A Comprehensive Guide to the Full Cycle of Accounts Payable

Any organization serious about vendor invoice management, vendor relations, compliance, and cash flow management will prioritize efficient accounts payable (AP) management. This guide thoroughly explores the accounts payable cycle, explaining each step with examples and formulas to enhance comprehension. Further, it shall look into the process end to end in accounts payable and the accounts payable cycle formula and highlight the importance of the process flow chart.

What is the full cycle of accounts payable?

Much like financial accounting, the complete cycle of accounts payable involves, among other things, how a company manages its obligations to suppliers and vendors. The full cycle begins with the receipt of invoices and ends with the payment of invoices, covering all checks and balances in between.

Full Cycle mainly includes:

  • Ensuring payment is accurate.
  • Regulating compliance with financial regulations.
  • Ensuring timely payment to avoid late fees or strained vendor relationships.

Steps in the Full Cycle of Accounts Payable

Here is a breakdown of the key steps involved in the full cycle of accounts payable:

Step 1: Purchase Order Creation

  • The AP process begins with creating a Purchase Order (PO).
  • This document includes details such as the product or service required, quantity, agreed price, and delivery terms.
  • It ensures that the vendor and buyer are aligned on expectations.

Step 2: Receipt of Goods/Services

  • Once the vendor delivers the goods or services, the receiving department checks whether they match the purchase order.
  • Any discrepancies are flagged and resolved before moving forward.

Step 3: Invoice Receipt

  • The vendor sends an invoice, which should include:
    • Vendor details.
    • Invoice number.
    • Amount due.
    • Payment terms.
  • The accounts payable team verifies the invoice against the purchase order and delivery receipt.

Step 4: Invoice Validation

  • The three-way matching process is conducted to validate:
    1. The purchase order.
    2. Delivery receipt.
    3. Invoice.
  • Any inconsistencies are resolved with the vendor.

Step 5: Data Entry

  • Validated invoices are recorded in the accounting system.
  • Critical information, such as invoice date, due date, and payment amount, is logged for tracking.

Step 6: Payment Approval

  • The invoice is routed for internal approval.
  • Authorized personnel review and approve the payment based on the company’s approval hierarchy.

Step 7: Payment Processing

  • Once approved, the accounts payable team processes the payment through methods such as:
    • Bank transfer.
    • Check.
    • Automated Clearing House (ACH) payments.

Step 8: Record Keeping

  • After the payment is made, the transaction is recorded for auditing purposes.
  • Supporting documents, such as purchase orders and invoices, are stored securely.

Step 9: Reconciliation

  • Periodic reconciliation ensures that all AP transactions align with bank statements and financial records.

Full Cycle of Accounts Payable Example

Here’s a practical example of the AP process:

  1. Scenario: A company orders office supplies worth $5,000 from Vendor X.
  2. Purchase Order: A PO is created and sent to Vendor X, specifying the products, quantities, and agreed price.
  3. Delivery: Vendor X delivers the office supplies, and the receiving team verifies the items.
  4. Invoice: Vendor X sends an invoice for $5,000.
  5. Validation: The AP team performs a three-way match between the PO, delivery note, and invoice to confirm accuracy.
  6. Approval: The invoice is sent to the finance manager for approval.
  7. Payment: The company processes the payment to Vendor X via bank transfer.
  8. Record Keeping: The invoice, PO, and payment receipt are stored for compliance and auditing purposes.

End-to-End Process of Accounts Payable

The end-to-end accounts payable process goes beyond invoice processing to include strategic financial management. It encompasses:

  • Supplier onboarding and management.
  • Negotiating payment terms.
  • Tracking payment due dates.
  • Monitoring cash flow to ensure optimal liquidity.

This holistic view ensures that the AP function contributes to the organization’s overall financial health.

Accounts Payable Cycle Formula

The accounts payable cycle formula is used to measure the efficiency of the AP process. It calculates the average time taken by a company to pay its suppliers.

Formula:

Accounts Payable Turnover Ratio=Total Supplier PurchasesAverage Accounts Payable\text{Accounts Payable Turnover Ratio} = \frac{\text{Total Supplier Purchases}}{\text{Average Accounts Payable}}Accounts Payable Turnover Ratio=Average Accounts PayableTotal Supplier Purchases​

Steps to Calculate:

  1. Calculate the Total Supplier Purchases for the period.
  2. Find the Average Accounts Payable, which is the sum of opening and closing accounts payable divided by 2.
  3. Use the formula to calculate the turnover ratio.

Example:

  • Total Supplier Purchases: $500,000
  • Average Accounts Payable: $50,000

AP Turnover Ratio=500,00050,000=10\text{AP Turnover Ratio} = \frac{500,000}{50,000} = 10AP Turnover Ratio=50,000500,000​=10

This indicates that the company pays its suppliers 10 times a year, or roughly every 36.5 days.

Accounts Payable Process Flow Chart

A process flow chart visually represents the accounts payable process, ensuring clarity and consistency. Here’s an example:

  1. Purchase Request → 2. Purchase Order → 3. Receive Goods/Services → 4. Invoice Receipt → 5. Validation (Three-Way Match) → 6. Approval → 7. Payment Processing → 8. Record Keeping → 9. Reconciliation.

Using a flow chart helps organizations identify inefficiencies, automate repetitive tasks, and maintain compliance.

Best Practices for Accounts Payable Cycle Optimization

  1. Automate Processes: Use software to automate 3-way invoice matching, data entry, and payment processing.
  2. Standardize Policies: Ensure clear payment terms and consistent approval workflows.
  3. Implement Early Payment Discounts: Take advantage of early payment discounts to save money.
  4. Reconcile Regularly: Perform regular reconciliations to avoid errors and fraud.
  5. Leverage AP Automation Tools: Tools like Serina Invoice Automation Software streamline the entire AP cycle, improving accuracy and efficiency.

Conclusion

The full cycle of accounts payable does not only concern financial management but also smooth operation and healthy vendor relationships. Businesses optimize their accounts payable processes by understanding the steps, examples, and metrics involved. AP automation software and flowcharts will also improve efficiency, cut errors, and ultimately create better cash flow management.