Accounts payable definition: A comprehensive guide and best practices
Read on to learn more about accounts payable and its importance in corporate finance
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1 minute
July 31, 2024
Businesses view accounts payable in three ways: (1) A process for documenting and transmitting supplier bills, (2) the team responsible for coding, approving, and processing payments to vendors, and (3) a current liability on their balance sheet for financial statement reporting.
To know all about accounts payable, read on for a short definition and examples, what the accounts payable process is, how the accounts payable process works, GAAP compliance for accounts payable, accounts payable metrics, and best practices, including AP automation.
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A simple accounts payable definition is a short-term liability on the balance sheet for the total amount of not-yet-paid supplier or vendor invoices (with credit terms) for purchasing goods and services.
Accounts payable is also an accounting process spanning invoice receipt to payment.
Some examples of accounts payable, by type of cash disbursement for expenditures, are:
The main difference between accounts payable vs. trade payables is that accounts payable is a broad term for amounts due to vendors or suppliers for credit purchases of goods or services.
In contrast, trade payables are accounts payable only for purchases of items used in the business for an eventual sale or service to customers, such as inventory and direct supplies.
The inventory purchases included in trade payables may be raw materials manufacturing companies use to produce finished goods or sold directly to customers in retail businesses.
How is accounts payable different from accounts receivable?
The difference between accounts payable vs. accounts receivable is that accounts payable relates to the company's payments owed to vendors or suppliers.
In contrast, an accounts receivable definition is the amounts due from customers on invoices for goods or services sold by the business.
To further differentiate accounts payable vs. receivable, accounts payable is a current liability, but accounts receivable is a current asset.
Do you know how to account for accounts payable?
AP accounting isn’t hard to understand, but you need to know basic GAAP rules to record accounts payable per the accounting standards.
Accounts payable accounting rules under GAAP (generally accepted accounting principles) are:
Under accrual accounting, expenses are recorded when recognized in the same period as related revenues under the GAAP matching principle. In contrast, cash-basis accounting, which is not allowed under GAAP, recognizes expenses in the accounting period when they are paid.
Using accrual accounting, inventory expenditures are initially recorded as a current asset called inventory and later transferred to cost of goods sold expense when sales occur.
Fixed and intangible assets like office equipment and patents are recorded as capitalizable assets, later depreciated or amortized as time elapses.
Double-entry bookkeeping in accounting means that transactions are recorded as balancing debits and credits.
Accounts payable are recorded as a credit upon invoice receipt, and equal totals as balancing amounts are recorded as debits for the expenses or assets purchased as an expenditure in this transaction.
When invoices are paid, accounts payable is debited, and cash is credited for an equal amount. Or, when applicable, an early payment discount is recorded as a credit with a smaller cash amount credited, and the accounts payable account is also debited to reduce the AP balance.
The accounts payable process includes these steps:
Accounts payable workflow process steps are also called the AP cycle of accounting. We describe the steps in more detail to indicate how the AP process works.
The end-to-end accounts payable process, covered by AI-powered AP automation software like Rho One-Click AP, begins with vendor onboarding and spans these invoice processing steps.
Next, in the end-to-end accounts payable process are analytics (for spend management and expense management) and general ledger account reconciliation.
A business receives invoices for credit purchases of goods and services from its suppliers. Invoices are recorded through manual data entry or automated electronic data entry into its accounts payable software system, using OCR (optical character recognition) technology.
Vendor invoices and bills may be emailed as an attachment or uploaded to an accounts payable platform.
Invoice verification involves comparing invoice amounts and cross-checking vendor details against their provided W-9 or equivalent document to ensure accurate setup and deter fraud.
Another step in the accounts payable process is the 3-way matching or 2-way matching of vendor invoices and bills with purchase orders (POs) and the receiving report, as applicable for ordered items received from suppliers.
This procedure ensures a business pays for approved purchases in the amounts ordered and received.
According to company policy, approvers within the organization (generally with supervisory and budgetary responsibility) are authorized to approve invoices for purchases of goods and services up to a certain dollar amount.
For large invoice amounts above an approver’s limit, two approvers may require invoice approvals. Approvals are made through the accounts payable system.
As a payment process, approved payments are paid in scheduled invoice batches for efficiency or single invoices when necessary. Payments may be made by paper checks that must be distributed by mail or as EFTs (electronic fund transfers).
Electronic fund transfers for payments include ACH, wire transfers, other digital money transfers, and debit card or credit card payments.
Rho’s automated finance and AP platform lets you make different fee-free global payments for accounts payable. With AP automation, you’ll be efficient enough to make timely payments.
Businesses record transactions with double-entry bookkeeping by coding invoices to general ledger accounts when inputting them into the system. Payments are recorded through the accounts payable system. The core accounts payable system produces an accounts payable aging report.
If AP automation software is used, it performs an automated AP flow and syncs with your general ledger in the ERP system (like Rho-NetSuite) or accounting software. The accounting software produces financial statements.
Financial management, accounting, and the accounts payable team are responsible for achieving proper accrual accounting for accounts payable and forecasting cash flows. Accounts payable-related responsibilities include cash flow management, invoice management, and financial reporting.
The CFO and treasurer are responsible for cash flow management in the business. Most of a company’s cash disbursements flow through the accounts payable system.
The amount and timing of those cash requirements for vendor invoice payments are essential for forecasting cash flow.
With excellent cash flow forecasting and management, you can determine when the company needs more financing or will use an existing business line of credit. Cash flow management is vital for businesses of all sizes; it’s essential for small businesses that could fail.
In accounts payable, growing companies have large volumes of supplier and vendor invoices, requiring payables invoice management solutions for proper control.
With the accrual basis of accounting, these invoices must be timely recorded in the system or accrued after a short month-end cut-off period to produce accurate financial reports.
Digitization of invoice data and centralized document repositories are efficient and effective means of invoice access for 3-way or 2-way invoice matching with supporting documents and reviewing invoices for payment approval.
Accounts payable automation software lets your business accomplish these electronic invoice management goals.
Using paper invoices instead of digital invoices is archaic and problematic. Suppose paper invoices aren’t scanned into the ERP or accounting system using OCR technology.
In that case, the AP staff has to perform manual processes to match supplier invoices with POs, receive reports, and route them to approvers. Invoices can be lost in the process.
Paper invoices (marked paid for internal control) need costly office and warehouse storage after completing payment transactions. It takes time to find filed paper invoices (that may be lost in the process) for an external audit and an eventual tax audit.
Consider using accrual accounting for accounts payable at the following three levels.
In internal company financial reporting, it’s essential to track accounts payable through a subsidiary ledger called an accounts payable aging report.
This lists outstanding invoices by vendor, with an assignment to one aging report column that’s either Current or in a range for the number of days the invoice balance is unpaid beyond the due date.
In the general ledger of companies using accrual accounting, the accounts payable balance is a credit balance overall. Businesses record accounts payable journal entries using double-entry bookkeeping.
In an accounts payable journal entry, the amount due on Invoices with payment terms received from suppliers is credited to the accounts payable account, and the expense account (related to the income statement) or asset account (related to the balance sheet) is debited.
Cash payments and early payment discounts reduce the debited accounts payable balance when these offsets are recorded as credits to cash and early payment discount accounts.
Credit memos issued by vendors for returned goods or price reductions from overcharge errors in original invoices are recorded as a debit to accounts payable and credit to the related expenditure accounts.
In accrual-basis financial statements, the total accounts payable balance is shown, according to GAAP, as a current liability on the balance sheet.
Accounts payable are recorded as current liability accounts because the term of free vendor financing is generally 30 days. However, it may be offered as a 60-day or rarely 90-day payment term in specific industries.
Accounts payable is an element of working capital. Therefore, in a cash flow statement prepared using the indirect method, the change in the accounts payable balance is used as one of the line items to reconcile net income from operations to cash flow from operating activities.
In contrast, when the cash flow statement is prepared using the direct method, accounts payable don’t appear on the financial statement called the cash flow statement.
Which financial ratios are helpful for accounts payable?
Days payable outstanding ( DPO) is a measure of the average number of days in which accounts payable invoices are being paid to suppliers. In contrast, accounts payable turnover ratio (APT) is expressed as the number of times accounts payable is paid in a year of either 365 or 360 days.
These metrics can also be measured for a different period of time, on a monthly or quarterly basis, to determine trends. The goals are to determine average AP payment timing and company liquidity for meeting cash requirements and to optimize payment timing.
A Deloitte Working Capital Roundup report, issued in the fourth quarter of 2023, measures average DPO as 56.0 days in Quarter 4, 2022 vs. 57.4 days in Quarter 4, 2021, meaning that accounts payable were paid 1.4 days sooner in the fourth quarter of 2022 vs, the fourth quarter in 2021.
The Deloitte study is based on more than 3,000 companies in four primary industries (Consumer, Energy, Life Sciences & Healthcare, and Technology). Data from these companies were used to compute their DPO ratios.
As a best practice, your company can benchmark its accounts payable ratios to other companies in its industry.
The days payable outstanding (DPO) formula is:
DPO = (Average Accounts Payable/Cost of Goods Sold) x Number of Days in the Accounting Period
Here's an example computed for a year:
($15,000,000/$100,000,000) x 365 days = 55 days
The accounts payable turnover ratio (APT) formula is:
Accounts payable turnover = (Net Credit Purchases/Average Accounts Payable)
For example, accounts payable turnover (APT) = ($130,000,000/$20,000,000) = 6.5 times
Note: Some companies substitute Cost of Goods Sold (COGS) for Net Credit Purchases in the accounts payable turnover formula.
Accounts payable is recorded on the company’s balance sheet, performed through a process of steps, and measured using metrics or ratios such as days payable outstanding (DPO) and accounts payable turnover (APT).
As we discussed, accounts payable represents the amounts owed by a business to its suppliers providing short-term credit payment terms on invoices for later payment and is the process for paying those vendor invoices.
Companies like yours can digitally automate the accounts payable process for efficiency and cost savings by integrating Rho’s One-Click AP automation software with your ERP system or accounting software.
Stakeholders will find a company’s accounts payable in the current liabilities section of the balance sheet. Besides finding accounts payable on its balance sheet when financial statements are prepared, employees will also find accounts payable in a subsidiary ledger/accounts payable aging report, on the trial balance, and in a general ledger account.
Some common accounts payable jobs are accounts payable supervisor or accounts payable manager and accounts payable clerk or accounts payable associate. Accounts payable accounting isn’t hard to understand, but you need a basic understanding to record it accurately.
To interview for an accounts payable job, understand the role of an accounts payable department member, accounts payable invoice processing workflow, and the accounts payable accounting cycle.
You’ll have a competitive advantage if you have prior experience with a particular ERP or accounting system and understand the added features and benefits of using an integrated AP automation system. Soft skills such as emotional intelligence, people skills, and problem-solving skills are also important for landing an accounts payable job.
Under double-entry bookkeeping, the three golden rules of accounting are:
So, how do these golden rules of accounting apply to accounts payable recording?
When a company purchases goods or services, the expenses (or assets like inventory) are debited, while accounts payable are credited.
Cash going out is credited when an accounts payable invoice is paid by the giver (and accounts payable is debited); the vendor receiving the cash payment will debit cash coming in and reduce its accounts receivable as a credit entry for the same invoice.
Accounts payable relates to paying suppliers offering invoice credit terms for purchases of their goods or services. Accounts receivable relates to collecting cash when payments for sales invoices are due from customers for products or services sold to them by the company.
If you use traditional accounting software or an ERP system without integrating accounts payable automation software, you’ll need to constantly expand your accounts payable team.
It will be time to expand your accounts payable team when vendor invoice volume increases due to growth and when more help is needed to correct errors and solve constant problems.
But by using the Rho One-Click AP automation platform that scales with your company growth, you won’t need to frequently expand your accounts payable team.
Invoice processing within the accounts payable process is much more efficient with Rho.
With Rho as your alternative solution, your invoices will be digitized rather than paper-based, not requiring time-consuming manual data entry or paper document matching by the AP department.
As a result, your business will save even more AP team time, delaying the need to add headcount to the accounts payable department.
No, accounts payable are different from business expenses. Accounts payable are liabilities (interest-free short-term debt unless late payments) for the amounts still owed for invoices with credit terms, submitted by suppliers or vendors for later payment.
Accounts payable refers to purchases of business expense items or assets like inventory or fixed assets, such as office equipment.
The AP cycle of accounting includes:
The best software for managing accounts payable is an integrated system of modern, cloud-based, third-party AP automation software combined with the user company’s ERP or accounting system to streamline and perform accounts payable business processes. Rho is this type of AP automation software.