Explaining what accounts payable are and reviewing the process for managing them is the topic of this episode.
Hello and welcome back to The Better Bookkeeper Podcast. I am your host, Patrick Donovan, President of Cape May Counting House. Thank you for joining me today as I talk about accounts payable. If you would like to see the transcript of today’s episode please visit thebetterbookkeeper.com/017. You can also follow our Facebook page to leave a comment or question at www.facebook.com/thebetterbookkeeper.
As I mentioned, the topic of this episode is Accounts Payable which are the bills that you owe to vendors, suppliers, and contractors. It can also include money that you owe on bank loans or liabilities that you owe but haven’t paid yet like utilities or sales tax or payroll taxes. Just like with accounts receivable from our previous episode, properly managing your accounts payable can also help improve your cash flow. So, let’s get into it.
I’ll see you on the other side.
Welcome back! In the intro I explained that accounts payable is money that you owe to suppliers, vendors, bank loans, tax liabilities, utilities, among other things. When you get a bill but will pay it at a later date, you will record it in your accounting software as accounts payable so that you will be able to keep track of what you need to pay out. If you are using the cash basis for your accounting you would not use accounts payable. Hopefully, you are using the accrual basis which means you will be entering these bills into your software.
The first step in managing your accounts payable is to actually have a system in place for managing your accounts payable. If you have multiple team members in your business there should be a process for receiving and entering a bill, verifying its accuracy, storing all source documents, and a process for approving the bill for payment. Within this process is what is called a three-way match where you match the purchase order to the receiving report to the vendor invoice. Any discrepancies should be addressed and resolved immediately.
Verifying that what you need to pay is exactly what you owe is done by communicating with any individuals who were involved with these transactions. You also want to verify that the vendor is correct, the unit costs, quantities, and terms, among other things, are correct. Look to make sure that the bill hasn’t already been entered into your system. If you had a contractor provide services, speak with those team members who oversaw the contractor’s work. Was it satisfactory? Did they complete all their tasks on time, completely and correctly? If the bill is for inventory, check with your receiving department to see if they did in fact receive all of the product you’re being billed for. Was the inventory in satisfactory condition? If not, you should be requesting a credit or returning product for a refund to lower the amount you owe. If you received inventory that you can’t sell because it is of inferior quality but don’t return it, then you will be taking the loss instead of the supplier where the real responsibility lies. When it comes time for a business to be paying money out, you should be scrutinizing every bill for accuracy. Communication between departments is very important to determine if credits need to be requested from vendors.
Furthermore, the person who is entering the bill should not be the same person who is approving and remitting payment because this opens up the opportunity for fraud. Separation of duties is an internal control function that helps to eliminate bogus bills from being paid or bogus invoices to customers from being reported in an attempt to inflate revenues.
Next, you should review your accounts payable aging report. Similar to your accounts receivable aging report, accounts are broken into different buckets such as 1-30 days past due, 31-60 days past due, and so on. Identify the oldest accounts as those are the ones that should be prioritized to prevent unfavorable outcomes. If needed, create a spreadsheet to do some analysis or play out some different scenarios.
You could also review your Accounts Payable Turnover Ratio which is calculated by dividing your net credit purchases from vendors and suppliers by the average accounts payable for the same period. This tells you how many times during that period you paid your average accounts payable.
To find out how many days it takes you, on average, to pay your bills you would divide 365 by your accounts payable turnover ratio that you just calculated. Once you have calculated this, compare it to the terms you have with your vendors and suppliers. It gives you insight into how well you are meeting your terms and if improvements need to be made. Creditors may be willing to offer better terms to borrowers who pay on time which could save you money down the road.
Now that you have gone through your bills and verified that the amounts are correct and identified accounts that need immediate attention, it’s time to determine your ability to pay them. You should start asking some basic questions about your current financial situation like what is the balance in your bank account? What are your projected cash inflows over the next 30-45 days? You should also factor in how quickly people typically pay you and take into consideration slow payers, late payers, and no payers. (Expecting every invoice to result in a payment on time is unrealistic.) Ask yourself what are your projected cash outflows over the next 30-45 days to become current on your bills?
Are you experiencing a cash crunch and need to hold off paying some bills? Do you currently have past-due bills to pay? Are you being charged interest or late fees for them? Are you at risk of being sent to collections? How many seriously delinquent bills do you have that need to be paid immediately? Are suppliers or vendors threatening adverse actions such as halting shipments, pausing services, or even switching to cash on delivery? Making notes in your vendor accounts can help provide important details regarding who may be willing to wait a little longer and those who will absolutely not.
Are you in a good cash position? Perhaps you could afford to pay some bills early to take advantage of an early payment discount. However, you should also look to see if there are other opportunities that could provide a better return for your cash than the typically 2% discount you may receive for paying a bill early.
Once you have selected your accounts to pay, prepare them for approval according to your accounts payable management process. Do you have to submit an approval request, attach source documents, and provide a summary? Providing all of the necessary information to the person responsible for approving bills for payment makes the process more efficient. By this phase, any discrepancies should have already been identified and resolved. If you are printing out physical checks, review each one for accuracy. Make sure that the checks are legible, aligned correctly, and the fields are filled out with the appropriate information. Make sure that the checks get signed by the appropriate authorized signers. As a final step, you may want to send out emails to your vendors to update them that the checks are going out. This would be wise if you are sending out payments for very old accounts where vendors have already threatened adverse actions. This would cause them to hold off on proceeding or at least delay that action for a few days to make sure they actually receive the payment before proceeding.
If you did, in fact, reach out to any vendors, make sure to add a note into the account in the event you need to refer to it later on.
So, to be clear, there is more to managing accounts payable than just writing out a check and mailing it. You should be verifying that the bill is legitimate and accurate before even recording it into your system by performing a three-way match, then resolving discrepancies. Separate duties between team members to hopefully eliminate the opportunity for fraud. Review your current financial situation, including funds you are realistically expecting to flow into and out of the business over the short term. Identify accounts to be paid, prepare them for approval, and finally verify that checks are complete and accurate before sending out.
And that, is that. I hope that you found this episode about accounts payable helpful. I also hope that you will make use of it in your business or that of your clients to provide additional value. In the end, that’s what it’s all about, the value you add to your boss or your client.