If you’re a business owner or interested in starting one, you’ve probably heard the term accounts payable (AP, for short). But what exactly is it?
Accounts payable refers to the money owed to others for goods and services received. Let’s look at what it means, how it works, and some tools you can use to streamline the process.
Accounts payable: An asset or liability?
You might be wondering is accounts payable an asset or liability? Accounts payable are short-term balances owed by your business to vendors. That’s why AP is listed under liabilities in your balance sheet, which is a key financial statement and part of a company’s general ledger.
Any open bill you get from vendors is considered accounts payable until the transaction is complete. This can include utilities and facility costs, rents, licenses, outstanding vendor or contractor invoices, and other monthly expenses.
Think of it this way: Imagine you own a bakery, and you order large batches of flour and sugar to make your delicious cupcakes. The supplier delivers the ingredients to your bakery, and now you owe them money for those supplies.
Until you pay that bill, the money you owe is considered part of your accounts payable. You might ask yourself, why should I care? Keeping track of expenses and money owed to suppliers is essential for any successful business.
How does accounts payable differ from accounts receivable?
Accounts payable and accounts receivable (also known as AR) are often confused, as both represent two sides of the same coin. Simply put, AP represents money that your business owes to suppliers, and AR represents the money owed to your business by customers. Accounts receivable is considered a current asset—resulting in cash inflow and revenue, whereas accounts payable is considered a current liability, resulting in cash outflow.
Why is accounts payable important?
To measure the profitability of your business, it is crucial to classify your expenses correctly. A company that keeps track of accounts payable will be able to determine where its money is going and how to be more cost-efficient. Additionally, many lenders and investors use AP and AR to determine a company’s financial health. Properly managing the money going out of your business helps with:
- Improving cash flow and financial stability
- Maintaining good relationships with vendors
- Saving time and improving work efficiency
- Preventing overdue charges, penalties, or late fees
- Maintaining your business’s reputation
What does the accounts payable process look like?
This is a simplified breakdown of how AP works:
- Your business submits a purchase order or signs a contract with a vendor.
- Goods or services are delivered, and the vendor submits an invoice to you or your AP department.
- The person in charge of handling your business payments should carefully review the received invoice, checking for vendor identification, itemized purchases, totals, and dates of issue and payment.
- Oftentimes, the business owner or department manager may need to approve the purchases (often known as an approval workflow).
- When the invoice is approved, the AP department, or whoever handles your business payments, processes payment and debits accounts payable.
Why you should use automation software for accounts payable?
Before the digital age, accounting professionals or business owners were required to manage everything by hand—a laborious task resulting in hours of manual data entry, human error, and vulnerability to fraud. That’s where automation comes in.
According to studies by research firms, The Aberdeen Group and PayStream Advisors, using automated tools can cut the cost of invoice processing by about 75%.
Here are some other benefits of automating your accounts payable:
- Reduced turnaround time by 10X
- Improved data capture accuracy
- Reduced operational cost
- Reduced human error and improved efficiency
- Quicker processing time
- Improved vendor relationships
- Security and fraud protection
So far we’ve covered what accounts payable is, why it’s important, some related terms, what the process looks like, and why it should be automated. Next, we’ll look at what tools you can use to streamline AP for your business.
How to look for an automated accounts payable tool
The key to succeeding in the modern business world is to minimize your time-consuming busy work so you can focus on executing your business strategy. One of the best ways to do this is by utilizing effective technology.
According to a report by Markets and Markets, the AP automation market is experiencing extremely rapid growth—from $1.9 billion in 2019 to a whopping 3.1 billion by 2024—to a projected $7.5 billion by 2030.
The industry growth means that finding the ideal AP software for your business might be challenging—since we have countless options to choose from. Here are some things you should consider when choosing a tool for your business’s accounts payable:
- A user-friendly interface that is both comprehensive and easy to navigate
- Global payments
- Simple and fast onboarding
- Visibility and tracking
- Integration capabilities, like accounting software sync
- Approval workflows
- Automatic invoice processing
- Great customer service
- Mobile app for on-the-go payments
Another part of the AP is the payments themselves. Doing that process online can help save time in the back office and reduce the busy work of handwriting checks. Nowadays, almost all banks have some kind of online bill pay feature, but many of these interfaces are outdated and not very intuitive. In addition, there are digital payment solutions that are more technologically advanced, free, and easy to use.
The bottom line
Keeping track of accounts payable allows businesses to determine where their money is going and how to be more cost-effective. Streamlining your AP process with the right tool can optimize your cash flow management and save you valuable time—so you can focus less on paperwork and more on growing your business.