A Complete Guide to Cash Application
24-03-2023 14 min read
Cash application is a process and work stream that exists inside accounts receivable teams worldwide. If you are managing accounts receivable (AR) processes or systems and are manually matching payments to invoices, then learning about automated cash application processes may be beneficial to you, your finance department, and your organization.
This detailed guide will showcase the essentials of the cash application process and how cash application software could improve efficiency and streamline the accounts receivable department within an organization.
Cash Application Guide topics:
- What is Cash Application?
- Cash Application Process – The Steps Involved
- Why is The Efficiency of a Cash Application Process Important in Your Business?
- Challenges With an Inefficient Cash Application Approach
- Problems With a Manual Cash Application Process
- Adopting an Automated Cash Application Process
- What is an Automated Cash Application Process?
- What Are The Benefits of Automating Your Cash Application Process?
Cash application is the process of matching incoming payments from customers with their respective open invoices and applied to their accounts, as well as matching outbound payments with the account. Until a payment has been matched, the business does not record the receipt of the payment and the invoice on the accounts receivable ledger will remain open or outstanding.
The purpose of cash applications is to monitor an organization's cash flow and working capital so that funds can be utilized efficiently and accurately.
There are a number of steps involved in the cash application process. In this guide, we will focus specifically on the accounts receivable side.
1. Receiving payments and remittances
The first step in cash application process is receiving payment and remittance information. Customers make payments either through cheques or electronic payment methods (Credit and debit cards), wire transfers or credit transfers, automated clearing house (ACH), lockbox services and other digital funds transfers like corporate trade exchange (CTX). Along with the payment information, customers will also send a notice called a remittance note, which should outline the payment, the date, and other aspects including the invoice the payment relates to. This remittance notice or slip may arrive in the form of:
- Excel sheets
- Web portals (i.e., accounts payable systems)
- Electronic data interchanges (EDI)
2. Matching payments received to open invoices
The second step of a cash application process is to take the payment/remittance note information and then match this to a customer invoice on the system. Cash application specialists will analyze a set of bank transactions and payments received and match them to the corresponding open invoices in the accounts receivable ledger. This will change the status of an open invoice to either paid, or partially paid depending on the payment amount received that can be correctly allocated.
There are many complications that may arise in this step - a single payment may have multiple invoices or payments may not match the invoice amount. This could be due to deductions from the customers, tax mismatches, or partial payments.
When a partial payment is applied, this is referred to as a short payment. Where a short payment is received, cash application specialists must provide a reason for the short payment and record this under a specific code.
3. Posting all payments to reflect the current position of accounts receivable
Once all the payments received have been matched to their corresponding invoices, the cash application process is nearly complete, and the cash application expert can then post all updates to reflect a live position of accounts receivable within the business.
By this point, the AR team should have an accurate position of any outstanding payments overview, any ageing debt, as well as payments collected, and the cash position of the business at that time.
An efficient and timely cash application process is required within a business to correctly attribute and post payments received to open invoices.
The challenge in this process comes when your customer makes part payments, or multiple payments, all with different references, relating to multiple invoices on your system. The cash application process also becomes more challenging and complex as your business grows and the number of invoices and payments to be matched increase in volume. The more payments you receive, the more work there is to match payments to invoices.
Without a streamlined and efficient cash application process, there's no guarantee that the cash received from customers correlates with what is owed to the business. There is also an impact on your customers and their future ability to transact with you, as well as your ability to utilize the cash within the business itself.
One of the key challenges in the cash application process is the high risk of errors and delays leading to unallocated and misallocated cash. This challenge can be detrimental when it comes to some of your key KPIs, such as working capital.
Help your customers transact faster with you, on their terms, without delay
If you have customer accounts with credit limits for example, the delay in matching payments to open invoices could mean that customers are unable to place further orders with your business. Thus your cash application process is slowing down your business’ capability to service its customers, and your customers ability to place orders and operate as quickly as they would like to.
Utilize cash application processes to provide a faster cash position of the company
The up-to-date financial information about the company’s cash position also provides management with data that can be used to drive the company’s operations on a daily basis. With this information, further financial decisions can be made on how cash needs to be utilized for other areas of day-to-day operations or fuelling the growth of the company through strategic investments.
Delays caused by any of these challenges will not only impact the efficiency and productivity of your team, but it ultimately slows down your cash flow.
These delays can make it more difficult to get an up-to-date and precise view of your receivables, making it harder to determine which accounts genuinely have overdue payments and which are yet to have their payments processed. This creates a domino effect resulting in an inaccurate overview of your accounts and overall business revenue.
A cash application specialist in your AR team will spend a significant amount of manual time, auditing various data points and then matching payments to open invoices on a customer's account. This is a manual cash application process.
A manual cash application process is highly labor intensive, prone to human error, and slow. If you're currently operating a manual cash application process, it may be worth evaluating the investment required to operate cash application efficiently and the resource it takes to do so.
With an increase in business activity, and more cash to be applied to invoices, the manual resource required will only increase - which may also lead to employee burnout or low productivity.
Growth is undoubtedly one of the top initiatives for organizations globally, irrespective of the size and the industry. When internal processes are cluttered and inefficient, this is a huge challenge.
Time intensive manual payment remittance aggregation
The step of manually linking payments to their corresponding remittance information can take a long time, especially when dealing with a large volume of transactions. This can lead to delays and errors in posting payments and reconciling accounts.
It also relies on human input and interpretation. If we consider the range of ways a customer can pay, along with how that remittance information is delivered, manually matching one payment to potentially multiple invoices across customers means a lot of manual-intensive work from the AR team. The volume, inconsistent format, processes and information across multiple remittance details and accounts means more room for errors, delays, and miscommunication.
Manually matching payments to invoices – long hours to decode
With that in mind, it’s common for a customer to make a payment that covers multiple invoices. That payment may also consider part payments or discounts, making it difficult for your team to understand what the payment precisely covers, especially if the remittance information is unclear.
This step also means long hours of decoding from your team, which contributes to higher processing costs and lower productivity. Additionally, if further communication with the customer is required to clarify inaccuracies, this not only delays processes for both parties, but miscommunication and portrayed time-wasting could put a strain on the client-customer relationship.
If payment matching isn't carried out efficiently, this may result in missed discounts, backlogs, and inaccurate records, unapplied or mis-applied cash that can harm the overall financial performance of the business.
Lockbox fees and check float time
A lockbox is a service offered by banks (mostly common in North America) where they collate all their customers checks in one place on behalf of the company – reducing the check float time and simplifying the cash application process as it reduces the time taken for the check float to process. It’s also keyed in electronically, making it easier to manage and share with the cash application team. While this process is convenient, it can get expensive for larger businesses as the service is charged based on keystrokes. There’s also the risk of the lockbox key-in data not being complete, meaning more manual work from the team to investigate further.
To summarize, a manual cash application:
- Is time consuming
- Increases the risk of errors (manual entry)
- Is difficult to track payments in real time
- Prove to create inconsistencies in processing
- Reduces efficiency
- Becomes unmanageable as business grows
This is where automated cash application solutions start to become a consideration.
Automated cash application processes and solutions are increasing in popularity amongst businesses worldwide. Automation within AR teams can greatly streamline the cash application process, reducing the risk of errors and increasing efficiency and same day matching.
Organisations across the globe have utilized the benefits of using advanced technologies like artificial intelligence (AI), robotic process automation (RPA), and other machine learning automated solutions to enhance the accounts receivable functions within the business. These automated solutions can automatically match payments to invoices and reconcile accounts in minutes, saving time and reducing the risk of manual errors encountered within manually driven cash application processes
Automating cash application processes involves implementing advanced technologies that identify, retrieve, and match payments and remittances from a variety of sources as detailed above. Cash application solutions use numerous data points to match these records, such as invoice number, customer name, amount, and payment date to match cash payments received to their corresponding outstanding invoices in your accounting system.
Automated cash application solutions are recognized as a quicker, more scalable, and smarter way to handle the cash application process.
Cash application automation software can not only help you streamline your financial operations, and avoid the challenges that come with handling the process manually, it can reduce the time it takes for the cash to have an impact on the business, cut down the number of low-value tasks carried out by human capital (improving customer and employee satisfaction), and reduce the number of errors occurring during the payment-to-invoice matching process. As a result, a business can experience fewer payment discrepancies, fewer customer disputes, and fewer chargebacks as a direct result.
More importantly, by introducing cash application software, a business can reduce unallocated cash and update customer accounts first thing in the morning. Accurate real-time financial data is then available for utilisation within the business.
Drive cash application success with intelligent automation solutions
With an automated cash application solution, it has never been easier, quicker, and more accurate to match incoming payments to outstanding invoices at large volumes. This means that the capacity inside your accounts receivable department increases significantly, without the need to scale human capital. Your AR team can process thousands of transactions, without additional hours of manual labor in the form of auditing, matching, and interpreting data.
An integrated cash application solution also enhances customer experience by providing customers with faster updates on their financial accounts with your company.
Better use of human capital in your AR team enhancing employee experience
By introducing an automated cash application solution, you will free up your team members capability to utilize their accounts receivable expertise to interrogate AR data rather than spending time collating it. This means happier team members, carrying out more fulfilling work, that has a bigger impact on the financial health and prospects of your business.
Less time, less errors, and less delays in cash application
Manual cash application also often leads to misapplied cash. Introducing automated cash application software means less errors in processing payments and increasing accuracy of data.
By using cash application software to automate the cash application process and reduce the time taken to match payments to invoices on account, customers can receive an accurate account balance figure faster and transact more frequently with your business. By reducing the delay time in associating payments to invoices means you open up more opportunity for your customers, and in turn for your business too.
Improve your company's cash flow and the reporting of working capital in real time
Not only does automated cash application streamline the process and reduce the time and effort required when manually reconciling accounts, but when payments are received and automatically applied to the correct invoice, it can accelerate the cash position of the company quicker. This enables businesses to record the collection of outstanding payments faster, give a real-time view of days sales outstanding (DSO) and reduce the risk of missed or misapplied payments.
With costs saved from less reliance on human resources, along with accurate and timely accounting of cashflows and up-to-date information, this ultimately helps businesses maintain better visibility into their working capital and cash, which in turn can inform better business decisions.
Benefits of an automated cash application process:
- Reduces unapplied cash and updates customer accounts first thing in the morning
- Monitors important KPIs and gains full transparency of the process
- Standardizes and centralizes your cash application process on a global scale for more quality, security, and compliance
- Minimizes bad debt and improves pre- and follow-up processes in your order to cash cycle
- Improves your DSO and optimizes your working capital by getting in cash faster
There are many benefits of implementing an automated cash application solution within your AR function. By turning your existing manual cash application operation into an automated process using technology, you can make better use of your human capital, avoid delays and errors, increase business opportunity, and make financial decisions faster using up-to-date financial information related to the cash position of the business.
By introducing automation within your AR team, you can utilise your team to work on more valuable tasks, analyzing the data output to make more strategic decisions and recommendations. In turn, cash application specialists are more fulfilled in their roles, and spending their time that is making the best use of their financial skillset.
At Serrala, we’re trusted by over 2,800 world leading brands to achieve automation rates of up to 99% with our cash application solutions driven by AI matching functionality for organisations looking to improve their cash application process. Many companies experience low automation rates due to country and industry specific cash application challenges. With Serrala´s FS² AutoBank software you will automate the cash application process from end-to-end, achieve highest possible automation rates and you will reduce manual and repetitive tasks to a minimum. Our solutions are fully integrated with your current SAP environment (S/4HANA or previous systems like ECC) and embedded in SAP which means you can post and update data in SAP in real time.
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