Imagine you have finally received a payment from a customer after weeks of sending reminders about overdue invoices. You are relieved, but there’s still work to do. Now, you need to record the payment in your accounting system to clear the open invoices—a process called cash application. But it’s not as easy as it seems.
For example, the customer paid for five invoices, but some of them had discounts. Plus, the invoice numbers they gave don’t match your usual format. This means you’ll have to spend hours finding the correct invoices, confirming the discounts with your sales team, and reaching out to the customer to clear up any confusion—all for just one payment.
Now, imagine this happening with the many payments you receive every day. It can quickly become overwhelming for any accounts receivable team.
What is the Cash Application Process?
Cash application is the process of matching customer payments to their outstanding invoices, making sure that the money is correctly recorded in the accounting system. This helps businesses keep track of their cash flow and manage their money efficiently.
While the concept of cash application is straightforward, its execution can be difficult. It involves aligning incoming payments, remittance data, invoices, and GL codes for accurate record-keeping.
In simpler terms, the cash application makes sure that when customers pay, the money is linked to the right invoices. It’s like putting puzzle pieces together—matching payments to the correct invoices—so the business’s finances are clear, accurate, and up-to-date.
Why is the Cash Application Process Important for the Accounts Receivable Team?
The cash application process is essential for the accounts receivable team because it helps accurately track and allocate remittance data to the right customer accounts and invoices. This process ensures that financial records are correct and reporting is precise.
Efficient cash application empowers the AR team to maintain up-to-date financial records, offering real-time insights into cash flow and receivables. This information helps in making better decisions about resource allocation, budgeting, and forecasting.
A smooth cash application process also improves 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.
Additionally, effective cash application helps manage working capital by quickly turning receivables into cash. This makes sure that funds are available to cover operational expenses, seize growth opportunities, and reduce the need for external financing.
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 is about making sure that when customers make payments, the money is correctly matched to the right invoices and customer accounts. This step is crucial because until the money is properly allocated, the company can’t use it.
When cash application is done quickly and accurately, it allows businesses to use their money sooner. This means they can pay employees, cover bills, fulfill orders, explore new investments, and give returns to investors on time.
In today’s digital world, cash applications are even more important because customers have different ways to pay. However, this also creates challenges. Companies need to adapt to these new payment methods and ensure that each payment is accurately recorded and assigned.
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.
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 a slow process for medium and large businesses. Many accounts receivable teams use Excel sheets to handle cash application tasks every day. But doing this manually not only limits their productivity but also increases the cost of running accounts receivable operations. Now that we know how cash application works, let’s look at some of the common problems that come with it.
Manual Unapplied Payments Matching
Manual unapplied payment matching is when you have to match incoming customer payments with their correct invoices or transactions manually. This involves going through payment records to find any payments that haven’t been assigned to specific invoices or accounts. Once found, you have to manually match these payments to the right invoices or transactions in the accounting system. This process can take a lot of time and is often prone to mistakes since it requires close attention and sometimes involves communication between different departments or with customers.
Error-prone Exception Handling
Accounts receivable teams often struggle to match invoices with payments when remittance details like invoice numbers or purchase orders are incorrect or incomplete. This makes it hard to accurately apply payments, causing delays and errors. When remittance advice is missing, the AR team has to reach out to customers, which slows down the cash posting process even more.
Follow-up with Customers for Unapplied Payments
AR teams have to manually send emails and make phone calls to customers to sort out unapplied payments. This process often requires multiple interactions, which can be time-consuming and cause delays in reconciling accounts. Additionally, constant follow-ups can strain customer relationships and take up valuable time. It impacts overall efficiency and satisfaction for both parties involved.
Time-intensive ERP Posting
Accounts receivable teams often face challenges with short payments, which can happen due to trade promotions or disputes. Figuring out the reason for these short payments and matching customer-specific codes to the codes in the ERP system is usually a manual and time-consuming task. The process becomes even more complicated when dealing with multiple ERP systems, each with its unique configurations. This requires careful handling of exceptions to ensure accuracy and timely posting.
Hindrance in Other Accounts Receivable Processes
Slow cash application can hurt other accounts receivable processes, especially credit and collections. When payments aren’t applied quickly, collectors may not know about customer payments and might send 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
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 involves several benefits. Let’s break down each benefit:
Time Savings
Automating cash application tasks saves AR teams a lot of time. Instead of manually entering payment details, they can use automated tools to process payments quickly. This frees up staff to focus on important tasks like analyzing financial data, improving customer service, or finding ways to make processes better.
Improved Accuracy
Manual cash application is prone to errors, like payments not being applied correctly or data entry mistakes. Automated systems reduce these errors by matching payments to invoices using set rules and algorithms. This means fewer mistakes and more accurate financial records.
Enhanced Efficiency
Automation makes reconciling payments with invoices easier and faster. It cuts down the time and effort needed for manual reconciliation, leading to quicker closing periods and better cash flow management. With automated systems, businesses can reconcile accounts more often and accurately, giving them real-time insights into their financial status.
Improved Visibility
Automated cash application systems give better visibility into payment statuses. Businesses can track payments in real time and easily spot outstanding invoices. This reduces the need for manual follow-ups with customers and provides timely updates on payment statuses, improving communication and strengthening 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.
