts that a company must settle within one year or one operating cycle. These liabilities arise during business operations and represent amounts owed to external parties, suppliers, lenders, or employees. They include accounts payable, accrued expenses, short-term debt, and deferred revenue.
• Non-Current Liabilities: These are long-term obligations due beyond one year, such as long-term loans, bonds payable, and deferred tax liabilities.

Best practices for managing accounts payable

Effective accounts payable management is essential for maintaining good vendor relationships, ensuring accurate financial reporting, and optimizing cash flow. Here are some best practices for managing accounts payable:

• Establish clear policies and procedures: Develop and document standard operating procedures for handling accounts payable, including invoice processing, approval workflows, payment terms, and dispute resolution.
• Centralized invoice processing: Streamline the accounts payable process by centralizing invoice receipt, data entry, and approval. This can help reduce errors, improve efficiency, and ensure timely payments.
• Automate where possible: Utilize accounts payable software or automation tools to minimize manual tasks, reduce errors, and speed up processing times.
• Regularly review and reconcile accounts payable: Periodically review the accounts payable ledger to ensure that all invoices are accurately recorded, and payments are made on time. Reconcile accounts payable balances with supplier statements and promptly address any discrepancies.
• Monitor cash flow: Regularly review cash flow projections to ensure the company has sufficient funds to meet its short-term obligations, including accounts payable. Adjust payment schedules or negotiate extended payment terms with suppliers if needed.
• Leverage early payment discounts: Take advantage of early payment discounts offered by suppliers to reduce costs and improve cash flow.
• Implement a system of internal controls: Establish a robust system of internal controls to prevent fraud, detect errors, and ensure the accuracy of financial reporting. This may include segregation of duties, approval limits, and regular internal audits.
• Continuously improve the process: Regularly review and analyze the accounts payable process to identify opportunities for improvement, such as reducing processing times, cutting costs, or enhancing controls. Implement changes and monitor their impact on performance.

Take charge of your accounts payable with Ramp

Ramp's accounting automation platform streamlines and optimizes the AP process with real-time data sync, automated invoice processing, and integrated payments. Ramp’s automation capabilities simplify invoice processing, ensuring timely payments and helping you build strong relationships with vendors.

Get Ramp today and experience the power of automated accounts payable first-hand.

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