Define a company’s payable cycle
A company's payable cycle, also known as the accounts payable cycle, refers to the process and timeframe from when a company receives goods or services from its suppliers until the payment for those goods or services is made. This cycle encompasses several key steps and is an essential part of the company's cash flow management and overall financial health.
### Key Steps in a Payable Cycle:
1. **Purchase Order (PO) Creation**: The process begins with the company creating a purchase order to request goods or services from a supplier.
2. **Receiving Goods or Services**: Upon receiving the ordered goods or services, the company inspects and verifies that the order matches the PO.
3. **Invoice Receipt**: The supplier sends an invoice to the company detailing the goods or services provided and the amount due.
4. **Invoice Verification**: The company verifies the invoice against the purchase order and the receiving report to ensure accuracy.
5. **Approval for Payment**: Once the invoice is verified, it is approved for payment by the relevant department or personnel within the company.
6. **Payment Processing**: The company processes the payment according to the agreed-upon terms, which could include issuing a check, electronic funds transfer (EFT), or other payment methods.
7. **Payment Recording**: The payment is recorded in the company’s accounting system, reducing the accounts payable balance.
### Importance of the Payable Cycle:
- **Cash Flow Management**: Efficiently managing the payable cycle helps ensure that the company maintains a healthy cash flow by timing payments to take advantage of cash discounts and avoid late fees.
- **Supplier Relationships**: Timely and accurate payments help maintain good relationships with suppliers, which can lead to better terms and reliability.
- **Financial Planning**: Understanding the payable cycle aids in forecasting cash needs and planning for future expenses.
- **Compliance and Accuracy**: A well-managed payable cycle ensures that the company complies with contractual terms and maintains accurate financial records.
### Key Metrics:
1. **Days Payable Outstanding (DPO)**: Measures the average number of days a company takes to pay its suppliers. A higher DPO indicates that the company is taking longer to pay its bills, which can be beneficial for cash flow but may affect supplier relationships.
\[
\text{DPO} = \left( \frac{\text{Accounts Payable}}{\text{Cost of Goods Sold}} \right) \times 365
\]
2. **Payment Terms**: The agreed-upon terms between the company and its suppliers, such as net 30 days, which specify the payment due date.
3. **Invoice Aging**: A report that shows the age of unpaid invoices, helping the company prioritize payments and manage overdue accounts.
### Example:
Consider a company that orders raw materials from a supplier. The payable cycle for this transaction might look like this:
- **Day 1**: The company issues a purchase order for raw materials.
- **Day 5**: The supplier delivers the raw materials, and the company inspects and receives them.
- **Day 10**: The supplier sends an invoice for the delivered materials.
- **Day 12**: The company verifies the invoice against the purchase order and receiving report, then approves it for payment.
- **Day 30**: According to the payment terms (net 30), the company processes the payment and records it in the accounting system.
By efficiently managing its payable cycle, the company ensures that it maintains good supplier relationships, accurately tracks its financial obligations, and effectively manages its cash flow.
