What is Cash Application and Why Is It Important?

May 23, 2023 by Kelsey Banerjee

Cash application is critical for the success of commercial transactions, but it can be complex in B2B exchanges. Transaction delays, invoice matching, and manual processes create challenges. This article explores the complexities of cash application and discusses solutions for streamlining the process.

In the workflow of commercial transactions, the flow of goods and services rarely waits for payments to be processed. But this process, better known as cash application, is critical for business success. If the relationship between two businesses in good standing is solid, their accounts are assumed sufficient to cover regular service exchanges.

However, this agreeable arrangement makes for more complex accounting than business-to-consumer (B2C) exchanges. What are the reasons for this complexity?

Transaction period delays, unrepeatable quote-to-cash, and manually closing open invoices are just a few.

Generally, when a consumer payment is approved, the order and payment are created simultaneously. However, with business-to-business (B2B) services, orders or invoices are made, and payments often arrive later. Thus, a lucky cash applications specialist or AR professional will manually match payments with their invoices afterward.

There are solutions for accounts receivable teams looking to streamline their cash flow. But before we can get to the fun stuff, it's worth looking at the nuts and bolts of cash application and payments.


What is Cash Application?

Cash application is the process of accurately matching payments from B2B customers to their orders or open invoices, then processing the payment so the money is available to be spent. Initially, this process was done by controllers and accountants very carefully and by hand, fulfilling each B2B transaction accurately and completely.

A cash application team typically tries to track three types of data:

  • Invoices or orders
  • Payments
  • Remittances, especially in the case of partial payments

The problem is that this method is hardly possible for modern billing. 78% of finance professionals believe that manual processes result in errors. With the ever-growing volume and complexity of commercial transactions, manual methods aren't practical or efficient.


What is the cash application process?

While 41% of CFOs want to implement cash application automation, many AR teams still use manual cash application. Matching payments appears deceptively simple. In short, the process is as follows:

  1. Receive the incoming payment and related remittance. If there is no remittance, contact the customer.
  2. Match the remittance data with the payment.
  3. Match the payment with the appropriate invoice.
  4. Determine if the customer made a partial or complete payment.
  5. Determine if the customer paid multiple payments or not.
  6. Apply discounts.
  7. Create a journal entry for the payment in your ERP account or spreadsheet.
  8. Post the payment.
  9. Save and move on to log more customer payments.

It sounds easy enough. But in reality, ensuring that an incoming payment is appropriately applied can become a time-consuming and challenging task, even for a seasoned cash application specialist.


What Makes Cash Application Complex?

Manual cash application was reasonably simple before the evolution of electronic payments and easy international business. Orders would come in and be recorded, followed by a check for the invoiced amount. The remaining task for an accountant was to match the client's name and amount on the order to the check and confirm the transaction was accurate. Finally, the business could cash the check to make the earned funds available to the business bank accounts.

Now there are dozens of ways for orders to come in, from electronic invoicing to digital payment portals to proprietary B2B apps. Payments can also come from traditional lockbox services, paper checks, eChecks, wire transfers, ACH, bank transfers, or credit cards, all of which need to be compared to the orders coming in from their various sources.

A single invoice is usually sent for multiple orders to complicate the process further, denying the ease of comparison of the simple amount.

Invoice matching is another headache for an accounts receivable specialist, as the payment may not match the invoice. Sometimes the total amount due on the account is received at different times during the month. This confusion prevents the AR team from closing out open invoices and daily reconciliations.

To make matters worse, it creates an incredible amount of tedious and manual work for an accounts receivable professional who needs help processing payments. After all, they could work on far more exciting and strategic tasks than invoice matching and scouring credit card statements.

These time-consuming steps ultimately lead to payment discrepancies, long outstanding invoices, and unapplied cash.


Challenges with Cash Application Today

Cash application is critical for predictable and steady cash flow and reduced DSO. Because, if you don't have it, you can't spend it. And payment discrepancies due to slow or inefficient cash application significantly affect how your company views its access to working capital.

Without control over cash flow, the organization will run into snags that can affect vendor and employee relationships. Companies need to use their money as efficiently as possible to make profits and keep shareholders happy, but they can't do this if the money is bottlenecked at cash posting.

Orders and payments waiting to be "applied" are not helpful to anyone. When a company has been paid but is waiting on a cash application, it is still essentially an IOU, as it cannot be used or invested in replacement products. The finance department can only say they have a solid picture of current funds if payments are waiting to be processed.

There are other potential challenges to streamlined cash application, too. Many times customer payments and remittance advice are sent at separate times. In some cases, customers may fail to send remittance information at all. This can delay and confuse the application process.

There's also a significant issue with unapplied cash. Failing to match a payment translates into inaccurate cash flow and potential tax and accounting compliance issues down the line. In the best-case scenario, your accounts receivable specialist identifies an unapplied cash payment during an audit or the month-close process and follows up with the customer. Of course, this can create a high-friction customer experience, too.

In short, the faster cash application is performed, the sooner the money can be spent on growth initiatives and ensure your accounting is compliant.


How Cash Application Impacts Business Relationships

Accounts and billing are critical to maintaining positive relationships with vendors.

Slow cash application is more than just irritating for the company that has been paid. Waiting for cash application on their orders creates unease and roadblocks in their checks and balances. As anyone who has waited for a check to be cashed knows, an inaccurate bank balance is misleading and unsettling. After a strategic partnership is finally established in the B2B realm, expectations are high in receiving a seamless transaction flow.

In other words, the customer experience suffers from delayed payments. For B2B, this prompt accounts receivables processing is even more important since the customer depends on predictable cash flow forecasting to grow. They may accidentally use those funds if they don't know when your team will apply the receivables to their outstanding invoice. Or they could send a duplicate payment.

Customers can also suffer from a manual cash application process when they rely on credit. Matching payments to outstanding invoices quickly allows customers to replenish their credit in a timely manner. But a significant lag in the accounts receivable process can result in customers not getting access to their business credit, thus holding up operations and weakling your relationship.

A timely cash application process in B2B sales is both a relief and a courtesy to your business customers, allowing them to keep their books as tidily as you like to keep yours. It also serves to build trust and retain those hard-earned relationships.


Optimize Working Capital with Cash Application Automation

The best way to improve cash flow and streamline your cash application process is through accounts receivable automation.

AR Automation largely centers around cash application and streamlined invoice matching. And there are quite a few benefits to automatic cash application software, including:

  • Fewer cash flow bottlenecks
  • Decreased or eliminated errors from payment processing
  • Overall cost reduction
  • Shorter DSO
  • Enhanced analytics, such as remittance data
  • Improved, potentially 100% visibility of the payments process

Setting up automation in the accounts receivable flow is less of a competitive advantage and more bare-bones essential these days. ERPs are helpful but rely on a manual cash application process. Automating your ERP processes with a cash application software integration requires a low learning curve since financial professionals still use their known ERP. But they can reap all the benefits of automatic cash application. That's why a cash application team relies on automation integrations that work with their ERP.

Through an automated accounts receivable process, they can retrieve order and payment information from multiple sources, then compare, match, and process them. Like at Paystand, all of these steps are automated in many cases. So a cash application specialist only has to review the exceptions.

Here's how it works (at least with us):

  1. You create an invoice and send it to the customer.
  2. Your customer receives an email with a "Pay Now" button.
  3. Your customer goes to the payment portal.
  4. They select their payment method.
  5. They can even choose to pay multiple invoices or make a partial payment.
  6. After payment, they are sent a certified receipt.
  7. The invoice and payment are matched and reconciled in your ERP.

And the outstanding invoice is not filled on time? You can create an automated payment collections workflow that will reach out to your late payers.


Interested in reading more about how to optimize your accounts receivable process? Check out our Quick Guide to Understanding Accounts Receivable Management.