Accounts payable is the aggregate amount of the entity’s short-term obligations to pay the creditors or suppliers for goods and services that are purchased on credit instead of paying for them up-front.
Within such an establishment the entity that makes the purchase on credit must agree to make the payments within a specific time-period to avoid payment default. Payment default may lead to the imposition of penalties or additional interest payments.
Accounts payable can aptly be called a short-term debt payment and is treated as a liability by the entity that owes the payment. It is placed under the head ‘current liabilities’ of the entity’s accounting books.
From a company’s point of view, accounts payable is recorded in the company’s account Payable sub-ledger as outstanding payment once the payment invoice is approved for payment but the payment is not yet made by the entity that is obligated to make the payment. Hence it stays in the accounting books of the payee entity as accounts payable.
3. The Relevance of Accounts Payable
Even in our daily households, the concept of accounts payable holds true to the payments we make for simple and necessary household items and services in use.
The amount we pay in the form of electricity bills, post-paid telephone bills, newspaper subscriptions is all accounts payable for us as these bills are paid after we have consumed or made use of the services. The bills typically paid at the end of the month are all a form of credit extended to us from the service providers and thus make us liable for payment towards the services we have already made use of.
As such these are accounts payable and can be counted as a liability since the amount pertaining to each payment is to be paid by us separately for each and every service consumed.
For a company, which plans to obtain services and goods from its suppliers and vendors, the concept of credit holds true in most accounts as very often the payment towards the goods and services obtained are made as per the agreement established between the two parties transacting. This agreement may involve the terms of payment like the mode of payment, the credit time period up to which the payment is to be made and the penalty involved in case of default from the payee in any case.
Hence for a company obtaining goods and services on credit may receive the payment invoice from the creditor or supplier and enter the outstanding amount of accounts payable in its Accounts Payable sub-ledger.
The objective of the accounts payable is to pay the company’s bills and invoices that are legitimate and accurate. The payment invoice before being entered into the accounting books and being scheduled for payments must register the details of the transaction. Accounts payable must have internal controls to safeguard the cash and assets of the company.
This accounts for not paying for invoices that may be fraudulent, inaccurate or may be billed twice on counts of duplication of invoice.
The accounts payable process uses three-way match technique to ensure that only accurate and legitimate invoices are recorded and paid for. The three-way match technique includes:
|Company Purchase Order||What the company has ordered|
|Company Receiving Report||What the company has received|
|Vendor Invoice||What amount the vendor billed the company|
When the details on these documents are in agreement the vendor’s invoice is entered into accounts payable and scheduled for payment.
The internal control of the company may use the technique of segregation of duties for accounts payable by assigning the duty to a specific individual with the skill set particularly for the job.
|1st Person||Prepares the company’s purchase orders|
|2nd Person||Prepares the company’s receiving reports|
|3rd Person||Compares purchasing order, receiving report and vendor’s invoice|
|4th Person||Pays the vendor|
It is important for the company to maintain a record of the accounts payable to run the business successfully. The timely settlements of the outstanding payments may help in improving the credit-worthiness of the company and result in improved trade relations.
It is paramount to understanding the accounts payable and the credit period or time due for payments associated with a particular account. The understanding of the significance of accounts payable for a company becomes increasingly important for maintaining an up-to-date record of the financial transactions carried out by the company with the vendors and creditors.
6. The significance of accounts payable for a company
I. A company must be able to identify its creditors in terms of the payments it owes to its creditors. For the various purchases made by the company for its necessary requirements, it is useful in maintaining an individual account for each of its creditors.
More importantly, a clear record should be kept of the details of payment to be made to the creditors and the due date within which the payment should be made. Accounts payable therefore helps in scheduling the payments of the creditors and suppliers of the company. The suppliers’ payments generally form the biggest non-payroll cash outflows in a company.
The transactions generating an invoice for payment to the suppliers have to be included in the accounts payable. This calls for a well-managed supplier payments strategy and hence the role of accounts payable can lead to adding strategic financial value to the company.
The supplier payment strategy when aligned with the working capital goals of the company makes the accounts payable a significant driver of financial value.
II. Accounts payable generates extensive information on the financial and operational aspects of the company. Companies mostly focus on the management and record storage of the data.
However, the use of these data to obtain financial and operational intelligence such as cash availability forecasts or suppliers performance management can lead to finding key insights into the current financial and operational standing of the company.
It may provide a real-time cash position of the company in the event of upcoming and outstanding payments nearing due date.
III. The Accounts payable can render more than payment of the outstanding dues within designated time-period to extend its advantage to cost savings by way of alternative payment methods. An early payment discount capture may have a direct impact on the company’s bottom-line.
This may result in additional liquidity to the company by way of creditor or suppliers’ discount. The supply chain finance can be an alternative solution of payment to the company.
Leveraging the supply chain finance may help in providing better management of days payable outstanding without compromising the supplier/creditor relations. The payment can thus be delayed for as long as possible to improve the cash management of the company.
IV. Accounts Payable can be instrumental in maintaining the cash flows of the company in case of mass purchases. It may prove helpful in negotiating the terms and conditions of the accounts payable.
There is a serious time gap between the payments to the creditors/suppliers and the receivables of the final sales proceeds. This entire cycle of cash conversion can prove to be unfruitful time lapsed with increasing payment load from the credit side.
This can be negotiated on the basis of the accounts payable keeping in mind the conversion rate and the due date for payment to the creditors.
The accounts payable can be treated as more than just a tactical invoice processing tool. The accounts payable can have a significant impact by providing internal financial and operational intelligence of the company’s standing and formulating a supplier/vendor payment strategy. Accounts payable can have a decisive impact on the cash flow management of the company.