Accounts Payable Process (AP): Full Cycle Explained with Flow & Examples

The Accounts Payable (AP) process is a critical part of every business’s finance workflow. From receiving vendor invoices to making payments, the AP process ensures proper cash flow and accurate expense tracking. In this guide, we’ll walk you through the full cycle of accounts payable with real-world examples.

Understanding the Accounts Payable Process: A Comprehensive Guide

Introduction to Accounts Payable

Accounts payable (AP) represents the money a company owes to its suppliers for goods or services received but not yet paid for. As a short-term liability, it plays a pivotal role in managing a company’s cash flow, maintaining strong supplier relationships, and ensuring financial accuracy. The AP process is a structured workflow that ensures payments are made accurately and on time, avoiding penalties and fostering trust with vendors.

This guide dives deep into the AP process, covering key components like Purchase Requisition (PR), Purchase Order (PO), Goods Received Note (GRN), invoice verification, payment terms, and payment processing. We’ll use XYZ Corporation, a mid-sized tech firm, as an example to illustrate each step, complete with journal entries for accounting clarity.

Key Points

• The AP process involves multiple steps, from initiating a purchase to final payment, ensuring accurate financial management.
• PR kicks off procurement, while PO formalizes the purchase agreement with suppliers.
• GRN verifies received goods match the PO, and invoice verification ensures payment accuracy.
• Payment terms, like Net 30, impact cash flow, and journal entries record transactions for accounting purposes.
• Effective AP management maintains supplier relationships and optimizes cash flow, as demonstrated by XYZ Corporation.

The Accounts Payable Process: Step-by-Step

The AP process is a series of interconnected steps, each requiring specific documentation and verification. Let’s break it down:

1. Purchase Requisition (PR)

A Purchase Requisition (PR) is a formal request from a department within the company to procure goods or services. It’s the starting point of the procurement cycle, ensuring that purchases are necessary and authorized before any commitment is made.

• Purpose: To prevent unauthorized spending and align purchases with organizational needs.
• Process: A department identifies a need, completes a PR form detailing the items, quantities, and specifications, and submits it for approval. Once approved by management, it moves to the next step.
• Key Details: Includes item description, quantity, estimated cost, and department requesting the purchase.

Example: At XYZ Corporation, the IT department needs 10 laptops for new hires. They create a PR specifying the laptop model, quantity, and estimated cost of $10,000. The PR is submitted to the procurement manager, who reviews and approves it based on budget availability.

2. Purchase Order (PO)

A Purchase Order (PO) is a formal document sent to the supplier, outlining the goods or services to be purchased, quantities, agreed prices, and delivery terms. It serves as a legally binding agreement between the buyer and supplier.

• Purpose: To formalize the purchase agreement, ensuring clarity on terms and expectations.
• Process: After PR approval, the procurement team generates a PO using details from the PR. The PO is sent to the supplier, who acknowledges it and prepares to fulfill the order.
• Key Details: Includes PO number, supplier details, item descriptions, quantities, prices, delivery date, and payment terms.

Example: XYZ Corporation’s procurement team issues a PO for 10 laptops at $1,000 each, totaling $10,000, with a delivery term of 14 days. The PO is sent to the supplier, who confirms receipt and agrees to deliver by the specified date.

3. Goods Received Note (GRN)

A Goods Received Note (GRN) is a document prepared by the receiving department to confirm that goods delivered by the supplier match the PO in terms of quantity, quality, and specifications.

• Purpose: To verify receipt of goods and ensure they align with the order before processing payment.
• Process: Upon delivery, the receiving team inspects the goods, checks them against the PO, and prepares the GRN. The GRN is then sent to the AP department for further processing.
• Key Details: Includes delivery date, item details, quantities received, and any discrepancies noted.

Example: When the 10 laptops arrive at XYZ Corporation, the receiving team inspects them for damage and verifies they match the PO specifications. They prepare a GRN, noting all 10 units are received in good condition, and forward it to the AP department.

4. Invoice Receipt and Verification

The supplier sends an invoice requesting payment for the goods or services delivered. The AP department verifies the invoice to ensure it matches the PO and GRN, preventing errors or fraud.

• Purpose: To confirm the invoice is accurate and aligns with the agreed terms before approving payment.
• Process: The AP team performs a 3-way or 4-way matching process, comparing the invoice with the PO, GRN, and sometimes a receiving report. If all details align, the invoice is approved for payment.
• Key Details: Includes invoice number, amount, supplier details, payment terms, and due date.

Example: The supplier sends XYZ Corporation an invoice for $10,000 for the 10 laptops, with Net 30 payment terms. The AP team matches the invoice with the PO and GRN, confirming quantities, prices, and terms are correct, and approves it for payment.

5. Payment Terms

Payment terms define when the payment is due and any discounts for early payment. They are agreed upon during the PO creation and impact cash flow management.

• Purpose: To outline the payment timeline and encourage timely payments, sometimes with incentives.
• Common Terms:
  • Net 30: Payment due within 30 days from the invoice date.
  • 2/10, Net 30: A 2% discount if paid within 10 days, otherwise due in 30 days.
• Impact: Payment terms affect cash flow planning and supplier relationships. Early payment discounts can save costs but require sufficient liquidity.

Example: The laptop invoice for XYZ Corporation has Net 30 terms, meaning the $10,000 is due within 30 days. The company evaluates its cash flow to decide whether to pay early for a potential discount or wait until the due date.

6. Payment Processing

Once the invoice is verified and approved, the payment is processed using the agreed method, and the transaction is recorded in the accounting system.

• Purpose: To settle the liability with the supplier and maintain accurate financial records.
• Process: The AP team schedules the payment (via check, bank transfer, etc.), and the accounting team records the transaction using journal entries.
• Journal Entries:
  • On Invoice Receipt: Debit the expense or asset account (e.g., Equipment, Inventory), Credit Accounts Payable.
  • On Payment: Debit Accounts Payable, Credit Cash/Bank.

Example: XYZ Corporation processes the $10,000 payment via bank transfer within the Net 30 period. The accounting team records:

On Invoice Receipt:
Debit Computer Equipment $10,000
Credit Accounts Payable $10,000

On Payment:
Debit Accounts Payable $10,000
Credit Bank $10,000

Company Example: XYZ Corporation

Let’s walk through the entire AP process for XYZ Corporation purchasing 10 laptops, illustrating how each step integrates:

1. PR: The IT department identifies the need for 10 laptops and submits a PR, which is approved by management after budget review.
2. PO: The procurement team issues a PO for $10,000 (10 laptops at $1,000 each), specifying a 14-day delivery term, and sends it to the supplier.
3. GRN: Upon delivery, the receiving team inspects the laptops, confirms they match the PO, and prepares a GRN, which is sent to the AP department.
4. Invoice: The supplier sends a $10,000 invoice with Net 30 terms. The AP team performs 3-way matching (PO, GRN, Invoice) and approves it.
5. Payment: The payment is processed via bank transfer within 30 days, and journal entries are recorded:
   Debit Computer Equipment $10,000
   Credit Accounts Payable $10,000
   
   Debit Accounts Payable $10,000
   Credit Bank $10,000

This example demonstrates how XYZ Corporation ensures accuracy and compliance, maintaining supplier trust and efficient cash flow management.

Challenges in the Accounts Payable Process

Despite its importance, the AP process can face several challenges:

• Manual Errors: Data entry mistakes can lead to payment discrepancies.
• Payment Delays: Slow verification processes can result in late payments and penalties.
• Fraud Risks: Inconsistent vendor formats or unauthorized invoices increase fraud potential.
• Complex Vendor Management: Handling multiple suppliers with varying terms can be cumbersome.

Automation tools, like those discussed in Accounts Payable Automation, can address these issues by streamlining processes, reducing errors, and providing audit trails.

Best Practices for Effective AP Management

To optimize the AP process, consider these best practices:

• Use a centralized repository for all AP documents to improve access and organization.
• Restrict access to the Master Vendor File to prevent unauthorized changes.
• Negotiate favorable payment terms to optimize cash flow.
• Take advantage of early payment discounts when feasible.
• Conduct daily reviews to catch discrepancies early.

These practices, as outlined in Ways to Improve Accounts Payable Process, enhance efficiency and strengthen vendor relationships.

Table: Summary of Accounts Payable Process Steps

Step	Description	Example for XYZ Corporation
Purchase Requisition	Department requests goods/services, gets approved	IT requests 10 laptops, approved by management
Purchase Order	Formal offer to supplier, details terms	PO for $10,000 laptops, 14-day delivery
Goods Received Note	Verifies received goods match PO	Laptops inspected, GRN prepared, matched
Invoice Verification	Matches invoice with PO and GRN	$10,000 invoice verified via 3-way matching
Payment Terms	Specifies payment due date, impacts cash flow	Net 30, payment due in 30 days
Payment Processing	Approved payment executed, recorded in journals	Payment via bank transfer, entries recorded

Conclusion

The accounts payable process is a cornerstone of financial management, ensuring timely and accurate payments to suppliers while maintaining cash flow and compliance. By understanding and optimizing each step—PR, PO, GRN, invoice verification, payment terms, and payment processing—companies like XYZ Corporation can streamline operations, reduce errors, and build strong vendor relationships. Automation and best practices further enhance efficiency, making AP a strategic asset for financial health.

Effective AP management not only avoids penalties but also supports compliance with regulations like GST for input tax credit claims, as noted in Input Tax Credit Under GST. By mastering this process, businesses can achieve operational excellence and financial stability.

Citations

• Accounts Payable Journal Entry: Types and Examples
• Understanding Accounts Payable (AP) With Examples and How To Record AP
• Accounts Payable Journal Entry: Full Guide With Examples
• Account Payable Journal Entries: Best Explanation And Examples

📘 Also Read: IAS 38 – Understanding Intangible Assets in Accounting