Accounts Payable

What is Accounts Payable?

Accounts payable refers to the subsection of your general ledger that denotes the money, also called debts, you owe to third parties like suppliers, contractors, and creditors. Importantly, accounts payable excludes payroll, which comes under wages payable.

Keeping on top of your accounts payable is crucial to running a healthy, trustworthy business. If you get behind on payments to your suppliers or creditors, it could damage your brand’s reputation, not to mention incur costly interest fees for late payments.

Note accounts payable relates only to short-term debts, services, and products you’re going to pay off in less than a year. Long-term debts, like mortgages, are called mortgage payables.

How Does Accounts Payable Work?

The accounts payable process begins when you receive an invoice from a supplier. Once you’ve taken a look at the invoice and double checked all is as it should be, it’s time to then record the details in your accounts payable ledger, noting the amount to be paid and the payment due date.

When you do this, you’ll notice that the credit balance at the bottom of the ledger increases. This represents the total amount of money you owe to third parties.

When the payment is due, you’ll then pay the supplier in question, and the accounts payable entry will be recorded as a debit in the accounts payable ledger, decreasing the overall amount of credit owed.

Of course, if your company relies on several suppliers, maintaining an accurate accounts payable ledger can be difficult to do manually. Luckily, the best accounting software can help automate the process of managing and paying repeat vendor invoices, making it quicker and more accurate in tandem.

Alternatively, you could also enlist the support of an accountant to help with your bookkeeping, including accounts payable and accounts receivable.

If you would rather save money and undertake the process yourself, one thing to note is that the accounts payable process is one of the most vulnerable to fraud. Online criminals are well known to send falsified invoices to companies in the hopes that an unwitting employee will process the invoice without a second thought.

For that reason, it’s crucial to double-check every invoice and ensure that the services or products listed are genuine and that you’ve actually used them.

Examples of Accounts Payable

Accounts payable refers to a huge range of goods and services, including software subscriptions, utility bills, freelancer services, hire cars, and so forth.

Here’s an example of accounts payable in practice:

You hire a freelance marketer at the beginning of the month, agreeing on a price of $250 for their services. At the end of the month, they send you an invoice for $250 with payment terms of 10 days.

You note the invoice amount in your accounts payable ledger and set an alert to remind yourself to pay the invoice a week later. A few days later, you pay the invoice and record the entry as a debit in your ledger.

How to Record Accounts Payable

So far, we’ve discussed the accounts payable process at a high level. Now, we’ll give you a step-by-step walkthrough on how to record and process accounts payable. This walkthrough is perfect for entrepreneurs and small business owners who are yet to formalize the accounts payable process but want to do it themselves:

Step 1. Establish a chart of accounts

Before you can log any payments in your accounts payable ledger, you’re going to need to create your tracker. We recommend creating a broader chart of accounts, which is your overall tracker for recording business transactions.

The chart of accounts usually has five categories. Accounts payable falls into the liability accounts section:

• Income accounts
• Asset accounts
• Liability accounts
• Expense accounts
• Equity accounts

Step 2. Enter vendor and invoice details

Next, you can start entering liabilities into your chart of accounts. Details are paramount here: include vendor details, payment terms, and payment deadlines. If you’re using a DIY tracker, it can also be helpful to hyperlink to your vendor or supplier’s invoice to make it easy to find and pay later on.

Step 3. Process payment for outstanding invoices

Now, it’s time to look through your chart of accounts and process payments for due invoices. Once you’ve done this, you should record the payment as a debit, marking the payment complete.

We recommend checking your accounts payable at least weekly to ensure that you make payments on time.

Every time you engage with a new supplier, you’ll need to complete steps two and three again. You can use invoicing software or manually keep a record like this. Whatever you choose, it’s crucial to keep note of all your expenses both to ensure that you’re paying suppliers on time and, moreover, because these expenses are also tax deductible.

Remember, too, that with accounting software, you can automate the accounts payable process, making it automatic and seamless rather than a time-intensive endeavor.

Accounts Payable vs. Accounts Receivable

Accounts payable and accounts receivable are two sides of the same coin. Accounts payable, as discussed, is the money you owe suppliers. Accounts receivable, on the other hand, is the money owed to you by your customers.

Accounts Payable vs. Trade Payables

Trade payables are a subset of accounts payables. The former refers specifically to debts that relate to inventory items. In simple terms, if the product or service is used as part of what you sell to clients or customers, it’s likely a trade payable.

Because trade payables fall under accounts payables, many small businesses choose not to treat them separately from each other. However, if your trade payables have long repayment periods, it’s worth classifying them separately for clarity.