Maintaining Financial Stability Is a Must for Any Company
Being able to manage your money can be the difference between life and death for a company. Having a handle on both the inflow and outflow of cash with diligently managed accounts payable days is the only way to keep your business stable, project the company’s future, and maintain employee confidence in the company’s short- and long-term future.
Smart cash flow maintenance also helps to maintain good relationships with suppliers, which opens an avenue for useful discounts and easier negotiations in general. Regardless of the industry that your company specializes in, having good contacts is the best way to increase investment — both financially and otherwise — in your business interests. The downsides of not having such relationships make company growth far more difficult to achieve.
These realities are what make the accounts payable department of a company so crucial to success.
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What Is Accounts Payable?
Accounts payable is an account in a general ledger that represents the company’s commitment to paying off a short-term debt owed to a supplier or its creditors after purchasing goods and/or services on credit instead of with cash upfront. This process gives a business what it needs now, and they receive a bill or invoice from the seller later on that states when the money is owed. On a balance sheet, it is listed under the head ‘Current Liability.’ It’s treated as a liability because goods were bought on credit. The debt payment has to be paid on time to avoid default. The time frame is usually within a year or less. Businesses have an AP department that is responsible for making the scheduled payments, but individuals also have accounts payable.
Like any other liability account, accounts payable will have a credit balance. When an account payable is paid, accounts payable will be debited, and cash will be credited. This means that the credit balance in accounts payable should be the same amount as the vendor invoices that have been recorded but have yet to be paid.
The company that receives the goods or services on credit has to report the liability no later than the date they were received. That date is used to record the debit entry to an expense or an asset account. Under the accrual method of accounting, expenses are reported when they are incurred, not when they are paid. The term accounts payable can also refer to the person or department that processes vendor invoices and pays the company’s bills.
The Accounts Payable Process
The accounts payable process usually involves reviewing an enormous amount of detail to make sure that the amounts listed in the accounting system are up to date and legitimate. The most important information exists in the following documents:
- Purchase orders issued by the company
- Receiving reports issued by the company
- Invoices from the company’s vendors
- Contracts and other agreements
The financial present and future of a company depend greatly on the veracity of the accounts payable process. If done correctly, this process includes:
- Processing accurate and legitimate vendor invoices
- Accurate recording in the appropriate general ledger accounts
- The accrual of obligations and expenses that have yet to be completely processed
What Are Accounts Payable Days (or DPO)?
To better keep track of these payments, companies and individuals can fall back on a reliable formula to help them pay bills and other obligations on time. Accounts payable days, also known as days payable outstanding (DPO), is a financial ratio that shows the average number of days of credit that a party has to pay its bills and invoices to its suppliers, vendors, or financiers in a period of time.
Conventional wisdom states that a low DPO is a healthy DPO, but this isn’t always the case. A business with a higher value of payable days can delay paying their payable balance for longer. They can then use the cash they have to make short-term investments to increase their working capital and free up cash flow. At the same time, a high DPO value may also signal an inability to pay bills on time. It can also indicate a general cash shortfall. Each business should aim for a DPO that best suits its context. If the number of payable days changes, then it could indicate that the payment terms with suppliers have changed. But this doesn’t have a serious effect on the number of days in most examples.
If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, either because short credit terms are part of their business models or because they feel the company is too high of a credit risk to allow longer payment terms.
Days Payable Outstanding Formula
Companies calculate accounts payable days by multiplying the average accounts payable (the total of the beginning accounts payable and the ending accounts payable) by the number of days in an accounting period. This formula reveals the total accounts payable turnover. Then, you take that number and divide it by the cost of goods sold. COGS, also known as cost of sales, is the cost of acquiring or manufacturing the products that a company sells during a period. The ratio indicates how well the company manages its cash outflows.
DPO value also plays a role in calculating the cash conversion cycle (CCC). This is another metric that expresses the amount of time that a company takes to convert inventory investments and other resources into cash flow from sales. DPO focuses on the current outstanding payable by the business. But the CCC, also known as the Net Operating Cycle or simply Cash Cycle, follows the entire timeline. This extends from when the cash is converted into inventory, expenses, and accounts payable, through to sales and accounts receivable, and then back into cash in hand when received. If you want to see the DPO of other companies, these figures can be found in their annual financial statements, income statements, and balance sheets.
Good DPO Management Is a Game-Changer
A well-run accounts payable process affects every level of a company’s cash position. Paying bills on a scheduled basis helps greatly to develop a relationship with suppliers. It also improves your credit rating. Suppliers may also deliver better privileges, such as higher discounts, in return.
It’s important to find the right balance on the number of accounts payable days. We covered the dangers of a higher ratio in the previous section. But keeping these accounts payable days too low will not make a lot of cash available to reinvest in future opportunities.
An accounts payable on the rise shows that the company will not be in a position to borrow cash if they need short-term capital. A weaker company may face liquidity issues.
Whatever the state of your company is, having a clear system to pay vendors at the right times is a vital component of any business.
Negotiatus automates the ordering process to free up more time for important day-to-day operations. Automated, proactive delivery tracking provides timely updates about the status of your shipment. Customers can complete orders 95% faster than before they began to use Negotiatus.
Customers can complete orders 95% faster than before they began to use Negotiatus
Firsthand Insights From AP Automation Technology Adopters
Many users of Negotiatus agree that the software has been transformative for their business.
Previously, ZeroCater needed one or two business days a month just to record payments and manage invoices. With Negotiatus, their number of invoices completed each month went down considerably. They went from sending 200 invoices to Amazon a month to three or four. This reduction made it much easier to track spending and wade through the ordering process. (Over 80% of our clients pay just one invoice per week or month.)
The real-time analytics feature was also a boon for them. It added substantial visibility to their budgets. Managers can see where every dollar goes and notice issues before they become unwieldy.
In their old system, managers at SoulCycle had to jump through several unnecessary hoops to complete transactions. Each vendor site had its own rules and logins to keep track of. Also, they had to manually count how all of this affected their monthly budgets. This made payment reconciliation a long and challenging process.
Once the company began using Negotiatus, everything changed. Orders were fulfilled much faster now that employees could place orders from one approved catalog into one cart that’s shared across every vendor. Also, reporting on expenses went from taking five to six hours a month to only requiring one consolidated invoice for the same amount of time.
Similarly, BLANKSPACES’s purchasing process was disjointed, difficult to parse, and far too time-consuming. Some purchases were never recorded, and miscommunications between their locations were common. But after working with Negotiatus, their workflow became simpler in mere minutes.
Acquiring supplies became much more cost-effective. Also, the pre-established vendor network included with Negotiatus made setting up accounts payable schedules a breeze. In the words of the facilities manager, Elizabeth Nowlin, ‘Once we’ve added a product to Negotiatus, we know everything has been taken care of.’
You can link vendor accounts and get Negotiatus up and running in less than 24 hours. If you want to learn more about using this software for your business, feel free to request a demo.