Definition of Accounts Payable Cycle
Accounts payable Cycle refers to the series of all the necessary steps that are to be followed by the production, purchase/ procurement, and accounts department to complete all the activities that are essential to acquire the goods & services that includes the three main steps where the first step is to Place the purchase order after selecting the vendor than to get the goods delivered and finally paying off the debts to that supplier/vendor.
Accounts Payable Cycle refers to the process that is required to be followed especially by the production, purchase and accounts payable division of the company to complete a purchase of goods & services. The step involves all the essential activities that are necessary for the completion of a purchase in a business. The cycle starts with the determination of the amount of goods required, selecting the vendor, negotiation with the vendor, placing the order at the decided price, taking the confirmation from the supplier, receiving of goods & services , inspection of the goods delivered, entry of invoice and then ends with the payment to the supplier. The important documents that are exchanged during the purchase process are purchase order; goods requisition notes, and the invoice from the vendor.
Step for Accounts Payable Cycle
Below is the diagram showing the cycle of Accounts payable.
Now the above steps are explained in detail as below:
Step #1: Identify the Goods Required
The production department of the company should firstly identify the requirements of the materials that are needed for production in the business. Then the production department should inform about their requirements to the purchasing department of that company.
Step #2: Finding the Supplier
After finding out the requirements of the production department, the purchasing department should check whether any orders of the similar materials are already been placed and if not then they should start searching for the supplier to whom the orders should be placed. The choice supplier depends upon many factors such as price, locality, credit policies, ease of transportation; past connections of the company with the vendors, etc. generally the orders are placed to the vendors with whom the company deals regularly. And in case of new vendors, the proposal is sent to all the prospective suppliers, and quotations of the price and quantity are received from them. Then after the proposed negotiation, the vendor is selected.
Step #3: Issuing the Purchase Order to The Supplier
Then after the selection of vendor, the purchase order is created in the name of the selected vendor which states the required quantity of material and the negotiated price along with the other terms & condition such as the deadline of delivery and it is mailed/sent to the supplier and after that, the acceptance from the supplier is to be received through the mail or other means.
Step #4: Receipt of Goods or the Services
Then the goods are received from the supplier and at the gate of the company when the goods are transported a goods requisition note (GRN) is prepared by the company to confirm the delivery of goods.
Step #5: Check that Received Item or Services Are as Per Requirement
After that, the inspection of goods is done which includes both quality check & quantity check. In quality check, it is verified that there is no defective product and all the products are of good quality whereas quantity check is to check that the quantity ordered matches with the quantity delivered by the supplier.
Step #6: Receive the Invoice from the Supplier
Then the invoice from the supplier is to be received which states the amount & quantity of material purchased along with the taxes required to be paid on it.
Step #7: Check Invoice with Respect to Purchase Order
Then the invoice is matched with the purchase order i.e. the quantity and rate should be matched with the quantity and rate mentioned in the purchase order and if there is any deviations then the company has to hold the payment.
Step #8: Invoice Entry in System
After the successful completion of the above mentioned steps, ledger accounts are updated and the details of the invoice are entered in the books of accounts which contains the information about the date on which payment is due, the rate & quantity of the material purchased, etc.
Step #9: Make Payment for Invoice
Then on the arrival of the due date, the payment is needed to be processed. The payment can be made through bank transfers, UPI transfer, and net banking or even in cash that totally depends upon the terms & conditions of the purchase.
Different benefits of the accounts payable cycle are as follows:
- The account payable cycle keeps track of all the steps involved in the purchasing of the goods and services and with the help of that management can ensure that all the steps are duly followed by the company and in case if anything goes missing then it can be tracked back with the account payable cycle and the reason for the same could also be identified.
- If the process of the accounts payable cycle is atomized, the human errors and the time involved in such a process can be minimized.
Different disadvantages of the accounts payable cycle are as follows:
- The process is time consuming as this a long process involving many steps and even passing on the information to different-different departments takes lots of time.
- Various departments are involved in this accounts payable process. Therefore, there is a high communication cost as well as employee cost.
- Even getting approvals of various departments at different stages is time consuming which thereby results in delaying the payment process.
Therefore, the accounts payable cycle is the series of steps that are followed to complete the requirement of the purchase of goods & services by the company. The main steps of the process of accounts payable are the issuance of the purchase order, receipt of goods and invoice, and then processing the payment.
This is a guide to Accounts Payable Cycle. Here we also discuss the definition and step for the accounts payable cycle along with benefits and disadvantages. You may also have a look at the following articles to learn more –
- Accounts Payable vs Notes Payable
- Accounts Payable Turnover Ratio
- Accounts Receivable Aging
- Days Payable Outstanding