Running a successful business calls for constantly balancing the revenue you have coming in with the money you must pay out to remain operational and grow. Regarding that second part, careful accounts payable (AP) management is critical to strengthening your company’s financial position.
Proper AP management enables you to maintain strong relationships with vendors, suppliers and other key providers. It also helps ensure you avoid costly mistakes, prevent fraud and maintain a steady cash flow. Underperforming at AP management may hamper your ability to obtain the materials or services you need to operate, damage your business’s reputation, and trigger financial penalties or other losses.
3 building blocks
No matter the size or type of company, most businesses’ AP management rests upon three fundamental building blocks. The first is documentation. You’ve got to accurately track how much your company owes and to whom.
Every invoice must be matched with a purchase order and proof of receipt. Mistakes can be costly in ways that aren’t always obvious. For example, overpaying or double paying invoices drains cash flow unnecessarily, and these amounts can be difficult to recover. Implementing, maintaining and continuously improving a top-notch AP management system helps ensure you know exactly what you owe and when payments are due.
The second building block is control of approvals. Before any invoice is paid, an authorized party in your business — whether it’s you or a trusted manager or other employee — should confirm it’s legitimate and matches the items ordered or services provided. This simple step is crucial to preventing payments for goods or services you never received, as well as to stopping fraud.
The third building block is the timing of payments. Many new business owners want to pay invoices as soon as they arrive. However, doing so can consume liquidity and leave you in a difficult cash flow situation. Of course, waiting too long to pay can strain relationships with creditors, trigger late fees and force your company into suboptimal payment terms down the line. Striking the right balance is key.
Best practices
For small to midsize companies, adhering to just a few best practices can stabilize AP management and set you on a path toward refining your approach over time. Begin by centralizing your AP processes with a secure, consistent system for receiving, recording and approving invoices.
Digitizing your AP records should make them easier to track and reduce the chances that an important invoice or document gets lost. Moreover, the right technology can help you analyze your payables to spot troubling trends or seize opportunities.
AP software enables you to track key metrics over time. One example is days payable outstanding (DPO). It measures how many days it takes your business, on average, to pay creditors. Generally, the formula goes:
DPO = (average AP / cost of goods sold) × 365 days
By regularly monitoring and benchmarking these and other relevant metrics, you can pinpoint optimal timing of payments, better manage cash flow and build your cash reserves.
It’s also worth reiterating the importance of clear, comprehensive and strictly enforced payment approval policies. Carefully vet who within your business has the power to approve invoices. Some companies require more than one person to approve bills exceeding a certain dollar amount.
To help prevent fraud, segregate or rotate duties related to receiving, recording and approving invoices. Regularly reconcile your AP ledger with supporting documentation, such as vendor statements, to catch signs of wrongdoing or errors.
We can help
Many business owners avoid or underemphasize AP management because, let’s face it, no one likes paying the bills. However, allowing this area of your company to languish can lead to any number of financial misfortunes. Contact us to have your AP process reviewed and discover ways to improve data capture and efficiency, strengthen internal controls, and optimize payment timing to support better cash flow.
