How to Process Accounts Payable: A Full Workflow

Accounts payable (AP) represents the money a business owes to its suppliers for goods or services obtained on credit. These amounts are short-term liabilities, typically due within a few weeks or months. Effective AP management ensures suppliers are paid on time, fostering reliable relationships and maintaining operational continuity. It also helps manage cash flow by predicting outflows, supporting budgeting, and contributing to overall financial health.

Preparing Your Accounts Payable System

Before invoices are processed, a business needs to establish a robust accounts payable system. This foundation involves gathering vendor information and defining financial terms and controls. A well-prepared system ensures accuracy and efficiency throughout the AP workflow.

Establishing comprehensive vendor records is a foundational step. For each supplier, a business should collect details such as their legal name, address, and contact information. Collecting a W-9 form from U.S. vendors provides their taxpayer identification number (TIN) and tax classification. This information is necessary for tax reporting obligations, such as preparing IRS Form 1099-NEC or 1099-MISC if payments to a vendor total $600 or more in a calendar year.

Defining clear payment terms with vendors helps manage cash flow. Common terms, such as “Net 30” or “Net 60,” indicate payment is due within 30 or 60 days from the invoice date. “COD” (Cash on Delivery) means payment is due when goods or services are received. These terms directly influence when payments are scheduled and should be agreed upon before transactions occur.

Setting up a chart of accounts is another preparatory step. This structured list categorizes all financial transactions, including expenses like office supplies, utilities, or professional services. Accurate coding of expenses to the appropriate general ledger accounts is important for precise financial reporting and budget tracking.

Businesses can manage accounts payable through various systems, ranging from manual ledgers to specialized accounting software like QuickBooks or Xero, or even larger Enterprise Resource Planning (ERP) systems. The choice of system depends on the business’s size and complexity, but the goal is a structured method for tracking all payable information. Regardless of the system chosen, it should facilitate organized recording and retrieval of vendor data and transaction details.

Documenting internal controls protects a business’s assets and ensures financial integrity. These controls involve setting clear guidelines for who can approve purchases and payments, establishing separation of duties, and defining workflows. Having these foundational rules in place helps prevent errors and potential fraud within the AP function.

Processing Vendor Invoices

Processing vendor invoices begins once the accounts payable system is in place. This stage involves verification and recording steps to ensure each invoice is legitimate and accurate before approval for payment.

Invoices can be received in various formats, including physical mail or electronic files. The initial step upon receipt is to log the invoice into the chosen accounting system, manually or digitally. This logging creates a record of the invoice and marks the beginning of its journey through the workflow.

Three-way matching, or sometimes two-way matching, is a verification step. Three-way matching compares the invoice against the original purchase order (PO) and the receiving report, confirming goods were delivered. This comparison ensures what was ordered, received, and billed all align in quantity, price, and terms.

For services, this might involve comparing the invoice to a signed contract or service agreement. Two-way matching, often used for lower-risk transactions, compares only the invoice against the purchase order. This verification helps prevent errors, duplicate payments, and fraudulent invoices.

After matching, the next step is coding expenses. This involves assigning the correct general ledger accounts to each line item on the invoice, using the chart of accounts. Accurate coding ensures expenses are categorized properly for financial reporting.

Obtaining approvals is an internal control within the invoice processing workflow. Invoices are routed to designated personnel for review and authorization, based on company policies and spending limits. This step confirms purchases were authorized and goods or services were received and are legitimate. High-value invoices may require multiple levels of approval.

Once an invoice has been verified, coded, and approved, the final step is to enter the complete data into the accounting system. This entry creates the formal payable record, acknowledging the business’s obligation to pay the vendor. This digital record then serves as the basis for scheduling and executing payment.

Managing Payments and Reconciliation

After an invoice has been processed and approved, the final stages of the accounts payable workflow involve executing payments and reconciling financial records. These steps ensure timely disbursement of funds and maintain the accuracy of financial statements.

Scheduling payments involves using the payment terms and due dates established during vendor setup. Businesses leverage their accounting systems to track these dates and prioritize payments. Paying invoices on time avoids late fees or penalties and maintains positive relationships with suppliers.

Businesses use various methods to execute payments. Common options include issuing physical checks, initiating electronic funds transfers (EFT) via Automated Clearing House (ACH), or using credit cards. Wire transfers are reserved for larger, time-sensitive, or international payments due to higher costs. Each method has its own considerations regarding speed, cost, and security, and the choice depends on the vendor’s preference and the business’s capabilities.

Reconciling vendor statements is a periodic activity. This process compares the business’s internal accounts payable records with statements provided by vendors. The purpose is to identify discrepancies, such as missing invoices, unapplied payments, or billing errors. Resolving these differences promptly ensures both the business and the vendor have accurate records of outstanding balances.

Maintaining thorough records is a requirement for accounts payable. All relevant documents, including invoices, purchase orders, receiving reports, and payment confirmations, should be systematically filed and archived. These records provide an audit trail and are important for future reference, dispute resolution, and tax compliance. The Internal Revenue Service (IRS) recommends keeping tax records for compliance purposes.