What is Cash Application and Why Is It Important?

Jul 10, 2017 by Kenzie Earle

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

However, this agreeable arrangement makes for more complex accounting than business-to-consumer (B2C) exchanges. The reasons for this complexity? Transaction period delays, unrepeatable quote to cash, and manual invoice closing procedures are just to name a few.

Generally, when a consumer payment is approved, the order and payment are created at the same time. With business-to-business (B2B) services, however, orders or invoices are made and payments often arrive sometime later. Thus, a lucky cash applications specialist or AR professional needs to manually match payments with their invoices after the fact. Yikes.

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 taking a look 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. Originally this process was done by controllers and accountants, very carefully and by hand, ensuring that each B2B transaction is fulfilled 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 method is hardly possible for modern billing. With the ever-growing volume and complexity of commercial transactions, a manual method isn't practical or efficient anymore. In fact, 78% of finance professionals believe that manual processes result in errors.

What Makes Cash Application Complex?

Manual cash application was fairly 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 left 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 in from traditional lockbox services, paper checks, eChecks, wire transfers, ACH, bank transfers, or a credit card, 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 further complicate the process, denying the ease of simple amount comparison.

Invoice matching is another headache for an accounts receivable specialist, as the payment may not match the invoice. Sometimes the full 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 gets stuck processing payments. After all, they could be working on far more interesting and strategic tasks than invoice matching and scouring credit card statements.

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

Why is Cash Application Important?

To put it simply: If you don't have it you can't spend it. Cash application is key for predictable and steady cash flow, and to put to rest any DSOs.

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 useful 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't even say they have a solid picture of current funds because there are payments waiting to be processed.

In short, the faster cash application is performed, the sooner the money can be spent on growth initiatives.

How Cash Application Impacts Business Relationships

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

Slow cash application isn't just irritating for the company that has been paid. 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. Waiting for cash application on their orders creates the same sensation of unease and roadblocks in their checks and balances.

ERPs are a common and vital piece to commercial business structure, and it is it common best practice for accountants to close their books at the end of the day based on the structure established in that ERP software. Knowing there is an unapplied payment, they face a certain amount of frustration because the number in their bank balance does not equal the amount of money they are clear to spend.

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.

The Solution? Cash Application Automation

AR Automation largely centers around cash application and streamlined invoice matching. And there are quite a few benefits to automatic cash application, 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 useful, but they still rely on a manual cash application process. That's why a cash application team relies on automation integrations that work with their ERP. This approach requires a low learning curve since financial professionals still use their known ERP. But they can reap all the benefits of automatic cash application.

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 team 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 reconciled in your ERP.

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