What is Invoice Processing (+How Payment Departments Use It)

Accounts payable departments are crucial to managing the cash flow at any company.

However, many of these organizations experience significant disruptions in their workflow due to an unmanageable amount of paperwork.

Much of it comes from processing invoices. Until recently, invoice processing was primarily a manual task performed by an accounts payable specialist. However, as technologies like business artificial intelligence, robotic process automation, and machine learning have made headway in improving many of today’s existing business processes, organizations are now looking to adopt those technologies to achieve accounts payable automation.

In this post, you’ll learn how invoice processing functions within the accounts payable department and some of the problems associated with this task.

What is invoice processing?

Invoice processing is the handling of invoices from arrival to payment. It matches purchase orders and payment terms with invoices to ensure payments are made accurately and on-time.

As the tip of the spear in accounts payable, invoice processing plays a critical role in managing any company’s cashflow.

Before an invoice is entered into an accounting software system, the accounts payable staff must ensure all invoices reflect what the company ordered is exactly what was received and that the amount to be paid matches the total on the invoice.

Invoice processing is crucial to managing cash flow within an organization. Accounts payable professionals are responsible for preventing invoice fraud, inaccuracies, and missed payment deadlines. When invoices are accurately processed, companies can maximize cash flow by getting more favorable payment terms, better pricing, or even better discounts.

Many suppliers even offer early payment discounts to companies that pay before the due date. Therefore, the person managing invoice processing must be extremely organized and knowledgeable of the various payment terms.

How does procure-to-pay work?

The accounts payable process, also known as procure-to-pay, has several steps, starting from when the invoice is received to Enterprise Resource Planning system (also known as an ERP system) input.

While there is no standard accounts payable process, the following workflow is typical when it’s entered:

1. Purchase order is prepared to communicate what the company is ordering from a vendor. The person sending the PO will give a copy to the accounts payable department, the accounts receivable department, and the vendor.

2. The company receiving the goods creates a shipping document to record the goods it is receiving.

3. After the shipping document and purchase order are complete, the vendor sends an invoice to the company that has received the goods. Although the information on an invoice can vary among vendors, it must contain the following:

  • Contact information of both the vendor and purchasing company,
  • Agreed prices and other terms related to the goods purchased,
  • Information on how to pay the invoice, and
  • The date the invoice was created and sent.

4. An accounts payable specialist or clerk uses either two-way matching – which matches the invoice to the purchase order – or three-way matching – which compares the two documents with the shipping document. If items have been back-ordered, the accounts payable specialist will make necessary corrections and note when the items should be delivered in the ERP system.

5. Verified invoices are passed to an accounts payable manager or team for review and to complete payment processing.

6. The accounts payable manager enters the invoice into its general ledger system (typically an ERP) and schedule the payment. Invoices are typically labeled “Net 30 days,” which means the payment for goods is due 30 days from the date of the invoice. Suppliers may offer an early payment discount, such as “2/10 net 30,” which offers a two percent discount if the payment is made within 10 days.

7. The accounts payable manager sends the requested payments and expected cash flow to the top financial officer to approve payment. This is often a Controller or CFO.

8. He or she approves payment and begins the process of preparing checks, which are then sent out to the vendor.

Many accounts payable departments still process invoices manually. However, the costs involved are varied: paper, postage, staff required, and many other factors put the real price of manual invoice processing between $12-to-$30 per invoice.

This comes before many of the other hidden costs associated with invoice processing – such as missed early payment discounts, late fees, and accounting errors – are considered.

Invoice processing is broken

As a company scales, the problem will only get worse. More invoices can overwhelm an accounts payable department due to the volume of paperwork. In addition, accounts payable departments are often understaffed, leading to hours of data entry.

Even when alternative solutions are offered to manual invoice processing, the IT team will be reluctant to implement them and, instead, favor legacy software and other processes. Many IT departments are backlogged with numerous tasks and don’t have the time for additional projects, leaving many technical initiatives on hold.

Purchasers may feel that Electronic Data Interchange (EDI) software can adequately solve most of these problems. The reality is that EDI fails to effectively lower the cost of invoice processing for a variety of reasons. As a result, these companies spend thousands of dollars per year without any improvement in their current business process.

What is EDI?

Electronic Data Interchange (EDI) is an exchange of business documents between computers in a standard electronic format. This platform replaces the cumbersome task of handling a variety of invoices received via email, fax, or postal mail.

EDI is commonly used between companies to increase the efficiency of data transfer. However, despite growing popularity in EDI software, it falls short of being a totally reliable solution for accounts payable departments in a number of ways.

Here are five reasons why not to use EDI:

  1. Setup is time consuming: Using EDI requires extensive staff training in order to run the software. This means that IT needs to balance the setup of EDI software with various other projects that are on its plate.
  2. Technologically complex: In order to implement EDI, businesses must invest in a separate network for receiving and transmitting information. As a result, EDI creates a significant barrier for small-or-medium-sized businesses.
  3. Expensive upfront costs: Without the IT bandwidth in place, many companies will outsource the implementation to a Value-Added Network. However, this service comes with costly fees for training or to perform EDI transactions on a customer’s behalf.
  4. Limits ability to do business: Many suppliers don’t have EDI implemented and have no plans to do so due to the costs and training involved.
  5. Can’t handle paper invoices: Because there will undoubtedly be some suppliers not using EDI, the accounts payable team is faced with significant bottlenecks from dealing with paper and EDI invoices.

Although EDI can be helpful in the transmission of invoices, it falls short when it comes to efficiently processing invoices. Accounts payable teams require tools that not only make their jobs easier, but can output files in a format that is friendly to their respective ERPs.

The ERP factor

ERP software is crucial to any accounts payable department. In fact, many organizations base their AP automation strategies on how they integrate with their ERP solutions.

ERP systems store all the accounts payable documents – such as open PO files, shipping documents, invoices, and receiving reports. The best invoice processing solutions can take advantage of the information stored in an ERP to further improve business workflows.

But not all automation solutions integrate with every ERP. Even worse, there may be issues with interoperability where the file exported from the invoice processing software isn’t accepted by the ERP.

Either issue may create more headaches for the accounts payable team rather than solve them. However, when there is seamless integration, the data can be used to provide a full overview of the accounting department.

What is 2- and 3-way matching

Human error in data entry is common among nearly every accounts payable department. Accounts payable clerks often perform two- and three-way matching using “stare and compare” to verify invoices.

Two-way matching is when an accounts payable specialist verifies that the goods and services ordered through a purchase order are reflected in the invoice. Some companies take this process a step further by performing three-way matching.

Three-way matching includes verifying the purchase order and invoice with the receiving documents. These documents are typically either packing slips or an order receipt.

When two- or three-way matching is performed hundreds of times per day, even the most careful human eye lacks the ability to guarantee accuracy. They typically miss dates, values, or formulas that can ultimately slow down the entire department and expose the organization to a variety of risks.

As a result, many organizations are opting to automate these processes through artificial intelligence and robotic process automation technology. These innovations have enabled accounts payable costs to dramatically cut back on errors and reduce processing times by as much as 80 percent.

Benchmarking your AP department

When looking for areas of improvement for an accounts payable department, it’s important to consider benchmarks comparing industry averages against world-class departments.

Your analysis should cover key metrics such as invoice turnaround, cost per invoice, the number of invoices per full-time employee, and several other key performance indicators.

Not sure where to start? Here are a few KPIs to help you understand the gap between average and world-class accounts payable departments.

Invoice turnaround time

The average small-to-mid-sized company takes 25 days to process a single invoice. For organizations processing between 3,000-to-5,000 invoices per month, this cycle time can create a significant strain on the accounts payable department.

Through the advent of automation, world-class organizations can reduce this processing time to as little as five days.

Cost per invoice

When considering what it costs to process a single invoice, be sure to include staffing and storage costs, in addition to hidden costs associated with invoice processing – such as late fees, accounting errors, and missed early payment discounts.

This can often make the cost per invoice significantly more complex. If you need a simple formula to calculate what it might cost you, here is a simple suggestion:

Cost per invoice = (salaries of full-time employees + postage costs + storage costs) / annual invoice volume

In this calculation, be sure to include both full-time accounts payable employees and part-time staff responsible for keying in invoices. World-class companies have dramatically lowered the cost of processing invoices to as little as $5, providing clerks with the ability to perform more strategically beneficial tasks to their company’s bottom line.

Invoices per full-time employee

According to the Institute of Finance & Management’s key metrics report on accounts payable, the average employee processes just over 8,000 invoices per year. This means that distributors must hire at least four accounts payable clerks just to handle manual invoice processing.

The average salary for this type of position is $42,000 – before considering benefits and technology costs related to each hire. Yet, world-class distributors are finding that by investing in an automation solution, they can process the same number of invoices with just two clerks. Through technologies like data recognition and extraction, accounts payable departments process as many as 20,000 invoices per year.

Establishing yourself as a world-class accounts payable department isn’t easy, especially for wholesale distributors. But with these benchmarks, you can better understand a baseline of where most of the industry stands and how early adopters of technology are becoming more efficient.

Achieving early payment discounts

Many accounts payable managers are leaving money on the table by not taking advantage of early payment discounts. Despite being concerned about their bottom-line, processing invoices is time-consuming and error prone, making it extremely challenging to receive these discounts. 

On average, it takes up to two minutes to manually process an invoice, creating a painful strain on AP specialists and vendor relationships.  

An early payment discount is a favorable credit term offered to companies in exchange for expedient payment. For example, many suppliers will offer a 1-to-2 percent discount per month when payment is made within 10 days of receipt.  

Over the course of a year, the cost-savings can mean thousands of dollars in savings. Many organizations have taken advantage of early payment discounts by investing in automation software.

This investment has reduced the stress on accounts payable departments and helped them take advantage of early payment discounts. In addition, it has presented the opportunity for AP firms to negotiate more favorable terms with vendors, even if the relationship has been strained in the past.  

The future with invoice processing

Invoice processing has progressed dramatically over the last few years through the purchase of invoice process automation solutions. As a result, companies have been able to reduce manual labor costs, accelerate invoice turnaround, and improve invoice processing accuracy.

Automating your accounts payable department can have tremendous advantages in terms of efficient resource allocation. It can help prevent fraudulent, inaccurate, and duplicate invoices caused by human error.

Many of these solutions utilize optical character recognition (OCR) technology or computer vision to perform accurate data extraction.

Over the next several years, machine learning will equip automation software with the capability of understanding each distinct invoice it receives from a vendor.

This capability will further eliminate the need for human validation when processing invoices and allow accounts payable departments to receive optimal results for an even better ROI.

Learn more about the future of invoicing with the biggest fintech trends in 2019.

Source: What is Invoice Processing (+How Payment Departments Use It)

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