There are many different forms or types of businesses. The simplest type of business is a sole proprietorship. It is a business that is owned by a single owner. Sole proprietorships are generally smaller in size and depend on a single owner to provide all the capital for their operations. Once these businesses grow, the owner may bring in other partners to join the business.
Businesses with more than one owner are known as partnerships. These are businesses that are formed by at least two owners. The jurisdiction in which a partnership operates will also define the maximum number of partners for a partnership.
In a partnership, the owners, or partners, share the profits and losses of the business. The percentage of their share of the profits or losses is predetermined. This is, generally, defined before the creation of the partnerships in the partnership contract or deed. Partnerships are bigger businesses as compared to sole proprietorships.
The problem with the above two types of businesses is that they are not limited liability business. This means that in case these businesses wind up, their owners will be fully liable to pay the obligations of the business. However, in some types of partnerships, the liabilities of one or all of the partners may be limited.
The final type of business is known as corporations. Corporations are legal business entities that can have anywhere between 1 to unlimited owners. The ownership of corporations comes in the form of shares. Shares are legal documents that give the ownership of a corporation to the shareholder.
The percentage of ownership depends on the number of shares that the shareholder possesses. The earnings that corporations pay to their shareholders are also dependent on the number of their shareholding.
Businesses can change from one type to another. However, these changes may be subject to some rules and regulations. For example, the owner of a sole proprietorship can easily convert it into a partnership or a corporation. However, it may be easier for businesses to upgrade rather than downgrade due to the different rules and regulations.
There are many advantages and disadvantages of corporations as a general or as compared to other types of businesses. Some of these advantages and disadvantages are as discussed below.
Advantages of Corporations
There are many advantages of corporations, as a type of business, for both the shareholders and the corporation itself. Some of these advantages are listed below.
1) Limited Liability
As discussed above, corporations create limited liability for the shareholders. It means that in case a corporation gets liquidated, the shareholders will not be fully liable for the debts of the corporation.
Its shareholders will only be liable for the debts of the corporation limited to the value of their shareholding or their capital invested in the corporation. Limited liability businesses are more lucrative to investors as investing in corporations ensures they don’t have to pay for any liabilities above their capital.
This is different from other types of businesses such as sole proprietorships or some types of partnerships. In case these businesses wind up, the owners are held liable for all the liabilities of the business.
This means that the owners of an unlimited liability business will have to pay the liabilities of the business from their personal assets.
2) Separate Entity
Corporations are also considered a separate entity from their shareholders. This is one of the main reasons why corporations are a limited liability. However, that isn’t the only benefit of being a separate entity.
Corporations can enter into contracts and guarantees, lend and borrow money, invest funds, buy, own or sell property, and get into legal disputes as a separate entity. This means that a corporation does not need its owners for these things.
3) Transfer of ownership
An advantage of corporations for their shareholders is that corporations allow their shareholders to transfer their ownership without restrictions. Shareholders can easily buy and sell the shares of a corporation in a stock market without the need for prior approval.
In partnerships, all the partners must agree to admit a new partner. If any existing partner does not approve of a new partner, then the new partner cannot join the partnership.
Similarly, it can also be advantageous for the corporation. When shareholders buy or sell their shares, the operations of corporations are not affected by these transfers. On the contrary, for partnerships, if a new partner joins, or an existing partner leaves, the existing partnership deed becomes invalid.
A new partnership deed made every time there is a change in the dynamics of the partnership. Furthermore, corporations exist even after a shareholder leaves, joins, or even dies, which may not be possible for other types of businesses.
4) Management expertise
In most cases, the shareholders of corporations will be different from their managements. This can be advantageous for both the shareholders and the corporations. For shareholders, it means that they do not need to have any technical skill or knowledge to become owners of a business.
This is different from partnerships where the partners are involved in the management of the partnership. While some partnerships may have partners that do not manage the partnership, most of the partners are still involved in management roles.
For corporations, it means that they do not have to be affected by shareholders leaving or buying shares. Similarly, it means that the corporations can hire professionals for every management role to ensure the operations of the corporation run as smoothly as possible.
This can also be useful for shareholders as expert management means the corporation generates the maximum possible wealth for its shareholders.
5) Unlimited potential
Theoretically, corporations also have unlimited growth potential. This is mainly because corporations are not dependent on a single owner or a few owners for capital requirements. As discussed before, a corporation can have an unlimited number of shareholders.
Similarly, even if the existing shareholders cannot provide capital to a corporation, it can issue shares to new shareholders to generate finance. Other types of businesses such as sole proprietorships and partnerships are dependent on the capital that the existing owners invest in them.
6) Easy to invest in
Corporations are also easier to invest in as compared to sole proprietorships and partnerships. For a sole proprietorship, the single owner of the business needs to bear all the capital requirements of its operations which makes it an expensive and risky form of investment.
For partnerships, the existing partners may not allow new partners to enter, thus, making investing difficult in partnerships. For new partnerships, it may still be difficult to find agreeable partners that share the same objectives and goals. For corporations, anyone can buy shares from the market.
Disadvantages of Corporations
Corporations can also be disadvantageous as a form of business. These disadvantages may apply to both the shareholders and the corporations. Some of the disadvantages are as discussed below.
1) Agency problem
One of the problems of corporations is that their management is separate from their shareholders. While this can provide advantages for both the corporation and the shareholders, as discussed above, it can also be problematic.
The management of a corporation acts as agents of the shareholders in the corporation. Agency problems arise when the objectives of the management do not align with those of the shareholders.
Since the shareholders of the company cannot continuously monitor the operations of corporations, it may promote fraudulent activities by the management. While this problem has existed for all corporations for a long time, there is no definite solution to it.
Corporations may be required by law to perform audits and comply with certain rules and regulations. However, these solutions still do not guarantee that agency problems within corporations will not exist.
2) Difficult to form
Corporations are more difficult to form as compared to other types of businesses. This is because corporations must comply with stricter rules as compared to other types of businesses. Similarly, there are several different stages that the initial owners of a corporation must go through to form a corporation.
These stages may require a lot of legal formalities to be performed. Furthermore, after forming a corporation, promoting it can be difficult and time-consuming. Overall, corporations are more difficult to establish and can result in more costs for the initial owners.
3) More compliance
As discussed above, due to various reasons, corporations are subject to stricter compliance standards as compared to other businesses. These compliances ensure the safety of shareholders’ investments in corporations and can also be beneficial for the corporation.
However, this may also create more administrative burdens and costs for corporations. Similarly, in case of any non-compliance, the corporations may face penalties or legal actions.
4) Double taxation
As discussed above, corporations are separate entities which may be advantageous for various reasons. However, this also means that a corporation, as a separate entity, will have to pay its taxes. Once a corporation is taxed, it can distribute any earnings to its shareholders in the form of dividends.
These dividends are then taxed again for each shareholder. This means earnings made by shareholders through corporations are subject to double taxation.
Corporations are one of the advanced forms of businesses. These are different from smaller types of businesses such as sole proprietorships and partnerships in many ways. There are many advantages and disadvantages of corporations as a type of business.
The advantages are that they are limited liability businesses, they are considered a separate entity, and their ownership is easily transferrable. Furthermore, they can benefit from management expertise, they have unlimited potential to grow and they are easy to invest in.
Their disadvantages are that they may give rise to agency problems, they are difficult to form, they are subject to stricter rules and regulations, and shareholders are subject to double taxation.
Accounts Payable Management tends to have a significant amount of importance for companies, primarily because of the reason that they tend to influence the overall liquidity cycle of the company. If not managed in an optimal manner, it might result in companies facing significantly higher purchase costs. Therefore, it is quite important to ensure that those companies pay significant attention to the management of these payables so that they are able to extrapolate the best possible spread between the time when they receive the money and the time when they have to settle their debts.
A lot of strategy and thinking goes into typical accounts payable management. The main criteria in this regard are to ensure that companies are able to manage their accounts, and ensure that they avoid any undesirable circumstances in the form of increased costs, or strained relations from the company in this regard. Given below are some tips and tricks that can be used in order to manage accounts payable for organizations.
Tips and Tricks to Manage Accounts Payable
- Simplification of the Accounts Payable Process: This tends to be one of the main precursors of accounts payable management. As a matter of fact, it is highly important to ensure that the process is as simplified as it can be, in order to eradicate any confusion. This can be done by reducing the number of check runs in a month, and establishing payment cycles over a period of time so that there is clarity regarding settling of debts over the course of time. In the same manner, SOPs before payment disbursement are also effective, because they ensure that organizational heads do not have to spend time verifying their transactions.
- IT Integration: IT integration is perhaps the best tool that can be utilized in order to get the maximum advantages from the Accounts Payable Cycle. Using technology can enable companies to ensure that they have a proper idea regarding the integrations that need to be carried out so that they can ensure that they do not miss out on payment discounts, or payment cycles. Transaction flow and arithmetical errors can also be highly damaging to the cause. Therefore, it is in the best interest of these companies to ensure that technology integration is in place so that the chance for human error is minimized.
- Internal Controls to reduce Fraud: Segregation of duties and a clear cut protocol to be followed in terms of cash disbursement is a preventive measure that can be utilized by the companies in order to ensure that they are able to reduce fraudulent activities within the company to a maximum. Prevention of dummy vendors by dishonest employees can only be curtailed if companies have a stringent structure to follow in terms of verifications within the company.
- Negotiation of Vendor Terms: Inventory holding and ordering costs can be detrimental to the finances of the company, if not managed properly. Therefore, in order to set up an Economic Order Quantity for the company to follow, it is imperative that companies are able to set up an agreement with their suppliers regarding the terms that are going to be offered to them. By establishing loyalty with these parties, companies can easily ensure that they are able to get the best contracts for themselves, and they do not have to spend time looking for other vendors. The lesser the vendors they need to manage, the easier the management of these payables.
- Role of the CFO: It can also be seen that the role of the CFO should be limited to the signing of authorities, and other relevant documents so that he does not get overwhelmed by the need to check every payment made from the company’s account. This can be done by establishing other secondary signatories, and verification channels, so that the entire burden does not fall on one person.
Therefore, it can be seen that accounts payable management tends to be an increasingly important component for companies. As a matter of fact, it can be seen that this particular management can easily help companies to manage their resources in a much effective manner. Proper management considerably adds to the credibility of the company and helps them establish their integrity in the market. This also opens avenues to get more discounts, and more credit periods for the company, because of the fact that the suppliers know about the intent of the company to settle their debts on time.
Liabilities can be defined as the amount that is owed by a company in exchange for goods and services that the company has utilized or plans on utilizing over the course of time. This is the amount that needs to be paid by the company, and therefore, should include a number of different things.
Liabilities can broadly be categorized into Financial and Non-Financial Liabilities. Whereas Financial Liabilities can be regarded as liabilities that are incurred as a result of normal discourse of the business, where liabilities are mainly subdued in cash, non-financial liabilities are the opposite.
On the other hand, non-financial liabilities are mainly contingencies or types of liabilities that are not of financial transaction origin. Examples for these liabilities include deferred revenue, advances received and provisions that might have to be made as a result of these changes.
Non-Financial Liabilities mainly require non-cash obligations that need to be provided in order to settle the balance, which includes goods, services, warranties, environmental liabilities or any customer liability accounts that might otherwise exist.
In other words, non-financial liability can best be described
as an obligation that is associated with the retirement or maintenance of a
long-lived asset in the future. Therefore, it might be contingent on certain
outcomes, based on which the company would then have to complete the required
Measurement and Accounting Treatment
According to IAS
37, Non-Financial Liabilities should be measured at amounts that would
rationally be paid to settle any present obligation or amount to transfer it to
a third party on the balance sheet date. An entity is supposed to recognize a
non-financial liability when the definition of a liability has been satisfied,
and the non-financial liability can be measured reliably.
The basis of estimating non-financial liabilities relied on the expected cash approach. In this regard, multiple cash flow scenarios are used which reflect the range of all the possible outcomes, coupled with their respective probabilities.
This is primarily because of the reason that the expected cash flow approach is an approach that makes an appropriate basis for measuring liabilities and classes of similar obligations for single corresponding obligations.
Additionally, it can also be seen that Non-Financial Liabilities can be measured before tax. In the same manner, an entity is also supposed to include all the relevant risks and uncertainties. Similarly, the non-financial liability should be canceled when the obligation is settled, or canceled.
In the case where the Non-Financial Liability cannot be measured properly, it shall make complete disclosure about certain disclosures so that relevant information can be communicated to other people.
To conclude, it can be seen that Non-Financial Liabilities can be regarded as contingent liabilities which may or may not occur. The overall assessment of this particular task is based on the risk and return rationale, relating to the possible outcomes which might occur as a result of the fulfillment of this obligation.
Calculation and recording this particular liability is an important aspect, and because of the importance of this possibility, it should be duly communicated to the shareholder in the year-end financial statements.
Accrued Liabilities can be defined as an obligation that a corporation has assumed in the case of the absence of a confirming document.
This is an internally created memorandum which is prepared in the case where the corporation is yet to receive a confirmation, like an invoice, from the supplier or the biller, but they have already consumed the goods or services. Subsequently, in this case, the accountants are supposed to record it as an accrued liability.
As mentioned earlier, it can be seen that Accrued Liability is regarded as an expense that needs to be paid for by the company but has not been billed for.
According to the matching principle, and the principle of relevance, it only makes sense to record the current year’s expenses in the current year’s financial records. There are a number of examples of such transactions, some of which are mentioned below:
- During a normal course of the business, there are wages and salaries that are incurred over a certain time frame. As a matter of fact, it can be seen that these wages and salaries need to be paid for, but there is not a proper invoice regarding the hours they have been billed. Therefore, this is going to be treated as an Accrued Liability.
- In the same manner, taxes and interest rate payments carried forward from one year to another are also treated as a Current Liability.
Speaking of the treatment of an accrued liability, it is calculated on the basis of the quantity information in the receiving log, as well as the pricing information mentioned on the authorized purchase order.
The main rationale behind this particular entry is to ensure that the expense of obligation is duly recorded in the period where it is initially incurred.
As far as accrued liabilities are concerned, they are expenses that have already been incurred and need to be paid for. Therefore, under the matching principle, they are supposed to be treated as current liabilities to denote that these are liabilities that need to be paid in the current time period.
Hence, it can be seen that accrued liabilities are placed in the Balance Sheet (or Statement of Financial Position) of the company, in the Current Liabilities section, unless they have been paid for. After payment, they are then eliminated from the Balance Sheet. The reason behind their classification is primarily on the grounds of the debts that need to be honored within a cycle of 12 months.
To conclude the points mentioned above, it can be seen that accrued liabilities are also referred to as accrued expenses. Examples include accrued salaries, wages, interest and tax payments and so forth. Therefore, these expenses are mainly clubbed in order to simplify the presentation process.
Regardless of the fact that they should be treated as Accrued Liability, yet it can be seen that they are reported as Current Liability because of their very nature.
In the same manner, it can further be noted that these liabilities are short term, and need to be settled at a time interval of a few months, because of the fact that they are expenses that are incurred in the day to day running of the business.
Accounts payable represents the purchases that are unpaid by the enterprise. In the cash conversion cycle, companies match the payment dates with accounts receivables making sure that receipts are made before making the payments to the suppliers.
Lower the accounts payable days the better. It reflects that the company is able to realize the cash in good fashion.
Accounts payable aging report
An accounts payable aging report is a vital accounting document that outlines the due dates of the bills and invoices a business needs to pay. The accounts payable aging report categorizes the payables as per days outstanding.
An AP aging report is organized into separate “categories,” with each category representing a 30-day period. The categories are usually:
- Current – invoices that are within terms
- 1 – 30 – invoices that are 1 to 30 days past due
- 31 – 60 – invoices that are 31 days to 60 days
- 61 – 90 – invoices that are 61 days to 90 days
- 90 – invoices that are more than 90 days past
Importance of accounts payable aging report
Accounts payable aging report helps you figure how well you are paying your bills and helps you prioritize payments. The importance of accounts payable aging report can be summarized into the following points:
1) Conversion cycle
The accounts payable aging report, when combined with the accounts receivable aging report, is able to show if the payments have significant lag or are made way before the desired time.
This gap between the time impacts the desired or near-perfect conversion cycle of inventory. The aging analysis comparison makes it possible to minimize the gap between payments and collection and reduce the conversion cycle as much as possible. This will lead to better liquidity of the enterprise.
2) Reconciliation of accounts payable
Accounts payable aging analysis is a handy tool to reconcile accounts payable to the general ledger. The general ledger is an important accounting record that incorporates all financial transactions.
The amounts in the accounts payable journal and the account in general ledger book shall match. This can be reconciled periodically say monthly with aging accounts payable.
If this does not match, the accountant shall examine the details of the accounts payable account in the general ledger to determine the problem. For example, this might happen if manual entries were made to the general ledger but not in the accounts payable system.
3) Payables management
Accounts payable aging analyzes the bills the company owes. While taking longer to pay bills could help effectively the company’s cash flow, it’s not always the best option.
The company could be missing out on early payment discounts or be incurring financing fees. The company may have older accounts payable meaning the company is not able to pay it on time.
The aging reports help to identify those payables so that the company can make immediate payment to payables or rectify the underlying cash flow problem in the company.
Hence, the accountants shall regularly review the aging report to identify accounts that need action and track the progress of strategic adjustments that need to be made.
Accounts payable are the expenses recognized on the liability side when purchases are made on credit. These are ongoing company expenses and are short term debts to be paid within 1 year so as to avoid default.
Accounts payable is the total amount of short-term obligations or debt a company has to pay to its creditors for goods or services bought on credit. Accounts payable is the result of purchases made on credit.
Let’s take an example:
Davidson company makes purchases worth USD 1 million on December 1 with 60 days payment terms. Now at the end of the current financial year, the company shall recognize USD 1 million as accounts payable.
flow of accounts payable
understand how to reconcile accounts payable, first the audit trail of accounts
payable needs to be created. The following is the paper trail in the cycle of
- The buyer asks for a quotation from suppliers along with payment terms and conditions.
- The buyer makes the purchases from suppliers on the account.
- The buyer receives the inventory/purchases.
- The buyer checks the purchases made for the quality he ordered and decides whether to accept the order in partial and full.
- The buyer makes purchases return for purchases which are found to be defective.
- The buyer makes the payment in full.
- Any outstanding liability is carried forward to next year.
Withstanding the size and nature of the company, the objective of the company is to pay the company bills and invoices that are legitimate and accurate.
Why review accounts payable?
The company’s objective is to protect its cash and cash equivalents used to pay to accounts payable. Hence, the accounting system ought to have strong internal control systems to prevent paying fraudulent invoices, prevent paying twice to vendors and prevent paying for the inaccurate invoices.
Further, the accounts payable terms shall be accepted in such a way that it benefits the collection process of receivables and saves the cost of money.
The process flow of accounts payable helps to depict what needs to be reviewed to get accurate accounts payable and strong policy in hand. Here are the accounting documents and aspects that need to be reviewed to check accounts payable balance.
When the company wants to make the purchases, the first step is to make the purchase order quoting the number of materials required along with quality and other dimensions.
The purchase order will indicate a PO number, date prepared, company name, vendor name, name and phone number of a contact person, a description of the items being purchased, the quantity, unit prices, shipping method, date needed, and other pertinent information. It shall be reviewed in cross-matching which we discuss later on.
When the goods are received, the buyer records the inventory in receiving the report. After the receiving report and purchase order information are reconciled, they need to be compared to the vendor invoice. Hence, the receiving report is the second of the three documents in the cross-matching.
Later on or along with the inventory, the vendors send the invoice depicting the number of goods sent and the amount to be paid along with terms and conditions of payment.
This is the process to make sure that only valid and accurate invoices are recorded and paid. The cross-matching involves matching purchase order which states what has been ordered with receiving report mentioning what is received alongside invoice which states what vendor billed the buyers.
After determining that the information reconciles, the vendor invoice can be entered into the liability account Accounts Payable and is reviewed properly.
The vendor confirmation is a periodical confirmation of balances at the end of the accounting period. It helps to ensure that balances as per ours and vendors book matches.
When there is a difference, the reconciliation statement has to be made in order to mend what the accounts have been missing. These are generally year-end transactions that may have missed the recording.
Aging analysis of accounts payable
Historical aging analysis of payables helps the company. The payables shall be categorized based on outstanding up to 30 days, 60 days and 90 days. The payables above 90 days are critical in nature and need immediate attention.
The analysis of the ageing report of payables helps to perfectly put the company to have better negotiation in having accounts payable policy with the vendors.