Accounts Payable Best Practices - A How-To Guide
Introduction
Every day, thousands of small businesses open their doors, but sadly within 5 years, 82% will have failed [1].
This is a disturbing statistic and one of the main reasons behind it is cash flow management problems.
And one area that greatly impacts cash flow is accounts payable or AP processes.
This is an appealing reason to work on your accounts payable process and perfect it. What follows in this article are the best practices used by companies that have succeeded.
What is accounts payable?
Two terms that confuse people are accounts payable and accounts receivable.
This confusion causes the incorrect input of data into the general ledger accounts. Let’s look at a summary that will make this easy to understand.
Accounts Payable
Accounts Receivable
A liability to the business
A current asset to the business
Decreases available funds
Increases available funds
Reflects that you owe money to a third party
Reflects that third parties owe money to you
The total cost of purchases
Total sales less returns and discounts
Example: Good purchased from suppliers to manufacture a product
Example: Payment for products or services provided by your business
How do accounts payable reflect in the accounting system?
Accounts payable (AP) is an account in the general ledger. It represents goods and services purchased by a company on credit. A supplier will issue an invoice and you must pay it within the agreed time or risk late fees.
AP is recorded as a short-term liability in the company balance sheet.
There are five functions to an accounts payable process:
1. Receive a purchase invoice from a supplier
2. The purchase invoice joins a queue internally for payment
3. The purchase invoice is reviewed against a receipt of goods to confirm accuracy
4. It is then loaded into the payment system
5. The payment is released
The accounting method used most often is accrual accounting. This is a system whereby money is spent, but the actual payment is only reflected in the AP process when the money leaves the bank.
The benefit of this is improving cash flow temporarily. However, delaying payments past their due date is bad business practice and should be avoided.
How to Keep your workflow Streamlined
A workflow is a series of reproducible actions that achieve an outcome. The AP workflow includes all the activities required to pay vendors and suppliers effectively.
Some of the activities in Accounts Payable processes are:
- Receive invoices and process them by the due dates
- Request authorization for invoices to be paid
- Handle email and telephonic queries regarding invoices
- Resolve disputes
- Log data into the financial management system
- Review accounts payable reports and make suggestions for improvement
Start by reviewing all the tasks required as well as how many resources it takes to complete the process. Once you have this information, you can decide where to simplify the workflow.
- Use technology to help your workflow
Accounting software has improved dramatically in the last decade and it’s impressive to see what it's capable of doing.
What was impossible a few short years back is now easily achievable. One of this software's key successes has been the accounting staff's involvement.
The goal with accounting software is for it to mimic your workflow and support it.
Most software can receive data from invoices and then automatically prompt you to the next stage until the payment of the invoice has been made. Since all data is kept in one place, queries are easier to answer and track.
Financial reports can be customized to provide you with data often as you require. You do need to do any manual calculations or search for information to compile a report. This saves a great deal of time and cuts staff resources down considerably.
- AP automation
Paper invoices require checking, processing, tracking and filing by a person, which can lead to human error. And the cost of manual data entry is high with accounts payable teams spending 84% of their time on data input.
These challenges are more than just an inconvenience, they are restraints on the effective processing of incoming invoices.
With technology advancing in artificial intelligence, new possibilities have opened up that allow software to read invoices and populate relevant information straight into the system.
What can automated systems offer your business?
- Image recognition and scanning capabilities extract information and automatically put it into appropriate fields.
- The software can pick up patterns that are out of the norm for your invoices and alert you to a problem. An example of this is the prevention of duplicate payments.
- It can match generated purchase orders with invoices and produce documentation for payment release
These three items mean an 80% reduction in manual processes and a return on investment within 3 months.
Payvy can help you automate your invoices and speed up AP processing
- Work with invoices according to priority
Early payment processing is key to establishing an accurate cash flow figure. Best practices dictate that you pay invoices immediately to avoid late payments and the fees they attract.
Sort out invoices according to the due date and type. Pay all accounts that attract interest, such as credit card bills, loans and other high-interest payments.
Next, deal with suppliers that have a large volume of invoices due. These can be batched and paid for together. Lastly, process ad hoc payments.
- Manage and safeguard against duplicate payments
This occurs when the AP department pays the same vendor or supplier twice.
The effort to get these funds returned takes numerous follow-ups and is largely only successful if you have a really good relationship with the vendor.
The average business makes 0.5% to 1% duplicate payments [2]. This may not seem like much, but these invoices can be high, indicating a substantial loss for the business.
Here are some steps to reduce duplicate payments:
1. Review the master vendor file regularly to eliminate duplicate vendors
2. Eliminate duplicate vendor index numbers
3. Input accounts payable data immediately so that the invoice is finalized.
4. Don’t make payments from multiple documents
Source: Pexels
- Put internal controls in place
Effective documentation of internal controls allows each employee to understand their roles and responsibilities. Misunderstandings or assumptions are avoided and fewer mistakes are made this way.
These internal controls also prevent fraud and give access to approve payments only to those who need it. This is an important element of the AP system to avoid making unwanted payments.
Responsibilities and authorizations
The AP team is responsible for preparing invoices for payment and sending them for authorization to senior management.
Only specific employees should have the authorization to release payments. Different levels of accountability are required in the approval process so that one employee cannot process, check and authorize the payment of invoices. This will also ensure regulatory compliance and give the business a clear audit trail.
- Track and solve disputes
Invoice disputes will inevitably arise, and dealing with them quickly will eliminate problems with your cash flow. These are some of the most common disputes:
- No correlating purchase order
- Invoice never sent
- Invoice sent after the payment date for the month
- Missing information on the invoice
- Return of goods and discounts
Consider a supplier portal
Every year, time is wasted in contacting suppliers to get missing information and invoices re-issued. In fact, this is the most complained about task amongst the payable team.
One way to deal with missing or incorrect information on invoices is to create a supplier portal. This will allow your suppliers to input compulsory information such as the registered name of the company, tax numbers and contact information of the person who will answer queries.
Payvy can take the headache out of vendor management with multiple ways to pay your vendors and track communication
- Use reports effectively
Three of the most common AP reports are:
The accounts payable aging report which reflects how many payments are overdue. This will indicate the extent of the cash flow problem and also any late fees.
The history of payments report shows all debts owed by the company over a period of time. This will indicate the total current liability to the business.
The invoice cycle time report tracks how long the business has taken to complete the payable processes.
You can analyse these reports to understand issues with the workflow, cash flow problems and total debt owed to third parties.
- Develop a fraud prevention process
A documented fraud handling process is important to every business. Inevitably a business will be targeted with false invoices and or duplicate payments.
Unfortunately, one cannot disregard that employees could be involved in fraudulent payments for their own benefit. If this does occur, having a documented fraud process in place will assist you in dealing with the case.
- Normalize payment terms for customers
Service level agreements are key to managing vendor relationships. Payment terms and discounts are part of these agreements and indicate how long the business has to pay the amount they owe to third-party suppliers.
Negotiations of payment terms should be down upfront when the contract is signed. Early payment discounts and the effect of any additional payment made on the account must be clear to all parties.
Source: Pexels
Conclusion
The accounts payable department is key to a successful business and needs to run like a well-oiled machine. Although these processes can be complex, the solution is to simplify your workflow.
Paper invoices are no longer feasible, and in a world driven by technology, now is the time to get ahead of the curve.
Making the change to automated processes may be easier than you realize.
Payvy is an all-in-one expense management platform that can help you make the change!
Footnotes:
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