HomeAccount ReceivableUnapplied Payments: What They Are and How to Manage Them

Unapplied Payments: What They Are and How to Manage Them

Unapplied payments can be a headache for businesses. These are payments that have been received from customers but cannot be matched to any specific invoice or account. Understanding unapplied payments and knowing how to manage them is crucial for maintaining accurate financial records and ensuring proper cash flow. 

In this blog, we’ll delve into the concept of unapplied payments, explore why they occur, and discuss strategies for managing them effectively.

What are Unapplied Payments?

Unapplied payments, also known as unapplied cash, are payments that have been received by a business but have not yet been applied to a specific customer account or invoice. These payments typically sit in a suspense account until they can be properly matched and allocated. Unapplied payments can be of many types, including:

  • Overpayments: When a customer pays more than the amount due on an invoice, the excess amount becomes an unapplied payment.
  • Underpayments: If a customer pays less than the full amount due on an invoice, the payment may be recorded as unapplied until the balance is settled.
  • Misapplied payments: Payments that are applied to the wrong customer account or invoice can result in unapplied payments.
  • Processing errors: Errors in payment processing or data entry can lead to unapplied payments.

Why Unapplied Payments Are a Problem?

Unapplied payments can create several problems for businesses, including:

Inaccurate financial reporting
Unapplied payments can distort financial statements because they represent funds received but not yet assigned to specific invoices or accounts. This can make it challenging for businesses to accurately assess their financial health, as the unapplied payments can artificially inflate or deflate revenue and accounts receivable figures. This, in turn, can lead to incorrect financial decisions and misrepresentation of the company’s financial position to stakeholders.

Cash flow issues
Unapplied payments tie up cash that could be used for other essential business activities, such as paying suppliers or investing in growth opportunities. When payments are not applied promptly, it can create cash flow shortages, impacting the company’s ability to operate smoothly. This can lead to missed opportunities and increased reliance on external financing to cover day-to-day expenses.

Customer dissatisfaction
Customers expect their payments to be applied accurately and promptly to their accounts. When payments remain unapplied for a long time, customers may become frustrated with the company’s billing process. This can damage the company’s reputation and lead to customer complaints and disputes. Resolving unapplied payments promptly is crucial for maintaining positive customer relationships and ensuring customer satisfaction.

Risk of loss
Unapplied payments that are not properly reconciled and allocated are at risk of being lost or misappropriated. This can occur due to errors in recording or processing payments, or due to fraudulent activities. Unresolved unapplied payments can create discrepancies in financial records, making it difficult to track and recover lost funds. Implementing strong internal controls and regular reconciliation processes can help mitigate the risk of loss associated with unapplied payments.

Common Reasons Why Unapplied Payments Occur?

Incorrect posting

One of the primary causes of unapplied payments is incorrect posting, where payments are mistakenly applied to the wrong customer account or invoice. This can result from human error or system malfunctions. For instance, if a customer makes a payment without specifying their invoice number, the cash may remain unapplied until the correct invoice is identified. To avoid this, it’s crucial to have strong payment reconciliation processes and ensure that all payments are accurately matched with their corresponding invoices.

Missing or incomplete information

Another frequent cause of unapplied cash is when payments are received without sufficient information to identify the customer or invoice. This often happens when customers provide incomplete remittance advice or fail to include any identifying information with their payment. To mitigate this, businesses should remind customers about including complete remittance information and consider implementing automated systems for accurate payment matching.

Bank errors

Unapplied cash can also result from errors made by the bank, such as misdirected payments, duplicate deposits, or processing delays. For instance, if a customer’s payment is deposited into the wrong bank account, it may take time to identify and apply the cash correctly. To address this, businesses should regularly reconcile their bank statements, promptly investigate any discrepancies, and maintain open communication with their banking partners.

Discrepancies in currency or exchange rate

Unapplied cash can arise in international transactions due to discrepancies in currency or exchange rates. For example, if a customer pays in a different currency or if the exchange rate fluctuates between the payment and reconciliation, it may result in unapplied cash. To minimize this risk, businesses can use automated currency conversion tools, provide clear instructions for international payments, and monitor exchange rate fluctuations closely.

Inefficient cash management processes

Inefficient cash management processes can contribute to unapplied cash and exception items. Delays in processing payments or lack of communication between departments can all lead to cash being left unapplied for extended periods. To improve cash management, businesses should streamline payment processing workflows and establish effective communication channels between departments.

How to Proactively Manage Unapplied Payments?

Managing unapplied payments requires a proactive approach. Here are some strategies for effectively managing unapplied payments:

1. Regular reconciliation

Regular reconciliation involves comparing the payments received with the invoices issued and customer accounts to identify any unapplied payments. This process helps ensure that all payments are properly matched and allocated. It is essential to perform reconciliation regularly, such as daily or weekly, depending on the volume of transactions, to promptly identify and resolve any unapplied payments. This can be done manually or using accounting software that automates the reconciliation process.

2. Clear payment instructions

Providing clear payment instructions to customers can help prevent unapplied payments. Instructions should include details such as the preferred payment methods, acceptable payment formats (e.g., check, wire transfer, online payment), and any necessary reference numbers (e.g., invoice number, customer ID) that customers need to include with their payments. Clear instructions help ensure that customers provide all the necessary information for payments to be properly allocated.

3. Timely follow-up 

Timely follow-up is crucial for resolving any discrepancies or unapplied payments. If a payment cannot be matched to an invoice or customer account, businesses should promptly follow up with the customer to obtain the necessary information. This may involve contacting the customer via phone or email to request additional details or clarification. By resolving unapplied payments promptly, businesses can ensure that their financial records are accurate and that customers are satisfied with the billing process.

4. Automated matching

Automated cash application solutions can significantly streamline the process of matching payments to invoices and customer accounts. These tools use algorithms to automatically match payments based on criteria such as invoice numbers, customer IDs, and payment amounts. By automating the matching process, businesses can reduce the risk of human error and ensure that payments are accurately applied. This can also help improve efficiency by reducing the time and effort required for manual matching.

By implementing these strategies, businesses can effectively manage unapplied payments and ensure that their financial records are accurate.

A Way Forward

Unapplied payments can be a challenge for businesses, but with proper management strategies in place, they can be effectively managed. By understanding the causes of unapplied payments and implementing proactive measures to address them, businesses can minimize the impact of unapplied payments on their financial operations and ensure smooth cash flow management.

Automating the manual steps involved in applying payments can significantly save your team time and effort. However, the effectiveness of automation relies heavily on the accuracy of the original data input. Regularly reviewing data is crucial to maintain accuracy, thereby reducing the likelihood of unapplied and duplicate payments. Moreover, utilizing technology can simplify various tasks associated with the accounts receivable process.

Peakflo’s Cash Application solution seamlessly integrates with accounting software, streamlining your receivables process. Let’s take a look at how it helps in managing unapplied payments:

  • Set up automated unapplied payment reminders based on your payment reconciliation frequency. 
  • Provide customers with visibility over unapplied payments through Peakflo’s Customer Portal, allowing them to apply payments against invoices directly. 
  • Capture remittance data with the OCR technology which then automatically applies payments to overdue invoices based on the reference number, customer ID, or other customizable rules, reducing manual effort and improving efficiency.