What is Accounts Payable (AP) Cycle?
Accounts Payable cycle is also known as ‘Procure to Pay’ or ‘P2P‘cycle is a series of processes which involves the purchase and payments department of the company and carry all necessary activities from placing an order to suppliers, purchasing goods and making final payments to the suppliers.
Every business has two major Business cycles – revenue cycle and expenditure cycle.
- The Revenue Cycle includes activities like sales, marketing, customer relationship, revenue collection, etc.
- The Expenditure Cycle includes purchases, supplier payments, production expenses, wages, and salaries, etc. The accounts payable cycle is a major part of the expenditure cycle.
Following are the Steps included in Accounts Payable Cycle –
- Determination of Goods Required
- Procurement Process
- Search for Suppliers
- Request for Proposal
- Review Receiving Quotation
- Purchase Order
- The Supplier’s Confirmation
- Suppliers’ Duty
- On Successful Delivery of Goods
- Invoice Entry
Let us discuss these in detail –
Steps Included in Accounts Payable Cycle
The following are steps included in the procure to pay cycle:
#1 – Determination of Goods Required
The purchases are made based on the stocks required by the production department of the company. The production manager identifies the required supplies and informs the purchasing department.
#2 – Purchase Department starts the Procurement Process
After getting the approval of supplies request from production, the purchasing department will look if some similar orders have already been placed; if not then fresh documents of purchase orders are generated.
#3 – Search for Suppliers
Finding suppliers is a tricky job which includes various factors like locality, ease of transport, credit policies, goodwill of supplier and its products, past connections with the company and many more. However, the company prefers transactions with it’s tried and tested suppliers. In other cases, potential suppliers are selected locally, nationally or internationally using an online business to business portals (like Alibaba.com), referrals, etc
#4- Request for Proposal
After selecting a few potential suppliers a formal document is delivered in order to receive quotations of the items, the document is referred to as a request for proposal (RFP). The supplier sends a proposal including product rates and qualities and asks the company to make business with them.
#5 – Review Receiving Quotation
Company reviews the quotations send by different suppliers and filters the suppliers which can fulfill the company’s requirements. The company informs the selected suppliers about its interest to make purchase deals.
#6 – Company begins the Negotiation Process
Negotiation is a hectic and sometimes time-consuming process where buyer requests seller to lower its rates, offer liberal credit policy and other basic negotiation terms like discounts, quality of products, freight charges, delivery, and insurance terms. Negotiation process performs the filtering and the company has identified the best suppliers.
#7 – Purchase Order
The company on approving the desired supplier awards him the order by sending the official purchase order document. This confirms the supplier about the company’s requirement and the deadline for the delivery of the products or services.
#8 – The Supplier’s Confirmation
The agreement initiates when a supplier agrees to sell its products at the requested terms and conditions. A confirmation of acceptance has to be sent by the supplier in written through post or email.
# 9 – Suppliers’ Duty
It’s the duty of the supplier to get the goods ready and shipped following the deadlines strictly and keep the company informed about the order progress. Notification must be sent when goods are ready to be shipped and a shipment notice including valid documents specifying a description of goods including weight or units, delivery date, location, etc.
#10 – Inspection of Delivered Goods
The process of inspection begins which includes both quality and quantity check. The purchase department checks if delivered goods are according to the purchase order.
#11 – Invoice Entry
On successful inspection, if everything finds fit, the purchasing department sends approval to the accounts payable department to begin the payments process. The accounts payable department thus makes a record of the invoice which contains all the specifications about the payment like final date and/ or a final date with discount, amount of reimbursement and other official details.
#12 – Payment
After every necessary check, the accounts payable department starts making payments to the supplier partially or fully as per company norms. There are various ways to make payments to the suppliers like:
- Cash payments
- Cheque payment (or other negotiable instruments)
- Online third-party transfer
- Credit Card Payment
- Payments in dollars or other foreign currency (generally applicable in import transactions).
- Barter payment i.e. paying some goods and/or services against the goods and/or services received by the supplier.
Important Documents Involved in AP Cycle
The following are major documents included in procure to pay cycle:
#1 – Purchase Order
The purchasing department of the company generates an order of the required goods and sends it to the vendor. The order details the vendor about the items along with its quantities. It also specifies a date on which the goods are required to be delivered.
#2 – Receiving Report
After the goods are delivered, the management inspects the shipment and checks the quality, quantity and other important aspects. After a full inspection, it creates a detailed report called receiving the report.
#3 – Vendor Invoice
The document is the legal contract in which vendor details the goods, the rate per unit and the total amount along with the applicable taxable amount. It also specifies the credit policy and the final date for payment.
This has been a guide to Accounts Payable Cycle. Here we discuss the top 12 steps of accounts payable cycle including the required documentation. You may learn more about financing from the following articles –