Accounting, Financial, Taxation

You must ensure that a well-managed accounts payable system is in operation. Any warning signs of problems with payables must be identified and solved. The control of the cash that leaves the company is as important as controlling the cash that comes in. To achieve control, payables must be aggressively managed in accordance with the company’s financial position and goals. Payment of bills must not be simply made but planned. Above all, payables must be viewed as a flexible system that you can manipulate in response to other factors such as sales decreases or slowdowns in collections.

Account Payable Control System

A well-managed accounts payable system should:

Evaluate Cash Flow - Every accounts payable strategy should be rooted in the realities of the company’s cash flow status. For example, if it takes 90 days to collect from customers, it is financially self-destructive to pay bills within 45 days. How long does it take dollars spent to be replaced? You should monitor the cash-to-cash cycle representing the length of time elapsing from the expenditure of dollars on inventory to the receipt of cash from sales. Take, for instance, a retailer who buys a product on January 1 and pays for it on January 30; it takes the retailer 60 days from that point to sell that product (which brings the retailer to March 31) and 45 days after that to collect the cash (May 15). The cash-to-cash cycle adds up to 105 days, which is the length of time the retailer is behind after expending the cash.

Set goals - Once cash flow has been appraised, establish written payment goals so there can be no confusion among bill payers. Avoid a situation in which staff makes the decisions about which bills are to be paid and when—usually suppliers who complain the most are paid first, regardless of overall benefit to the business. The payment of bills should be timed to coordinate exactly with formal disbursement goals. This means checks should be dated no earlier than the dates upon which payments are due (and suppliers should receive checks no more than a day or two earlier than the due date). The goal should be to hold cash in interest-bearing accounts until the last possible minute in which payments must be made and still maintain good relations with suppliers.

Establish payment priorities - It is advisable to establish a two-tiered list of payment priorities, which then becomes part of the formal payment strategy. Tier one, the group that should be paid at all costs and at whatever terms have been agreed upon, should include major vendors and service suppliers, bankers, and the government tax authorities. Tier two, which offers more room for short-term maneuvering during cash flow crunches, should consist of minor suppliers whose goodwill is less vital to the overall well-being of the company. Payment priorities should be in writing.

Aggressively negotiate payment - Granted, there is not much room for negotiation with bankers or tax collectors, but once they are taken care of, everything else on the payables front is open for discussion. You have leverage to negotiate better-than-usual terms from major suppliers, especially during recessionary times, when vendors are afraid of losing business. Determine the optimal payment terms (using the cash-to-cash or other cash flow information as a guide) then when orders are placed, not when bills become due or overdue, negotiate to achieve those terms.

Forecast cash needs - You should predict how much cash is needed—and when—to fulfill the payables obligations. That forecast becomes an important tool in averting cash flow problems. Will funds be available at the right time from bank accounts or bank credit lines? If funds will not be available, take precautionary measures such as stepping up customer collection efforts.

Keep good payables records - Payable records include weekly updates about the aging of every outstanding bill; documentation that matches each bill paid with its original sales order, delivery records, and payment invoice; and total cost records, including interest penalties paid on each bill. The last is important because it may not be evident how much it adds to the cost of doing business when the company winds up having to pay interest charges to finance late payables. Review payables records regularly. Payables reports are as important as other cash flow documents and must be evaluated. Review payables—aging schedules—weekly; cost records can be appraised monthly.

Recognize warning signs - Since cash flow cycles vary, there may be periods when payables get stretched without any long-term risk. But it is essential to spot indications of more serious problems. One approach is to draw up a ‘‘payables problems’’ checklist, which breaks down average bill age, promptness of tax payments, any interest charges and other warning factors.

Paying the right amount - Payments should be made in accordance with purchase order terms and discounts taken where allowed. Payments should only be made against the original invoice to prevent a duplicate payment against a photocopy or summary statement. Match all vendor invoices against receiving reports and purchase orders.

Considerations To Take In Managing Payables

Sound management of accounts payables takes into account the following:

Prioritize - Financial obligations fall into three categories: the bills to be paid as soon as they are due (wages and salaries, bank loans, and taxes), bills to be paid within 15 days (to important contractors for services already performed), and bills you try to pay within 30 days (all others). As your business begins to feel the recessionary pinch, try to stretch that third category out longer. In looking at cash flow, accounts payable are something that you have some control over—and suppliers can be ‘‘played with’’ if needed.

Negotiate - Negotiate longer payment terms in advance, although the process can be time consuming. Contact major vendors to ask when they absolutely have to have their money. This information should then get recorded in each vendor’s accounts payable file. It sets the guidelines for payment of all major outstanding obligations. With smaller suppliers, however, there may not be much potential payoff from stretching out payments.

Monitor payables closely - Each week analyze an accounts payable aging schedule along with other cash flow documents. As a last resort, the company should use its credit line to make payments if cash collections from customers are behind schedule.

Demonstrate good faith - When money does not come in, the company is in a jam. One possible solution: Pay only absolute essentials, such as salaries, rent, taxes, and loans. These expenditures cannot be delayed. Suppliers are more tolerant and flexible since they need the business. However, try to pay more to the demanding vendors and less to those more likely to wait. A partial payment shows vendors that the company is trying to pay them. Do not just send the money—get on the phone and explain what is happening and why and set up an informal payment schedule. Let the vendors know when they can expect to receive the balance due. A follow-up letter should confirm the telephone conversation.

3 Typical Symptoms Of Account Payable Problems

Some typical symptoms of accounts payable problems are:

Aged payables - Chances are that the company is heading for trouble when bills start becoming, on average, 45 to 60 days past due. (The only exception: bills whose issuers have approved late payment terms without interest penalties, at the time of order).

Interest penalties - Do not box yourself in by paying interest charges on overdue bills—unless there are clear financial benefits from using funds elsewhere. Once the company is paying penalties to even a few vendors on a regular monthly basis, it is in trouble. Instead, approach creditors with a workout plan that will reduce or perhaps eliminate interest charges.

Hassles from creditors - Make it a habit to communicate informally with creditors whenever there is a developing cash crunch. Creditors are typically understanding if the company has good intentions and is honest.

Information You Should Obtain From Vendors

Money can be saved by getting to know the policies of vendors and suppliers. Probe them for the best prices and terms. Ask open-ended questions, such as ‘‘What else can you do for me?’’ Ask vendors to complete an information sheet that forces them to write down the terms and conditions of their sales plans. With this form, their verbal promises become written ones. A list of useful information follows:

[-]. Vendor’s name, address, and phone number (will the vendor accept collect calls? Is there an 800 number?)
[-]. Sales representative’s name, phone number, and qualifications
[-]. Amount of minimum purchase
[-]. Quantity discounts available
[-]. Advertising/promotion allowances
[-]. Availability of extended payment terms
[-]. Financing charge on overdue accounts
[-]. Delivery terms
[-]. Service policies
[-]. Return privileges for damaged goods (who pays the freight?)
[-]. Credit terms (how flexible is it?)

A major cause of duplicate payments is multiple copies of the same supplier invoice being entered in the computer system, but with slight variations on the invoice number that keep the computer from flagging them as duplicate invoices. This is an especially common problem when suppliers issue invoices with leading zeros, since one data entry clerk may enter the zeros, while another may ignore them. It also common for employee expense reports and a variety of utility billings, since these documents have no invoice number. It also happens when an original invoice is not paid on time, so the supplier floods the company with extra copies of the invoice, hoping that one of the copies will eventually be paid.

There is no perfect solution to this problem, but the basic approach is to use a standard invoice numbering for the data entry staff to follow, thereby introducing some consistency into this aspect of invoice data entry. It can include some of the following rules:

Drop leading zeros. It is also possible to reverse this rule and always use leading zeros, but the extra characters may overflow the computer field for invoice numbers.

Use the packing slip number. If the invoice contains no invoice number and it is related to a physical delivery, then there should be a packing slip that accompanied the delivery. If so, enter the packing slip number as the invoice number. If a duplicate invoice arrives, it must still be matched to the packing slip before payment is approved, so the packing slip number will be flagged by the computer as a duplicate invoice number.

Use an alternate document identifier. If an invoice contains no invoice number but does have other tracking numbers, such as an internal indexing number or a job number, then use this number instead.

Use invoice date. A less foolproof alternative is to use the invoice date. This approach can still result in duplicate payments, because suppliers may legitimately issue more than one invoice on the same day, resulting in such coding variations as MMDDYY-2 to signify that an invoice is the second one received that has the same invoice date. If this alternative must be used, then at least require that dates always be entered using the same format every time, such as MMDDYY or MMDDYYYY.

Avoid all punctuation and spaces. Some invoice numbers include slashes, spaces, or dashes, which should be avoided. It is especially common for some systems to add “-IN” (for invoice) or “-CN” (for a credit note) or “-PMT” (for payment) to the end of an invoice number, in order to signify that this number is related to an invoice or credit note or payment. If so, drop both the dash and the “IN/CN/PMT” from the invoice number.

The standard invoice numbering should specify what type of alternate identifier to use if there are several options available, otherwise, the data entry staff may enter a different number, resulting in a possible duplicate payment.

The accounts payable process is one of the most complex of all the processes where accounting staff spent most their time. It requires the collection of information from multiple departments; purchase orders from the purchasing department, invoices from suppliers, and receiving documents from the receiving department, that is first. The process then involves matching these documents, which almost always contain exceptions, and then tracking down someone either to approve exceptions or at least to sign the checks, which must then be submitted to suppliers. The key to success in this area is to thoroughly reengineer the entire process by eliminating the paperwork, the multiple sources of information, and the additional approvals. The only best way that truly addresses the underlying problems of the accounts payable process is paying based on the receipt.

To pay based on receipt, one must first do away with the concept of  “having—an—account payable—staff—that—perform—the—traditional—matching process“.

Instead, the receiving staff checks to see if there is a purchase order at the time of receipt. If there is, the computer system automatically pays the supplier. Sounds simple? It is not. A company must have several features installed before the concept will function properly. The main issue is having a computer terminal at the receiving dock.

When a supplier shipment arrives, a receiving person takes the purchase order number and quantity received from the shipping documentation and punches it into the computer. The computer system checks against an on-line database of open purchase orders to see if the shipment was authorized. If so, the system automatically schedules a payment to the supplier based on the purchase order price, which can be sent by wire transfer. If the purchase order number is not in the database, or if there is no purchase order number at all, the shipment is rejected at the receiving dock.

Note: the accounts payable staff takes no part whatsoever in this process—everything has been shifted to a simple step at the receiving location.

Before laying off the entire accounts payable staff and acquiring such a system, there are several problems to overcome. They are as follows:

[A]. Train Suppliers

1. Every supplier who sends anything to a company must be trained to include the purchase order number, the company’s part number, and the quantity shipped on the shipping documentation, so this information can be punched into the computer at the receiving location.
2. The information can be encoded as bar codes to make the data-entry task easier for the receiving employees.
3. Training a supplier may be difficult, especially if the company only purchases a small quantity of goods from the supplier. To make it worthwhile for the supplier to go to this extra effort, it may be necessary to concentrate purchases with a smaller number of suppliers to give each one a significant volume of orders.

[B]. Alter the Accounting System

The traditional accounting software is not designed to allow approvals at the receiving dock. Accordingly, a company will have to reprogram the system to allow the re-engineered process to be performed. This can be an exceptionally major undertaking, especially if the software is constantly being upgraded by the supplier—every upgrade will wipe out any custom programming that the company may have created.

[C]. Prepare for Miscellaneous Payments

The accounts payable department will not really go away because there will always be stray supplier invoices of various kinds arriving for payment that cannot possibly go through the receiving dock, such as subscription payments, utility bills, and repair invoices. Accordingly, the old payments system must still be maintained, though at a greatly reduced level, to handle these items.

[D]. Pay Without a Supplier Invoice

One of the key aspects of the reengineered process is paying based on the information in the purchase order, rather than the information in the supplier’s invoice. To do so, one must have a database of all the tax rates that every supplier would charge, so that the company’s computer system can automatically include these taxes in the invoice payments.

Note: There will sometimes be discrepancies between the purchase order prices and quantities paid, versus those expected by suppliers, so an accounts payable staff must be kept on hand to correspond with suppliers to reconcile these issues. Warning: Make sure you haven’t adopt this way yet, until this note is strictly followed.

There are wide arrays of problems that must first be overcome before the dramatic improvements of this new process can be realized. However, for a company with a large accounts payable staff, this can be a highly rewarding system to adopt, for the savings realized can be the elimination of the majority of the accounts payable department.