Accounts Payable: Definition and Process

In accounting terms, the meaning of accounts payable (AP) is the amount of money owed by a business to its creditors that needs to be paid back in a short period of time. It includes vendor bills and records short-term debts in the general ledger (GL).

Accounts payable is listed under current liabilities on a balance sheet. Individuals tasked to handle the AP need to verify the issued invoices against purchase orders and ensure that the goods were received before paying the vendors.

Accounts Payable Examples

In addition to vendor payments, accounts payable also includes the following:

Reimbursement of internal payments

AP manages reimbursement of internal payments, administration of petty cash and control of sales tax exemption certificates. Employees need to submit receipts to support their reimbursement requests. Out-of-pocket office supplies, company lunch meetings and other small expenses are considered petty cash.

Business travel expenses

Some companies require their employees to travel and the expenses incurred are included in the accounts payable. This might include purchasing airline tickets, car rentals and hotel reservations.

What is the Accounts Payable Process?

Before making a vendor payment, a process must be set up for the team handling the accounts payable. The established guidelines will help determine the value and volume of transactions within a specific period.

1. Receiving the invoice

After your company purchases goods or services, you will receive an invoice. This document indicates what is included in the order and the validity of the bill.

2. Reviewing bill details

The AP department must review what is listed on the invoice. The vendor name, authorisation, date, and items received must be correct and complete.

3. Updating ledger accounts

Ledger accounts are updated upon receipt of the bill. An accounts payable journal entry (expense) must be added. The invoice must correspond to the packing slip and purchase order to confirm that the goods or services have been received. Depending on your company policy, managerial approval might be necessary to update the ledger.

4. Paying creditors timely

Maintaining good credit standing is vital to a business. That is why settling payments before the stated due date on the bill is necessary. Also, the following information must be reviewed and verified:

Details on the cheque
Bank account details of the vendor
Vouchers
Original bill and purchase order

In addition to the steps mentioned, an AP team should have the following internal controls to ensure that the company’s cash and assets are secure:

All vendor invoices are accounted for
Not paying a fraudulent invoice
Not paying the same vendor twice
Not paying an inaccurate invoice

Accounts Payable (AP) vs Accounts Receivable (AR)

These two types of accounts are similar in the way they are recorded. However, they are distinct from each other.

Accounts payable is listed under current liability on the balance sheet. It records the amount of money your company owes a third party. A third party can be a bank, any company or even an individual from whom you borrowed money. Depending on your agreement, the repayment can be due immediately or within a short period.

On the other hand, accounts receivable are listed under the current assets of the company. It reflects the money that other businesses (like AP, it can also be banks, companies or an individual) owe you.

What is an Accounts Payable (AP) Turnover Ratio?

An AP turnover ratio determines the efficiency of a company’s ability to settle its short-term debts with its vendors. A high ratio indicates that the company is able to satisfy its AP obligations promptly, while a low ratio might suggest that a company is struggling to settle its debts.

The formula for calculating the accounts payable turnover ratio is:

Average number of days a creditor remains unpaid / 365

Business owners should aim to have a good AP turnover ratio as some investors and suppliers will look at it closely. It can also be used by creditors to determine their financing terms.