If you have ever purchased something on a credit card, then it’s a form of Accounts Payable. When you purchase any product or a service on credit with an unsaid promise of paying for it in the near future, it can be termed as Accounts Payable. This account is created to record all due payments and is treated as a liability. Different companies treat this within their own workflows. While this might seem like a small task, in reality, it requires a lot of time and resources. This is mainly why several organizations are now moving towards automated Accounts Payable management systems.
What is Accounts Payable?
In simple words, Accounts Payable or AP, is an account that records the amount which is due and to be paid to the creditor at a future date. This amount occurs against purchasing something in credit. Thus, that amount is treated as a current liability for the organization or even an individual as it is to be paid in a short period of time. Let’s look at some use cases for AP to gain a better understanding.
Use Cases of Accounts Payable
Example 1: Energy sector
In this example, we will consider a solar energy company, Sunpower Ltd., which has been working in the industry for over a decade. They majorly operate in Gujarat, India.
Scenario: With the market increasingly favoring electric vehicles (EV), the company has seen potential to scale up their business. Along with the increasing capacity of their three existing solar plants, they also plan to project a new, upgraded plant on the outskirts of Gujarat. To begin with, they contacted their suppliers for equipment like electric conductors, convertors, and more. The firm decides to buy solar panels and some converters for the new plant on credit from the supplier, while financing the equipment for the upgrade.
They want to upgrade their existing plants, and planned to pay the credit amount from the revenue that they shall generate from the upgraded plants. Listed below is the total cost that they have to bear:
Upgrade Equipment - ₹56,00,000
Equipment on Credit - ₹20,00,000
The company is confident that they will generate revenue from their current business and plan to pay the due amount to their supplier in 30 to 60 days. Here is how this will be treated.
Sunpower Ltd. will record the entire amount (₹20,00,000) as a short-term liability, hence it will be known as Accounts Payable. They will also record an equivalent debit amount in their expense account. This will be settled once the due amount is paid by crediting the cash or equivalent account and debiting the accounts payable by the due amount.
The supplier will record the same amount of ₹20,00,000 as Accounts Receivable. Both of these amounts will be recorded on the day the sale is made and the company has purchased the equipment. This is how their account statement would look like:
For Sunpower Ltd.
Relevant Equipment A/c ₹ 20,00,000
To Accounts Payable A/c ₹ 20,00,000
For the supplier
Accounts Receivable A/c ₹ 20,00,000
To Sales ₹ 20,00,000
Example 2: Financial services
Let's take a look at an example of a financial services company. Since these companies belong to the financial industry, their accounts payable and receivable requirements are different. A lot of documentation, verification and processing is also required.
Scenario: A company, Simplecard Ltd., provides financial services like credit buys or Buy Now Or Pay Later (BNPL). It is a form of short-term financing which allows the user to make purchases and pay for it at a future date. The payment is often interest free and the due date is not too far fetched from the date of purchase. In essence, it is just a purchase made on credit and the amount is due.
Mr. Ramesh buys a new laptop through BNPL by Simplecard Ltd. The laptop costs about ₹68,000. He was allowed to make this purchase post a series of checks and consideration from the company’s end. Later, he was asked to pay 25% of the total amount which was about ₹17,000 as a down payment. He can pay the remaining amount later in installments.
Total Cost = ₹68,000
Down Payment = ₹17,000
Due Amount = ₹51,000
Example 3: Logistics
Nowadays, it is more common to hire or rent trucks for transporting goods rather than own them. There are several situations which can call truck transportation into use.
Scenario: A construction company, RG Builders Ltd. has a new project for which they require to set up their machines and other equipment at the construction site.
They assess that it’ll take 2-3 days to transport all the machinery from their warehouse to the project site. RG Builders Ltd. hires a logistics company, PickTrucker Ltd. to ease this transportation process.
PickTrucker Ltd. took up this assignment and made a deal for ₹1,70,000. RG Builders Ltd. paid ₹50,000 upfront, in advance, and the goods were transported safely to the construction site. RG Builders Ltd. had earlier generated an accounts payable for ₹1,20,000, and has now paid it to PickTrucker Ltd. The logistics company had created an accounts receivable, which was settled after 3 days.
Total Cost = ₹1,70,000
Advance Payment= ₹50,000
Amount Due = ₹1,20,000
For RG Builders Ltd.
Outbound Logistics Expense A/c ₹1,20,000
To Accounts Payable A/c ₹1,20,000
For PickTruckers Ltd.
Accounts Receivable A/c ₹1,20,000
To Service Rendered A/c ₹1,20,000
Accounts Payable workflow in an organization
An AP workflow is the process of handling all the Accounts Payable, Accounts Receivable and their settlement. It outlines a process that organizations can use to manage the documentation, verification (required for procurement) and payment of transactions. It helps the business in becoming consistent and efficient in their operations. These AP workflows can be either managed manually or automated. Any basic AP workflow will work on these elements:
- Types of documents required to validate the process
- Details of the vendor
- Payment method and settlement duration
Here is what a basic workflow would look like -
- Receiving invoices
- Validating and approving the invoices
- Updating the records
- Authorization and processing the payments
- Settling the accounts in ledger
Accounts payable helps in generating more cash at your disposal. Here is how it actually happens:
As Accounts Payable is the amount that is due to be paid but it is still with you, it means that it blocks cash outflow and lets you hold on to as much cash as possible. It enables you to use the cash for other purposes. An increase in Accounts Payable affects the cash flow positively and a decrease in will affect the cashflow negatively. Using this information, an organization can efficiently manage their entire cashflow. You can also check our blog for a better understanding of this concept.
Why is automating accounts payable processes a good idea?
All organizations today are working with some kind of credit. This means that they have to handle invoices and settle accounts on time and more. It is a hectic task and extremely time-consuming if done manually. With automated accounts payable workflow, organizations are now able to optimize their time and resources.
Differences between Accounts Payable & Accounts Receivable:
Accounts Payable (AP) and Accounts Receivable (AR) are like two sides of the same coin. Though they revolve around the same concept, they’re the complete opposite.
Accounts Payable (AP)
Accounts Receivable (AR)
It records money or amount that is due and to be paid on a future date.
It records the amount that is yet to be received.
It is treated as a current liability until paid.
It is treated as a current asset until written off.
Client or receiver of credit records it.
Vendor of credit records it.
Moreover, if you consider how monotonous and future oriented this process is, there is a lot of room for error such as time delay, mismatch of amounts and more. When it comes to finance, it is not safe to make errors. By leveraging an automated process to manage AP, organizations can run their workflows with minimum errors while saving a lot of time and resources.