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Cash Application Explained

Corporations should consider adopting automated cash application systems that can be easily customised to reflect their business operations.

Dimitri Raziev
Dimitri
Founder, Kolleno
datepicker icon October 7, 2022

Key Points

In the typical workflow of business-to-business commercial transactions, the delivery of products and/or services are completed prior to the processing of payments from customers. Thus, accounts receivable professionals within the company will need to perform a procedure known as cash application.

Cash application is an element of the accounts receivable process, whereby the procedure involves matching customers’ payments as well as remittance details with their relevant invoices.

Unless the money received from the customers has been applied to the company’s enterprise resource planning system, the funds received cannot be used for business development purposes or be distributed amongst the company’s shareholders.

In general, the cash application procedure appears straightforward in concept. However, its proper execution is often complex and prone to human errors if the company adopts a manual approach.

Corporations should consider adopting automated cash application systems that can be easily customised to reflect their business operations. Such tools may also provide the senior management team with insightful data to closely monitor the company’s cash flow and make better business decisions as a result.

Put simply, cash application is a matching system that cannot be overlooked by accounts receivable professionals if they hope to improve the company’s financial health. To address this need, Kolleno is a software extension connecting users to intelligent, innovative accounting software like Xero and QuickBooks to help businesses automate their cash application processes.

What is Cash Application?

Cash application is a vital component of the accounts receivable management procedure as it involves the matching of a customer’s payment to the relevant invoice being settled in the merchant’s accounts receivable ledger.

The cash application protocol usually begins with matching payments from the company’s customers/clients with their corresponding accounts and bills. Credit card payments, physical checks, wire transfers, and Automated Clearing House (ACH) payments are evaluated during this step, followed by matching with unpaid invoices to be marked as paid.

Should, for any reason, the payment could not be correctly matched with its associated invoice, then it will need to be matched with the appropriate customer at the customer account level. Upon the completion of this step, the payment can then be applied to lower the company’s total accounts receivables.

What Are the Various Components of the Cash Application Process?

In general, the critical components of the cash application process can be summarised as follows:

Payments

Payments are essentially the amount of money transferred from the customer/client to the company, and the transaction can come through various payment channels. For instance, payments can come in the form of paper payments (such as paper checks). Meanwhile, electronic payments are an alternative approach involving either wire transfers, procurement cards, virtual credit card payments, or ACH.

Remittance Advice

Remittance advice, also known as remittance, is the data documenting the reason behind the individual or entity making a payment to the corporation. In this documentation, accounts receivable professionals would usually include the invoice details and identification numbers. For example, the invoice could include a note specifying that the customer is only making a payment covering 50% of the billed amount as the delivered goods have been damaged upon receipt.

Besides that, remittance advice is occasionally offered together with the payment, though it can also be delivered separately via a phone call, email, or web portal.

Invoice

The invoice is fundamentally the original receipt detailing the reason for a payment to be made by the customer. During the cash application process, the accounts receivable professional will need to review the remittance advice to determine which invoices are being paid for by the money that the customer sent. Following that, the finance professional will need to match the payment to the relevant invoice and mark it as paid in the company’s enterprise resource planning (ERP) system before moving on to matching the next set of incoming funds.

Why Does Cash Application Matter?

As the wise saying goes, “cash is king”, this emphasises the importance of cash application as a critical component for businesses to accurately monitor their financial health and the state of their cash flow.

Upon receiving payments from customers, companies have to ensure that they have a right to those funds prior to entering the collected money into the fund’s payroll, making investments, or providing dividends to their shareholders. Put simply, the quicker the companies are able to apply their cash, the sooner they can use it for business purposes.

Besides that, given that most B2B sales are completed via credit, meaning that the business consents to delivering its goods and/or services to its customers whilst receiving the financial compensation at a later date, the company will need to establish a limit on the amount of credit it will be willing to offer to the buyer. All in all, this is a vital step to make sure that the business is not over-extending its credits to a specific customer, thereby protecting itself from potential payment delays and missing out on other business development opportunities. With that, establishing a proper cash application process is imperative because it ensures a positive operational cash flow by monitoring the customers’ integrity and how their payments are applied to the company’s books.

What Does the Cash Application Process Look Like and What Makes It So Complicated?

One of the most critical aspects that accounts receivable professionals need to understand about the cash application process is that no two corporations will adopt identical protocols. Much of this is because there are numerous factors that come into play, including the number of clients, the number of invoices, as well as the company’s preferred approach to delivering invoices to customers and receiving payments. As a result, the process often involves a series of steps before the entire cash application process can be completed.

Regardless, some of the inevitable steps within the cash application procedure include establishing the individual accounts for newly onboarded customers, collecting payments for the delivered goods and/or services, inputting the relevant payment information into the company’s accounting software or database, reconciling the bank accounts, as well as investigating any payment discrepancies that have been uncovered during the process.

Not to mention, the cash application process has evolved dramatically over time as the digitalisation of the accounting process has become commonplace. Essentially, there are two approaches that companies may adopt for their cash application process, namely, a manual procedure or an automatic one.

To elaborate, the manual process basically involves an accounts receivable professional going through every payment and remittance document, followed by using the customers’ names and invoice numbers to match the documents with their corresponding invoices. This data, in turn, will be entered into the firm’s ERP system to complete the process for one customer. Since the vast majority of business-to-business (B2B) payments were completed via paper checks prior to the massive adoption of digital tools, it is clear that the manual approach is often time- and labour-intensive, with corporations having reported facing issues with its scalability and vast potential for human errors. This thereby makes the manual cash application process a reasonably straightforward, albeit taxing, accounting procedure since accounts receivable professionals will only need to match those checks with the correct bills.

Fast forwarding to our world today, electronic payment methods have overtaken paper checks in terms of popularity, with cash application automation becoming increasingly common. In particular, cash application automation not only reduces the amount of time required to complete a full round for one client, but it may also significantly lower the chances of human error. Overall, the larger an organisation becomes, the higher its chances of having a more complex cash application process, and therefore, the need for an automated process becomes increasingly apparent.

The Advantages for Corporations That Automate Their Cash Application Processes

With the cash application process automated, the company’s management team will be able to match payments with the associated invoice faster, and as soon as an invoice has been settled, the customer’s credit can be replenished for additional purchases. Consequently, the business will be able to generate more revenue and increase its bottom line.

Other than that, automated cash application processes may allow corporations to introduce additional payment channels, which in turn, helps them to fulfil a diverse range of payment preferences amongst their customers. Moreover, companies would have increased flexibility in their payment acceptance policies.

In addition, automated cash application procedures are much more scalable. This means that businesses adopting such methods would be able to serve a more extensive customer base whilst being able to cap the cost structure of their accounts receivable unit.

Signs That Your Business Should Consider Improving Its Cash Application System

If your business has experienced any of these symptoms within your cash application process, there is a high chance you probably need to consider investing in the relevant system upgrades:

-High quantities of cash from customers that have yet to be applied,

-A large number of payments that have yet to be filed appropriately,

-A high volume of customers requesting receipts,

-The absence of an opportunity to get high-level insights on the company’s cash application efforts,

-The poor or non-existent customer service offered by your existing accounting system.

Given that a company’s best bet nowadays for enhancing their cash application system is to either purchase new software or develop their in-house system, it is usually a far more practical option for the majority of firms to invest in an external system.

Things To Take into Account When Selecting a Third-Party Cash Application System

As many cash application systems will be providing similar features, companies will need to study their efficiency and capability in fulfilling their specific business needs. Nevertheless, there remain several non-negotiables to look out for within these systems:

An Efficient and Robust Payment-Invoice Matching System

Companies will need to be able to customise their payment-invoice matching system without compromising its accuracy. On that note, excellent matching systems should be able to match at least 90% of the customer payments and manage millions of transactions seamlessly.

A System That Can Improve Its Efficacy Over Time

On some occasions, artificial intelligence (AI) and machine learning (ML) features may be incorporated within specific cash application systems. For instance, the software could learn the customers’ bank details in real-time as well as aggregate and import data from remittance advice information (such as header data, customer details, credit lines, and invoice numbers) whenever necessary. As a result, these capabilities may help accelerate the company’s cash allocation significantly.

A System That Is Compatible with Various File Formats

In an ideal situation, companies should seek a flexible cash application system with a wide range of bank files and formats (e.g., Microsoft Word and PDFs) to simplify the entire cash application process.

Practical Dashboard Analytics Tool

Furthermore, an excellent cash application system ought to come with a solid dashboard reporting feature to help the accounts receivable department offer practical high-level insights to the senior management. Plus, a powerful user stratification feature should be included, whereby companies are recommended to keep a clear paper trail of their customers’ activities to safeguard themselves from any potential fraud.

Concluding Thoughts

Although the concept of cash application and its process may appear simple on paper, the complicated nature of modern payments can be overwhelming for accounts receivable professionals.

To help prevent the emergence of such frustrations, Kolleno is a smart credit control platform that can be adapted to fit your business needs ideally. Some of the notable aspects of Kolleno include its ability to help companies automate their cash application processes so that the senior management can focus on what they are best at – growing the business by bringing in new customers.

Frequently Asked Questions (FAQs)

What Does Cash Application Mean?

Cash application is a vital component of the accounts receivable management procedure involving the matching of a customer’s payment to its associated invoice, followed by entering the details into the company’s accounts receivable ledger.

What Are the Different Components in The Cash Application Process?

The cash application procedure has three essential elements: invoice, payment, and remittance advice.

Is Cash Application the Same as Accounts Receivable?         

Cash application is a component of the company’s accounts receivable procedure, which involves the application of incoming payments from customers/clients with their corresponding invoices to be updated within the firm’s enterprise resource planning system.

Dimitri Raziev
Dimitri
Founder, Kolleno
Are you looking to centralize your payments, collections and reconciliation in one place? Book a demo to learn how Kolleno helps businesses to free up resources and focus on core priorities.