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No matter what industry you’re in, you’re likely paying someone for something in order to keep your business running. Altogether, those expenses—most specifically the ones purchased on credit—create a line item on your balance sheet known as “accounts payable,” and the management of accounts payable is one of your most crucial tasks as a small business owner.
To be fair, management of accounts payable can be tedious and time-consuming. But implementing reliable accounts payable organization ideas is critical to the long-term vitality of your business—your accounts payable impacts both your relationships with your vendors and your cash flow, which spell the difference between future success and business failure.
Here, we dive into everything you need to know to create an easy-to-use and successful accounts payable system that will help your business thrive for years to come.
“Accounts payable” refers to all the money a business owes vendors and suppliers for the purchases of goods and services made on credit. Just to clarify, a vendor can be any individual or company that provides supplies, equipment, or services required for the operation of your company. (For example, a retail jewelry shop’s vendors may include wholesale jewelers, while a printing shop may count their ink supplier among their most crucial suppliers.)
On your balance sheet, the total sum owed to your vendors are listed together as a “current liability.” Along with your accounts receivable, accounts payable is one of the greatest factors determining your business’s cash flow.
Clearly, it’s important that you have an accounts payable filing system in place. That way, you’ll always know how much you owe all your suppliers, and that you make payments on time, every time. Failure to properly manage accounts payable can lead to late payment penalties, damaged supplier relationships, and even business failure that could have been avoided if oncoming cash flow issues had been foreseen and properly managed.
It’s important that every small business owner implements an accounts payable reconciling process; and the most successful accounts payable process requires an understanding of the accounts payable cycle.
The accounts payable cycle is essentially simple—basically, it refers to the process of checking your invoices, entering them into your accounting system, and settling the payment after ordering and receiving goods from your vendor. But it involves a few steps which, to the newbie entrepreneur, can seem complicated.
We asked Billie Anne Grigg, owner of Pocket Protector Bookkeeping and a Fundera contributing writer, to break down the accounts payable cycle in a few straightforward steps:
At a minimum, the following steps need to be followed:
Create a purchase order and enter it into the accounting system.
When the merchandise arrives, compare the packing list to the purchase order, making note of any discrepancies in price, quantity, etc.
Receive the purchase order in the accounting system.
Enter the invoice against the purchase order when it arrives. (If purchase orders aren’t used, go to step 5.)
If purchase orders aren’t used, an approval process needs to be in place to ensure that only the invoices that the owner approves are being paid. When an invoice arrives, the owner must sign off on the invoice. More efficiently, you can use an electronic A/P system, like Bill.com, and set up approval levels. This way, the bookkeeper can enter the invoice, but the business owner still has to approve it before it can be paid.
When payments are made, they should be posted against the invoice in the accounting system to mark the invoice as paid.
No one other than the business owner should sign checks for invoice payments. Also, the business owner should review the bank statement each month, paying special attention to the check images on the statement to identify possible misuse of the check stock.
At a minimum, the following steps need to be followed:
Finally, Grigg advises using an invoice numbering system. “This will help prevent duplicate invoices from being entered and paid,” she says. “Best practice is to enter the invoice number into the accounting system exactly as it appears on the invoice.”
Especially for rookie entrepreneurs with little or no business background, setting up your accounts payable for the first time can be pretty intimidating. But the process itself is fairly straightforward—and you don’t even need special accounting software to do it.
If you’ve been managing your personal bills for a while—including utilities, student loans, mortgage or rent payments, and the like—you’ve likely already used a very similar system. The point of your accounts payable system is simply to keep track of when payments are due, and make sure that you don’t let any bills get lost in the shuffle.
The most basic way to manage your company’s accounts payable is in a spreadsheet format, such as with Microsoft Excel, Numbers for Mac, or Google Sheets. Using an accounting spreadsheet system is a great way to learn how accounts payable works, and may even be a sufficient solution for very small businesses who work with just a few vendors.
First, you’ll need to gather your open invoices, then find the following information to track on your spreadsheet:
Insert this information into your spreadsheet for each of your unpaid invoices. If you’ve been in business for a while and haven’t been tracking your accounts payable, you may want to repeat this process for your last 60-90 days of paid invoices, just so that you have all of your information in order and can compare current and past invoices.
This initial setup process will be heavy on data entry—but don’t be discouraged. Once the setup is complete, your day-to-day payables process will likely be far less time-intensive.
You’ll need a system to keep your paper bills organized, too. Plan to open paper bills immediately, enter the data into your spreadsheet, then file the hard copy until it’s paid. After you’ve sent payment, you’ll want to keep a hard copy of the bill stub for your records. If you have an even split of paper and digital invoices, it may be beneficial to scan paper invoices to keep all files in one place.
A DIY accounts payable spreadsheet may suffice for small business owners who work with only a few vendors, and cut fewer than a dozen checks per month. But if you’re juggling a large number of vendors and suppliers, you may find you need more efficient tools.
In that case, consider a business accounting software for managing your company’s accounts payable, like one of the following three options:
Businesses dealing with a large volume of accounts payable may benefit from an AP automation system like Mineral Tree, which integrates with QuickBooks and some other accounting software. Mineral Tree allows you to manage your accounts payable cycle from invoice approval to final payment in one simple interface, while maintaining a clear segregation of duties with email alerts and approvals to prevent internal fraud.
Considered the gold standard of accounting software by most professional small business accountants, QuickBooks has all the bells and whistles you could ever need for managing your accounts payable, receivable, and much more.
Of course, QuickBooks is a total accounting system, not solely an accounts payable tool. But unless you’re managing many invoices and vendors, QuickBooks would likely suit the majority of your accounts payable and other accounting needs.
If you’re looking for a full-service online accounting system with the best available accounts payable solutions, Xero may be your perfect tool. Through Xero, suppliers can send their invoices directly to your accounts, where you can follow a graph of your bills to decide when to pay which bills, manage your cash flow, and schedule vendor payments—making Xero’s the most user-friendly accounts payable system out of the full-service accounting options.
Whether you manage your accounts payable manually or via software, consult these four tips for maintaining a successful accounts payable system—and stick to them, lest you risk missing payments and damaging valuable relationships with your suppliers.
After you’ve been tracking your payables for some time, you’ll start to notice recurring trends in your payment scheduling. At which times in the month or year do you spend the most money? Which payables categories tend to fluctuate the most?
The longer you’re in business, the better you’ll be able to predict monthly, quarterly, and annual trends, and create accurate cash flow projections. Knowing when trouble areas arise—aka, when your major expenses are due—allows you to better plan for them, so that you always have enough cash on hand to meet your needs.
After you’ve been tracking payables for several months, you’re likely ready to hand the task off to a trusted employee or administrator, or to a third-party bookkeeping service. That way, you’ll regain valuable time to spend on your many other responsibilities.
But before delegating any parts of your payables process, make sure that you have clear procedures in place for your accountant to follow. If they suggest any changes to your payable procedures, make sure you understand those changes and stay hands-on in the process.
Regardless of whether the work you’re delegating involves basic data entry or cutting checks; whether you’re entrusting your payables to your sister, your favorite employee, or your best friend—you absolutely must have checks and balances in place to protect your company’s finances.
According to a report from the Association of Certified Fraud Examiners, at least half of small businesses will experience fraud at some point in their business’s life cycle. And while we’d all like to trust those closest to us, ACFE’s report found that accounting fraud is most often committed by a “loyal” employee.
Even innocent accounting mistakes can compromise trust and ruin relationships when they cost the company money. Protect yourself and your business by routinely checking invoices, payables ledgers, and checks to vendors to look for discrepancies. Set up accountability systems by not letting the same individual write, sign, and authorize checks, and perform regular spot-checks for errors or fraudulent activity.
It’s easy to fall into the trap of believing a late payment here or there is no big deal—after all, your own customers probably make late payments all the time!
But you can’t let yourself go there. Not only does that thinking set yourself up for late payment penalties, but failing to make timely payments on current debts will destroy your business and personal credit ratings (not to mention your relationships with vendors).
Don’t cause yourself unnecessary stress when proper management of your payables could easily fix the problem. Put a thorough system in place and stick to it. That way, if true financial difficulty hits later on, you’ll have your own good credit and your vendors’ loyalty to help get you through the storm.
Once you’ve nailed down your accounts payable system, our dictum of “avoiding late payments” is relatively easy—that is, as long as your business has enough cash to pay all your bills. But what happens when your slow sales month becomes two or three, when a major client is past due on a major invoice, or when an emergency expense depletes your cash reserves?
Before you panic, remember that you’re not alone. A huge number of small businesses hit bumps in the financial road from time to time, and some of those may even include your vendors themselves! The folks you work with know what it’s like to be in business, and many of them may be more understanding than you might think.
The key to surviving this difficult stretch? Be proactive and honest with your creditors. Here’s how to go about it diplomatically.
Think about which creditors are most essential to keeping your business running, and talk to those vendors first. Gauge their willingness to work with you and, if they are, prioritize these bills so you can continue receiving shipments and services that you need to stay operational.
Then contact the rest of your creditors in order of how essential they are to your business. A few straightforward conversations will help you determine who is willing to create a payment schedule around your debt, and who isn’t.
Remember that you have more bargaining power than you may think, especially with your suppliers who are small business owners themselves. After all, if you go out of business, they’ll lose a customer. If you demonstrate your loyalty to your vendors, you may receive loyalty and compassion in return.
Once you’ve had those tough conversations and worked out a payment schedule with each creditor, do everything in your power to stick to that schedule. If your sales take a turn for the better, make an effort to pay creditors early—even a few days earlier than expected does a lot to show them that you recognize and appreciate their loyalty.
If you’re not able to meet that payment schedule, communicate with your vendors as early and honestly as possible. The worst thing you can do in this scenario is pay late without warning. Treat your vendors the same way you would want a late paying customer to treat you.
Creating a payment schedule for immediate payables is one thing, but in order to form a long-term solution to your cash flow problem, you’ll likely need to cut costs. Look for ways to scale back your company’s ongoing liabilities and turn your cash flow around as you look to new options for increasing sales volumes.
Not having the cash on hand to honor your debt agreements to your vendors is frustrating at best. But business loans were designed to be your recourse to financial stability in almost every scenario imaginable—including cash-flow issues.
Consider invoice financing if most (or all) of your cash flow is currently tied up in your clients’ overdue invoices. If you’re approved for invoice financing, your lender will front you up to 85% of the total value of your outstanding invoices; you’ll receive the remaining amount, plus fees, when your customers fulfill their payments. But that immediate cash in hand means you can pay your own invoices ASAP.
If you’re not a candidate for invoice financing, you may have better luck securing a business line of credit. Much like a credit card without the plastic, lines of credit allow you access to a predetermined amount of cash whenever you need it, for practically any purpose as you see fit. Unlike a traditional term loan, you don’t necessarily need to repay your line of credit loan in full—instead, you simply pay for the funds you actually use, plus interest.
Business lines of credit are handy to have in wait in your business bank account; tap into them whenever a cash-flow issue or emergency expense (like paying your vendors) arises.
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When you look at your balance sheet, accounts payable may look like a single line item that you wouldn’t give much, if any, thought. But in reality, accounts payable is made up of many bits and pieces required to make your business run.
The ultimate goal of your accounts payable filing system is that you’ll stay on top of your debts to your vendors. As a result, you’ll maintain important vendor relationships, and see exactly when and where your cash flow might take a hit and plan accordingly.
So while we can’t say that management of accounts payable will be your favorite task as a small business owner, remember that in this case, an ounce of prevention is worth a pound of cure. Taking the time to create stellar accounts payable procedures now is an effort for which future you (and your bank account) will be eternally grateful.