Accounts Payable Basics
When starting a business, you’re probably focused on revenue. Landing those new clients. Building your portfolio of work. Seeing those deposits hit your bank. Revenue is exciting.
But just as important is tracking your expenses, and that means having a solid understanding of Accounts Payable. Nobody loves bills (whether we’re talking about paying bills or tracking them) but let’s talk about why it’s important. So, buckle in and read on for our introduction to accounts payable.
What is Accounts Payable?
The short answer is that Accounts Payable, sometimes referred to as AP, consists of your bills and the payments you’ve made against those bills. Your Accounts Payable balance is:
Accounts Payable = Bills Received – Payments on Bills Received
Your AP balance at any moment of time indicates your obligations to pay your vendors and suppliers. Accounts Payable shows up your balance sheet as a short-term liability meaning that it’s an obligation that will be paid (or should be paid) within a year.
Accounts Payable does not include all of your obligations – it does not include long-term liabilities such as loans, leases, or pension payables. It also does not include tax payment obligations which are tracked separately.
Why is Accounts Payable important?
You’ve probably had the moment of panic when you spot an unpaid bill buried on your desk and wondered if you’re going to get hit by a late fee, or maybe you’ve been embarrassed by a phone call from one of your vendors politely inquiring where their payment is.
Knowing who you owe money to, how much you owe, and when the payment is due is key to streamlining the financial side of your business. By tracking your bills carefully, you’ll be better able to predict your cash flow (or at least the outflows) in the future.
Ensuring that all your bills are paid on time can protect your business credit, or if you’ve personally guaranteed any of the bills, your personal credit. Businesses that habitually pay their invoices late ruin their reputations and have trouble finding good vendors to work with. Just like you want your clients to pay you on time, so do your vendors.
I use cash accounting – why should I care?
It might be tempting to not enter your bills into your accounting system if you use the cash basis of accounting. Most modern accounting systems allow you to switch your reports easily between cash and accrual basis, so don’t use messing up your reporting as an excuse to avoid entering your bills.
As a business owner, you have enough on your mind with the actual operations of your business. Trying to remember how much you owe on a specific bill and when the bill is due just adds one more item to your mental juggling. By entering the bills as they are received, you’ll be able to easily pull up reports and receive automated reminders when bills need to be paid.
Additionally, although the cash basis of accounting may be sufficient for tax purposes, entering your bills will allow you to better match up your revenue and expenses based on when they were incurred. It’s a little extra work to enter the bills, but the extra insight that you gain from entering the bills is usually worth it.
What is the best way to manage your AP?
There are many ways to manage your Accounts Payable.
You could pay each bill the moment you receive it. This is often not practical since it means pulling out a checkbook, going to a vendor’s website, or entering information into your bill pay when the mail comes every day (or more likely, whenever you receive an email requesting payment). Along with the impracticality of being interrupted by bill paying on a regular basis, you may not have funds available to immediately pay a bill that isn’t due for 30 or 45 days.
You can have a folder set up on your desk with all the bills inside and rifle through it occasionally to figure out which bills are due. This may work while you’re a very small business, but it’s not going to serve you well in the long run. There’s a reason that large corporations have entire departments devoted to Accounts Payable.
Ideally, you’ll enter each bill into your accounting system along with the vendor’s name, bill amount, when it was received, and when it is due. Your accounting system will then produce reports such as an Accounts Payable Aging Report that show which bills are current and if you’ve fallen behind with any vendors. It’s best practice to have one person enter the bills and a second, independent person sign the checks or approve the payments.
If you are a large company, it probably makes sense to have internal people managing bill payment and tracking. But if you’re a small business, it often makes sense to work with an experienced bookkeeper or accounting service. After working with you to gain an understanding of your business and operations, they’ll be able to handle the Accounts Payable system and work with you to make sure that everything stays current and hassle-free for you.
No matter what size business you have nor how complicated your business finances are, Accounts Payable plays an important role in the expense side of your Profit and Loss statement.
Want to dig deeper than our simple introduction to accounts payable can offer? Check out this Udemy course for advanced AP training.
Looking for an outside bookkeeper to handle your accounts payable for you? Reach out to My OC Bookkeeper! At My OC Bookkeeper we are experts at helping businesses with their accounts payable. Not only that, we can help you with all kinds of issues related to accounting, bookkeeping, outsourced CFO services, and general business consulting. Click on the surfers below to learn more.