Accounts payable is a crucial aspect of financial management for every startup to master. Understanding what accounts payable is and how to manage it effectively is essential for maintaining healthy cash flow, fostering strong vendor relationships, and ensuring the smooth operation of your business.
Following the best practices for accounts payable and maintaining strong internal controls can prevent fraud and mismanagement of funds — and help your startup thrive.
What is accounts payable?
Accounts payable (AP) refers to the short-term debts or obligations a business owes to its suppliers or vendors for goods and services purchased but not yet paid for. These liabilities are crucial to the day-to-day operations of any startup, as they ensure vendors are paid on time, and that the supply chain remains uninterrupted.
Managing accounts payable effectively is not only a financial responsibility but also a gesture of respect towards your vendors, helping to build long-term, mutually beneficial relationships.
Accounts payable vs. accounts receivable
While accounts payable represents the money your startup owes to vendors, accounts receivable (AR) is the flip side of the coin. Accounts receivable refers to the funds your customers or clients owe to your business. Essentially, AP focuses on outgoing payments, while AR deals with incoming payments. Together, these two elements offer a clear and complete picture of your business's financial health and cash flow dynamics.
Key steps in the accounts payable process
Without a streamlined system, managing accounts payable can be overwhelming and increase the risk of errors. Here’s a step-by-step guide to ensure a smooth accounts payable process:
Vendor onboarding and management
The initial step in the accounts payable process is setting up accurate vendor profiles. This involves gathering and maintaining up-to-date information for each vendor, including their contact details, payment terms, and any outstanding balances. By properly onboarding your vendors, you can ensure incoming invoices are seamlessly matched with your vendor list, reducing the risk of errors and fraudulent payments.
Invoice receipt and verification
When a vendor delivers goods or services to your startup, they issue an invoice. This document should contain all the necessary details, including a unique invoice number, the date of issue, a description of the product or service, quantities, costs, and payment terms. Upon receiving the invoice, it's crucial to verify its accuracy.
Implementing an automated system that matches invoices with purchase orders can help streamline this process and prevent discrepancies. For example, a three-way matching process, which compares the purchase order, goods receipt, and supplier invoice, is a crucial control mechanism.
Invoice approval and payment scheduling
Once an invoice is verified, a designated approver must sign off before it can be processed. This step ensures that the expenditure is legitimate, within budget, and properly authorized. It also adds an additional layer of internal controls to verify the accuracy of the invoice.
Who the designated approver is depends on the size and nature of the expense. For smaller, routine expenses, it may work to have a single approver who works closely with the vendor and has already received initial approval from management to engage their services. However, for larger invoices, it’s smart to have a two-tier approval process. This would involve the employee directly working with the vendor providing the first level of approval, followed by a second approval from a senior stakeholder. This extra layer of oversight for significant expenses helps maintain financial control and accountability.
After approval, the invoice should be scheduled for payment according to the agreed-upon terms with the vendor. Prioritizing payments based on due dates and setting up reminders can help avoid late payments and maintain healthy vendor relationships.
Payment processing and account coding
With the invoice approved and scheduled, it's time to process the payment. Depending on your company's policies, this may involve issuing a check, initiating a bank transfer, or using an electronic payment platform.
It's important to make payments from a centralized account to ensure accurate recording of all transactions.
Additionally, each invoice should be assigned the correct general ledger (GL) code to ensure proper categorization and allocation of expenses. Account coding is crucial for precise financial reporting. By categorizing expenses by department, it ensures that each expenditure is properly attributed to the correct monthly, quarterly, or annual budget allocations.
Reconciliation and recordkeeping
The final step in the accounts payable process is reconciliation. This involves comparing the payments made against your accounting records to identify and rectify any discrepancies. Maintaining detailed and accurate records is essential for tracking cash flow, managing budgets, and ensuring compliance with accounting standards. Proper record-keeping also creates a clear audit trail, which is crucial for both internal and external financial audits.
Common accounts payable challenges and how to overcome them
Identifying and addressing common challenges early on in your accounts payable function can prevent financial losses and operational disruptions. Here are a few common areas of concern that might arise as you work through the process:
Manual processing
One of the most common challenges in accounts payable is the reliance on manual processes. Manual data entry, invoice approvals, and payment processing can be time-consuming and error-prone.
These errors can lead to delayed payments, strained vendor relationships, and inaccurate financial reporting. To mitigate these risks, consider adopting automated AP solutions that streamline workflows and reduce manual intervention.
Duplicate payments
Duplicate payments can occur when the same invoice is processed multiple times, either due to human error or inadequate controls. This can result in significant financial losses and can create confusion in your account records.
Some AP systems lack features to detect duplicates, while others have inconsistent processes that might lead to various employees handling the same invoice separately. Without automated checks, duplicate invoices can easily go unnoticed.
To prevent duplicate payments, it’s smart to implement thorough invoice verification procedures and utilize AP software with built-in duplicate detection features.
For example, Mercury's AP solution automatically flags potential duplicate invoices based on key data points like invoice number, date, and amount. This helps catch duplicate payments before they occur. This automated safeguard provides an additional layer of protection against processing the same invoice multiple times.
Late payments
Late payments can strain your relationships with vendors and result in late fees or supply chain disruptions.
Inefficient invoice approval processes, lack of visibility into payment due dates, and manual payment scheduling can all contribute to delayed payments. To ensure timely payments, establish clear approval workflows, leverage automation for payment scheduling, and regularly monitor your AP aging report, which organizes your outstanding invoices based on how long they have been overdue.
Typically, invoices are grouped into buckets such as current (not yet due), 1-30 days past due, 31-60 days past due, 61-90 days past due, and over 90 days past due. An AP aging report provides a snapshot of your payables status, allowing you to prioritize payments and identify any invoices that require immediate attention.
Lack of visibility
Limited visibility into outstanding invoices and upcoming payments can hinder effective cash flow management. Without proper tracking and reporting mechanisms, maintaining visibility over accounts payable becomes challenging, hindering the monitoring of outstanding invoices and payments.
To improve visibility, implement a centralized system that provides real-time insights into your liabilities, payment statuses, and cash flow projections.
Best practices for ensuring a smooth AP process
In addition to the suggestions above to help alleviate some of the key challenges that often arise when managing AP, there are several key best practices that can significantly enhance your accounts payable accuracy, control, and operational efficiency. Here are a few to keep in mind:
Payment centralization
Centralizing payment processes can streamline operations, minimize errors, and enhance efficiency. Channeling all payments through a central account significantly reduces the risk of duplicate payments and processing mistakes. Eliminating extra accounts or reliability on extra vendors also allows you to gain full control of your cash flow from end to end. Without centralized payments, companies might end up using multiple payment platforms, for example, resulting in fragmented financial processes and heightened vendor dependencies that increase the risk of manual errors.
Another way to enhance payment organization is by utilizing designated subaccounts. These subaccounts, which are linked to your main account, can be set up for specific purposes, like paying certain types of expenses or vendors. By channeling payments through dedicated subaccounts, you can maintain centralized control while also making sure funds are allocated and tracked appropriately. This level of organization simplifies reconciliation, improves visibility, and strengthens your overall financial management.
Segregation of duties
Segregating duties among different individuals or departments is essential for a smooth accounts payable process, as it ensures that no single person has excessive control over the process.
Successful segregation of duties involves creating a linear process with multiple touchpoints rather than simply siloing responsibilities. By having different individuals handle tasks like invoice entry, approval, and payment, you establish a clear chain of accountability. This linear process helps eliminate the risk of different people inadvertently processing the same invoice — and helps minimize the risk of fraud and error, as well.
Ultimately, having multiple checks and balances improves accuracy and maintain financial integrity, preventing any one person from having too much control.
Payment tracking
Real-time payment tracking offers real-time visibility into the status of all outstanding invoices and payments, helping you stay on top of accounts payable. By monitoring due dates and setting up automated alerts, you can ensure timely payments, avoid late fees, and maintain strong vendor relationships, as you’ll always know exactly where each payment stands. This visibility also allows for early detection of discrepancies or issues, preventing them from escalating into more significant problems.
Leveraging automation
Automated systems efficiently manage your financial workflows, including invoice receipt, verification, approval, and payment processing. This significantly reduces manual effort, minimizes errors, and can improve efficiencies. These tools often use technologies like OCR (Optical Character Recognition) to swiftly capture and validate invoice data, reducing manual data entry mistakes and accelerating approvals. Additionally, automation offers real-time tracking and alerts for due dates, ensuring timely payments and accuracy and promoting more efficient financial reporting.
Mastering accounts payable is crucial for the financial health and operational efficiency of your startup. By streamlining your AP process, you can maintain healthy cash flow, ensure accurate financial reporting, and build strong vendor relationships. A well-managed accounts payable function not only supports your startup's growth but also demonstrates your commitment to financial responsibility and transparency.
At Mercury, we understand that a seamless accounts payable process is crucial for startups aiming for long-term, sustainable success. That’s why we continually innovate our product, focusing on financial accuracy and accounting automation.
Tony Molina, CPA