Lesson 20 of 33 · Free
Contents
- 1 Accounts Payable
- 1.1 What accounts payable is
- 1.2 The five steps of P2P
- 1.3 Payment terms — the lingo
- 1.4 Internal controls around AP
- 1.5 AP KPIs
- 1.6 Common AP journal entries
- 1.7 Lesson recap
- 1.8 Practical Indian Application
- 1.9 Worked Example — Ananya Garments MSME Payable Risk
- 1.10 Common Payable Management Mistakes
- 1.11 Frequently Asked Questions
- 1.12 Vendor Management Process
Accounts Payable
What you owe suppliers. The P2P cycle, payment terms, fraud controls, and the math behind early-payment discounts.
What accounts payable is
Accounts payable (AP) is the mirror image of AR — it’s money your business owes suppliers for goods or services already received but not yet paid. AP is a current liability on the balance sheet. Managed well, it’s a free source of short-term financing. Managed poorly, it kills supplier relationships and triggers late fees.
The five steps of P2P
- Purchase order (PO). Issued to supplier specifying item, quantity, price, delivery date. No accounting entry yet.
- Goods receipt note (GRN). Supplier delivers; warehouse confirms quantity and condition. Inventory goes up, but a “GRN-pending invoice” entry parks the credit.
- Invoice received. The formal journal entry: Dr. Inventory / Expense, Cr. Accounts Payable. The cost of goods (or the expense) is now in your books.
- Three-way match. AP team verifies that PO + GRN + invoice all agree on quantity, price, and total. Discrepancies are escalated.
- Payment. Dr. Accounts Payable, Cr. Cash. The liability is settled.
Payment terms — the lingo
- Net 30 / Net 45 / Net 60 — full payment due 30/45/60 days from invoice date.
- 2/10 Net 30 — 2% cash discount if paid within 10 days; otherwise full amount due in 30. The 2% over 20 days works out to roughly 36% annualised — usually worth taking.
- EOM — end of month. Net 30 EOM means 30 days from the last day of the invoice month.
- CIA / CWO — Cash In Advance / Cash With Order. Required when supplier is unsure of creditworthiness.
- LC at sight — Letter of Credit released immediately on document presentation. Common in international trade.
Internal controls around AP
AP is fraud-prone — fictitious vendors, duplicate payments, kickbacks. Standard controls:
- Segregation of duties. The person who creates a vendor in the master can’t approve invoices; the person approving invoices can’t release payments.
- Vendor master review. Quarterly audit of all active vendors — flag dormant ones, mismatched addresses, vendors sharing bank accounts.
- Three-way match. No payment without PO + GRN + invoice reconciliation.
- Dual approval for payments above a threshold (commonly ₹1 lakh).
- Payment-run review. Treasurer signs off on the batch payment list before release.
AP KPIs
- Days Payable Outstanding (DPO) = AP ÷ Daily COGS. Higher means longer credit period from suppliers.
- Early-payment-discount capture rate — % of discount opportunities you actually take.
- Late-payment ratio — % of invoices paid after due date. Should be near zero.
- Invoice-to-payment cycle time — days from invoice received to payment released.
Common AP journal entries
| Event | Entry |
|---|---|
| Invoice for ₹50,000 of materials received | Dr. Purchases 50,000 / Cr. AP 50,000 |
| Invoice for ₹20,000 + 18% GST on services | Dr. Expense 20,000 + Dr. GST input 3,600 / Cr. AP 23,600 |
| Payment to supplier of ₹50,000 | Dr. AP 50,000 / Cr. Bank 50,000 |
| Settle ₹50,000 invoice with 2% discount | Dr. AP 50,000 / Cr. Bank 49,000 + Cr. Purchase Discount 1,000 |
| Vendor advance ₹30,000 before goods arrive | Dr. Advance to Supplier 30,000 / Cr. Bank 30,000 |
Lesson recap
- AP records what you owe suppliers — a current liability.
- P2P cycle: PO → GRN → invoice → three-way match → payment.
- Cash discounts annualised are often worth taking.
- Strong controls prevent fraud (segregation, three-way match, vendor reviews).
- Track DPO, discount capture, late-payment ratio.
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Practical Indian Application
Compliance resources: Udyam Registration portal to verify MSME status; Section 15 and Section 16 of MSMED Act 2006 for payment timelines; Section 43B(h) of the Income-tax Act for tax disallowance; Ministry of MSME’s Samadhaan portal for grievance redressal.
Worked Example — Ananya Garments MSME Payable Risk
Consider Ananya Garments, Tirupur, owes ₹40,00,000 to suppliers as on 31 March 2026, of which ₹6,00,000 is to MSMEs unpaid for 50+ days. Section 15 of the MSMED Act requires payment within 45 days; the overdue amount attracts interest at 3× bank rate from day 46. If bank rate is 6.5%, penal interest = 19.5% × ₹6,00,000 × (5/365) = ₹16,027 for 5 days. Worse, Section 43B(h) of the Income-tax Act disallows the underlying purchase expense in AY 2026-27 if the dues are not paid by 31 March 2026 — increasing taxable income by ₹6,00,000. The company must clear the MSME dues immediately or lose both the deduction and pay interest.
Common Payable Management Mistakes
- Not tagging MSME vendors in vendor master — Section 43B(h) trap
- Missing the 45-day clock by even a few days during financial year-end
- Forgetting TDS deduction at time of accrual (not just payment)
- Recording purchase without GST input credit accounting
Frequently Asked Questions
How does Section 43B(h) interact with MSME payments?
Any sum payable to a Micro or Small Enterprise beyond the time limit specified in Section 15 of the MSMED Act is allowed as a deduction only in the year of actual payment, not the year of accrual.
Should I segregate MSME and non-MSME payables in books?
Yes. Schedule III requires disclosure of dues to Micro and Small Enterprises separately; many Tally users create distinct ledgers for clarity.
Is GST input credit available immediately on accrual of payable?
Only when (a) goods/services are received, (b) supplier has filed GSTR-1 and ITC reflects in your GSTR-2B, and (c) payment is made within 180 days of invoice — else proportionate ITC must be reversed.
Vendor Management Process
Practical steps for MSME payable compliance: (a) Tag every vendor master entry with MSME status verified through Udyam certificate; (b) create automated alerts in Tally/SAP when an MSME invoice ages past 30 days; (c) implement weekly MSME payment runs to clear dues within 45 days; (d) disclose MSME ageing in the audit report under Note III(d) of Schedule III. The 2023 amendment to Section 43B of the Income-tax Act has elevated MSME payable management to a board-level priority. Any sum payable to a Micro or Small Enterprise that remains unpaid beyond the MSMED Act time limit (45 days where there is an agreement) is disallowed as a deduction in the year of accrual — only allowed when actually paid.
Closing Discipline
Build a vendor master with MSME tag, ageing alerts at 30 days, and weekly MSME payment runs. Section 43B(h) of the Income-tax Act makes this a board-level priority — each crore of MSME payables held beyond year-end can cost ~₹25 lakh in tax disallowance plus interest. Top up vendor relationships with early-payment discounts where economically sensible.
Trade Credit and Vendor Relationships
Negotiating supplier payment terms is part art, part science. Three frameworks:
- 2/10 net 30: 2% discount if paid in 10 days, otherwise full payment in 30 days. Effective interest rate of taking the discount = 36% per annum — usually worth taking.
- Bulk payment incentives: Negotiate 1-3% discount for monthly bulk payments vs invoice-wise
- Reverse Factoring (Supply Chain Finance): Large buyer arranges bank financing for suppliers at the buyer’s lower credit rating. Supplier gets early payment; buyer extends payment to bank.
Indian large companies (Tata Steel, Reliance, Maruti) run sophisticated vendor finance programmes that strengthen supplier ecosystems while optimising their own working capital. Smaller buyers can offer simpler 2/10 net 30 terms to extract early-payment discount.