What is Cash Application?

For those who deal with cash application on a daily basis, what cash application is and why it is important is probably pretty obvious, but for those who don’t know what cash application is, it may be a little difficult to fully understand why it is so important. While it can seem simple on the surface, there is a lot of complexity to it. For those with questions, we’ll look to answer what cash application is, how you do it, why it is complex, and why any of this matters.

What is cash application?

Cash application is a part of the accounts receivable process that applies incoming payments to the correct customer accounts and receivable invoices. To do this, the first step is to determine where to apply the payments. This is normally done by matching the payment to the associated invoices. If for some reason the payment cannot be correctly matched to its associated invoice then the payment is matched to the customer at the customer account level. Once this is done, the payment can be applied to reduce accounts receivables. Seems pretty simple, so let’s move into how cash application is done.

How do you do cash application?

It’s one of the most important components of any accounts receivable process. At the highest level, there are two ways that cash application is done, manually or automated. A manual process involves a cash application specialist going through payments and associated remittance and matching the payment amounts with their associated invoices. The cash application specialist will look at the customer name or invoice number on the payment, find the associated remittance and post it to the outstanding accounts receivable invoice in their company’s ERP. An automated cash application process goes through the same process, but can match payment and remittance at a faster speed. As the cash application process has grown more and more complex, many companies have moved to an automated process, as reducing the staff workload to reduce costs and work burnout and applying cash becomes more important.

What makes it complex?

When being paid by check, cash application was pretty straightforward for accounts receivables teams; checks would come in with remittance advice attached, allowing for a simple one-to-one matching that was basically already completed. Many accounts payable teams have adopted electronic payments to reduce costs. With the advent of electronic payments – ACH, wire, and card – remittances often now comes separately, via mail, email, web portals, or other sources. Another issue occurs when accounts payable departments send a single electronic payment for multiple invoices. This makes matching a much more difficult process since you can’t just look at dollar amounts of payments to match proper payments to the invoices. The remittance now becomes vital as it is the only means of relating the payment to the correct invoices. A newer problem for accounts receivable departments is the requirement of retrieving remittances from web portals. The prominent shift occurred in 2014 when Walmart, Amazon, and many other buyers set up web portals as a cheaper way to distribute remittance to vendors. These large retailers usually dictate the process, making it hard for their suppliers to avoid the burden and costs of retrieving remittances from web portals. The suppliers have to comply because they can’t afford to lose business! When these challenges come together, it is easy to see why accounts receivable teams are stressed and overworked. On top of all this, cash application is a time-sensitive process; its speed and efficiency directly affect a business’s performance. In a manual process, an AR specialist has to retrieve all of the remittances, from mail, email, web portals, and more just to begin. For companies that work with multiple retailers and receive remittances daily, just retrieving remittances from web portals requires multiple full-time employees. Then they have to use the remittance information to match the payments to the associated invoices to post them to the ERP. Automation has allowed companies to eliminate routine tasks in the process. A centralized archive can be set up for storing all remittances. Robotic Process Automation (RPA), a form of automation that we will discuss in a later blog, can retrieve remittances from web portals and receive emails and extract the remittance information. From there, remittances from all sources can be put in a centralized archive, eliminating the issue facing cash application teams that work with multiple sources of remittance information. RPA can also automate the matching. Whether a company decides to automate one part of the cash application process or the entire process, one thing is clear, automation leads to faster cash application. That brings us to our next section.

Why does it matter?

You’ve probably heard the phrase “put it in the books!” Cash application is how payments get applied to the books. Many payments are point-of-sale, where payment is issued, and then goods are received. This is how many B2C transactions work. However, in the B2B world, something is sold and payment usually won’t arrive until later. When the seller receives payment, they need to apply the cash to track cash flow to maximize cash utilization. If you can’t use it, it might as well not be there! With an efficient process, the faster cash is applied results in a lower Days Sales Outstanding (DSO), the time between sales and completed payment. A lower DSO means that you will have more capital to invest in other opportunities or use in everyday business. With a poor cash application process, a company will is not able to accurately monitor cash flow and capital, leading to other missed opportunities, like sales etc. The bottom line is “cash is king,” and cash application is key factor for any successful accounts receivable department.