4 Reasons Accounts Payable Is Important
This month I am moving a client away from using Excel to track bills and payments to QuickBooks Online.
This client works with suppliers and contractors and usually has several bills each month with varying payment terms.
As a business grows and the monthly accounting becomes more complex, it becomes more important to start tracking bills in QuickBooks Online.
Yes, it is more work. But here are 4 Reasons why it is worth it.
1) Stay on track of bills and payments
Having a formal system in place will make staying on top of upcoming bills and tracking payments easier. All the better if that system is already in your accounting software. Having an Accounts Payable workflow will ensure bills don't get paid late or too early.
2) Accurate & Useful reporting
When a business starts tracking Accounts Payable in QuickBooks Online, the accounting changes. The accounting moves from cash basis to accrual basis. When bills are used, the expense will be dated in the accounting software as of the bill date, NOT the payment date.
Reports will better reflect what is actually happening in the company. Some owners do find this shift somewhat confusing. Why? Because so many owners want to view reports in the context of the cash coming in and cash going out. Viewing financial statements on an accrual basis can take some time to get used to. But it is important to understand net profit, cash flow, and the bank balance are not the same thing.
3) Keep track of business health
Tracking Accounts Payable will allow your CFO, bank/lender, and yourself to know the health of the business. A few key ratios use current liabilities, which includes Accounts Payable in their calculation. The Current Ratio measures a company’s ability to pay short term obligations. Solvency Ratios are useful for lenders when analyzing a company's ability to pay financial obligations. These ratios are monitored on a monthly, quarterly, or annual basis. Doing this allows trends and patterns to be observed.
4) Understand your Working Capital Cycle
If your company buys supplies and materials from vendors/suppliers, converts those to into inventory, and then sells to customers, the Working Capital Cycle is an important concept to understand.
For most companies, the working capital cycle works as follows:
- The company purchases, on credit, materials to manufacture a product. For example, they have 120 days to pay for the raw materials (payable days).
- The company sells its inventory in 90 days, on average (inventory days).
- The company receives payment from customers for the products sold in 30 days, on average (receivable days).
Why does it matter?
Do you have cash flow problems?
Are you trying to get a line of credit?
Does your bank balance experience large fluctuations?
While many companies stay on top of the revenue side, by using invoices in QuickBooks Online, Accounts Payable is often ignored.
The working capital cycle can’t be easily understood/analyzed since we are missing a key piece of information.
Tracking Accounts Payable in QuickBooks Online does require some extra work. It is important to follow the correct workflow so nothing gets entered twice. The last thing you or your bookkeeper wants is to fix a mess created by introducing Accounts Payable to your accounting.
It is worth taking that extra time since it provides us with financial reports and metrics that can help us understand the business better. Posting expenses in the correct month gives us better reporting, this matters when calculating Gross Profit and Net Profit. Including Accounts Payable on the Balance Sheet each month allows us to know who is owed money.
When we have accurate liabilities on the Balance Sheet, we can track important financial ratios, such as the current ratio and various solvency ratios. Finally, calculating the working capital cycle can be helpful when analyzing cash flow. If a business wants a working capital line of credit, they will need to know their working capital cycle.
James Fleming III, EA
Sentinel Tax & Accounting