HomeAccount ReceivableWhat is the Cash Application Process & How Does It Work?

What is the Cash Application Process & How Does It Work?

Imagine you’ve just received a payment from a customer after weeks of reminders about overdue invoices. You’re relieved, but there’s more work ahead. Now, you need to post the payment to your accounting system to clear the open invoices, a process known as cash application. However, it’s not as simple as it sounds.

Let’s say the customer paid for five invoices, but half of them had discounts applied. Moreover, the invoice numbers provided don’t match your standard format. This means you will have to spend hours hunting down the right invoices, confirming discounts with sales, and reaching out to the customer for clarification—all for just one payment.

Now, imagine this scenario repeating for the numerous payments you receive daily. It quickly becomes overwhelming for any accounts receivable team.

If your cash application process sounds like this, you’re likely bogged down with manual tasks that could be streamlined. In this blog, we’ll walk you through the typical cash application process and explore how automation can simplify it.

What is the Cash Application Process?

The cash application process is a vital order-to-cash function of matching payments from customers to their outstanding invoices, ensuring that funds are correctly allocated in the accounting system. This helps businesses keep track of their cash flow and resources, enabling them to use their money efficiently and accurately. While the concept of cash application is straightforward, its execution can be intricate, involving the alignment of incoming payments with specific invoices to ensure accurate recording in the ERP system.

In simpler terms, cash application ensures that money coming in from customers is properly linked to the invoices they’re paying for, allowing businesses to stay on top of their finances. It’s like fitting puzzle pieces together—matching payments to invoices—so that the company’s financial picture is clear and up-to-date, enabling informed decision-making and effective financial management.

Why is the Cash Application Process Important for the Accounts Receivable Team?

The cash application process is fundamental for the accounts receivable (AR) team due to its multifaceted importance. It serves as the backbone for accurately recording and allocating incoming payments to the appropriate customer accounts and invoices, thereby upholding the integrity of financial records and facilitating precise reporting.

Efficient cash application empowers the AR team to maintain up-to-date financial records, offering real-time insights into cash flow and receivables. This timely information aids in informed decision-making concerning resource allocation, budgeting, and forecasting. Moreover, a streamlined cash application process directly impacts customer satisfaction by reducing errors and delays in payment processing. Prompt and accurate payment application fosters positive customer experiences, strengthening relationships and fostering repeat business.

Furthermore, effective cash application optimizes working capital management by swiftly converting receivables into cash. This ensures that funds are readily available for covering operational expenses, seizing growth opportunities, and minimizing reliance on external financing.

The cash application process is pivotal for the AR team, playing a crucial role in maintaining financial accuracy, enabling informed decision-making, enhancing customer satisfaction, and optimizing working capital management for overall organizational success.

Which Businesses Need Cash Application Process?

Cash application is crucial for various types of businesses, especially those involved in B2B transactions. These businesses often deal with multiple invoices and payments from different clients, making the cash application process essential for managing their accounts receivable effectively. Examples of industries that typically require robust cash application processes include:

  • Manufacturing
  • Wholesale Distribution
  • Professional Services
  • Healthcare
  • Software Development

While cash application is essential for B2B businesses, it’s also relevant for some B2C industries, particularly those with recurring billing or subscription-based services. Examples include utilities, telecommunications, and subscription box services.

How is the Cash Application Process Used?

The cash application process involves ensuring that when customers pay, their money goes to the right place—matching payments to the correct invoices and customer accounts. This process is essential because until the money is properly assigned, the company can’t use it. 

When cash application is done quickly and accurately, it allows businesses to put their money to work sooner. This means they can meet their financial responsibilities like paying employees, covering bills, fulfilling orders, exploring new investments, and giving returns to investors.

In today’s digital world, cash applications are even more important because customers have various ways to pay. But this also brings challenges. Companies need to adapt to these new payment methods and ensure that each payment is correctly recorded and allocated.

By staying on top of cash applications, businesses can avoid mistakes, maintain good relationships with customers, and manage their finances effectively. It’s about making sure every dollar that comes in is accounted for and used wisely.

What are the Steps in the Cash Application Process?

Step 1: Receipt of Payment and Remittance Details

Upon receiving a customer’s payment, accompanying remittance advice typically indicates which invoice(s) the payment covers. For checks, this information may be included in the memo line or attached as a separate document. However, electronic payments, such as ACH or wire transfers, often entail separate remittance advice in various formats. Occasionally, payments may arrive without associated remittance details, adding complexity to the process.

Step 2: Matching Payments with Invoices

After receiving a payment, cross-referencing it with the accounting system to align it with the correct invoice(s) is essential. Even with provided remittance advice, matching payments to invoices can be challenging, especially when a single payment covers multiple invoices or if the payment amount doesn’t precisely match an invoice due to discounts or order issues, necessitating thorough investigation by the accounts receivable team.

Step 3: Posting Payments to ERP

The final step in the cash application process involves posting the payment to the ERP system or accounting software, indicating the closure of the accounts receivable entry. Without an integrated accounts receivable solution, this step often relies on manual processes, potentially involving multiple spreadsheets and manual data entry, leading to inefficiencies and increased error risks.

Overall, the cash application process entails several intervening steps, such as reaching out to customers for missing remittance information or clarifying discrepancies between payments and invoices, as depicted in the accompanying flowchart.

Challenges Faced by AR Teams in Manual Cash Application Processes

According to a study by The Institute of Financial Operations, manual processing error rates for cash application processes can range from 2% to 5%, resulting in reconciliation challenges and potential revenue loss.

Cash application in accounts receivable can be time-consuming for mid-sized businesses and large organizations. AR teams often use Excel sheets for their daily cash application tasks. However, doing this manually not only reduces how much work they can get done but also affects how much it costs to run AR operations. Now that we understand the cash application process, let’s explore the common challenges that come with it.

Manual Unapplied Payments Matching

Manual unapplied payment matching refers to the process of matching incoming payments from customers with their corresponding invoices or transactions manually. This involves reviewing payment records and identifying payments that have not been allocated to specific invoices or accounts. Once identified, these unapplied payments need to be manually matched with the correct invoices or transactions in the accounting system. This process can be time-consuming and prone to errors, as it requires careful attention to detail and often involves back-and-forth between different departments or with the customers.

Error-prone Exception Handling

AR teams face challenges in manually matching invoices with payments based on information provided in remittances, such as invoice numbers or purchase orders. Incorrect or incomplete remittance details make it difficult to accurately match payments, leading to delays and errors in the cash application process. Additionally, the absence of remittance advice necessitates proactive outreach to customers, further delaying the process and hindering daily cash posting.

Follow-up with Customers for Unapplied Payments

The AR teams need to manually send emails and make phone calls with the customers regarding unapplied payments to resolve discrepancies in payment allocation. This process involves multiple interactions, which can be time-consuming and may lead to delays in reconciling accounts. Additionally, repeated follow-ups can strain customer relationships and consume valuable resources, impacting overall efficiency and satisfaction for both parties involved.

Time-intensive ERP Posting

A common issue encountered by AR teams is handling short payments, often due to trade promotions or disputes. Identifying the reason for short payments and mapping customer-specific codes to ERP system codes is a manual and time-consuming process. Furthermore, managing multiple ERP systems with unique configurations complicates the process, requiring thorough exception handling before posting to ensure accuracy and timeliness.

Hindrance in Other Accounts Receivable Processes

Slow cash application negatively affects other AR processes, particularly credit and collections. Delayed application of payments can lead to miscommunication, with collectors unaware of customer payments and inadvertently sending incorrect dunning notices. This not only results in a poor customer experience but also creates confusion and frustration, hindering effective collection efforts. Streamlining the cash application process is essential to prevent such downstream impacts on AR operations.

Manual Vs Automated Cash Application Process

Manual Vs Automated Cash Application Process

There are two main methods for carrying out the cash application process: manual and automated. In a manual process, a specialist or AR staff member matches each payment with its corresponding invoice by examining the customer details on the invoice. This information is then entered into the company’s ERP system before moving on to the next customer. The manual approach is time-consuming, labor-intensive, and not easily scalable. It also leaves room for human error.

On the other hand, cash application automation is increasingly common. It reduces the time needed for the process and minimizes the likelihood of errors. As the cash application process becomes more complex for a growing organization, the importance of automation becomes even more apparent.

Benefits of Automating Cash Application Process

Automating the cash application process offers several benefits. Let’s break down each benefit:

Time Savings 

Automating data entry tasks involved in cash applications saves valuable time for AR teams. Instead of manually inputting payment information into the system, they can utilize automated tools to process payments quickly and efficiently. This time savings allows staff to focus on more strategic tasks, such as analyzing financial data, improving customer service, or identifying opportunities for process improvement.

Improved Accuracy 

Manual cash application processes are prone to errors, such as unapplied payments or incorrect data entry. By automating the matching of payments to invoices, the likelihood of mistakes is significantly reduced. Automated systems use algorithms and predefined rules to accurately allocate payments, minimizing the risk of misapplied funds and ensuring that financial records remain accurate and up-to-date.

Enhanced Efficiency

Automation streamlines the reconciliation process by automatically matching payments to corresponding invoices or accounts. This reduces the time and effort required for manual reconciliation tasks, leading to faster closing periods and improved cash flow management. With automated systems, businesses can reconcile accounts more frequently and with greater accuracy, providing real-time insights into their financial position and performance.

Improved Visibility 

Automated cash application systems provide better visibility into payment statuses, allowing businesses to track payments in real time and identify outstanding invoices more easily. This reduces the need for manual follow-ups with customers to clarify payment details or request missing information. By providing customers with timely updates on payment statuses, businesses can improve communication, enhance transparency, and ultimately strengthen customer relationships.

A Way Forward

By leveraging automation tools and technologies, businesses can streamline their financial operations, improve accuracy, and better serve their customers. With Peakflo’s Cash Application solution, organizations can automate the cash application process, saving time, reducing errors, and enhancing efficiency. 

By leveraging advanced algorithms and predefined rules, Peakflo ensures accurate matching of payments to invoices, minimizing the chances of unapplied payments and improving financial accuracy. Moreover, the solutions provide real-time visibility into payment statuses, allowing businesses to track payments, reconcile accounts, and manage cash flow more effectively. With Peakflo businesses can streamline their financial processes, improve customer satisfaction, and drive growth in today’s dynamic marketplace.

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