How Accounts Payable Works: A Step-by-Step Process

Accounts payable (AP) represents the money a business owes to its suppliers and vendors for goods or services purchased on credit. This financial obligation is a short-term liability recorded on a company’s balance sheet. Effectively managing accounts payable is important for maintaining a business’s financial health, optimizing cash flow, and fostering strong relationships with vendors.

Understanding Key Accounts Payable Documents

The accounts payable process relies on foundational documents. These documents create a clear audit trail and ensure accurate record-keeping.

A purchase order (PO) is an internal document generated by a buyer to formally request goods or services from a vendor. It details the items, quantities, agreed-upon prices, and delivery terms, acting as the initial record of a purchase. Once accepted by the seller, the PO becomes a legally binding contract.

Following a purchase order, a receiving report documents receipt of goods or services. This report confirms what was delivered, including the date received, items, quantities, and their condition. It verifies ordered items arrived.

The vendor invoice is a bill sent by the supplier, formally requesting payment for the goods or services provided. It typically includes an invoice number, the amount due, payment terms (such as “Net 30”), vendor details, and an itemized list of what was supplied. This document is the formal request that initiates the payment process.

Matching these documents is a core principle in accounts payable. Two-way matching involves comparing the vendor invoice against the purchase order to verify billed amount, quantity, and items align with what was ordered. For a more robust control, three-way matching adds the receiving report to this comparison, verifying consistency between order, receipt, and invoice. This matching process is essential for preventing overpayments, paying for undelivered goods, or processing fraudulent invoices.

The Step-by-Step Accounts Payable Process

The accounts payable process involves structured steps to manage financial obligations. These steps ensure invoices are legitimate, approved, and paid on time, impacting a company’s operational flow and financial standing.

The process begins with invoice receipt and review. Invoices arrive through various channels. A preliminary check ensures the invoice is complete.

After receipt, document matching and verification occurs. This involves comparing the vendor invoice against the purchase order and the receiving report, if applicable. The accounts payable team verifies invoice items, quantities, and prices match what was ordered and received. Discrepancies must be investigated and resolved before proceeding.

After successful matching, the invoice moves to the approval stage. Designated personnel, such as department managers, review and authorize payment. This approval ensures the expenditure aligns with company policies and allocated budgets.

Payment processing is the next step, where funds are disbursed. Businesses use various methods, including physical checks, Automated Clearing House (ACH) transfers, or wire transfers. The accounts payable team prepares the payment.

Each accounts payable transaction is recorded in the accounting system. This involves updating the general ledger and the accounts payable sub-ledger to reflect invoice receipt and payment. Accurate recording is fundamental for generating reliable financial reports, tracking expenses, and maintaining an up-to-date view of liabilities.

Internal Controls for Accounts Payable Accuracy

Establishing internal controls within accounts payable is paramount for maintaining financial integrity, preventing errors, and safeguarding against fraud. These mechanisms ensure disbursements are accurate, authorized, and properly recorded.

Segregation of duties involves distributing critical tasks among different individuals. For instance, one person might create purchase orders, another process invoices, and a third authorize payments. This separation ensures no single employee has complete control over a transaction, reducing fraud or errors.

Regular reconciliation involves comparing internal accounts payable records with external vendor statements to identify and resolve discrepancies. This includes reconciling the accounts payable sub-ledger with the general ledger control account. This comparison helps catch missing invoices, duplicate payments, or pricing errors.

Payment authorization limits require different levels of approval based on payment value. For example, a department manager might approve invoices up to a certain amount, while higher-level approval is needed for larger payments. This tiered structure ensures oversight for significant expenditures.

Technology and automation enhance accounts payable controls. Accounting software and automated systems can implement controls like automated matching of invoices with purchase orders and receiving reports, flagging discrepancies. These systems create audit trails, restrict access to sensitive data, and detect duplicate invoices, strengthening the control environment.