Understanding the Cash Application Process and How To Improve It 

Here’s a scenario you’re likely all too familiar with. After weeks of chasing a customer about several overdue invoices, you’ve finally received a payment from them via bank transfer. Hurray!

But hold on. Maybe your celebration is premature.

You still have to post the payment to your accounting system to close out the open invoices (the cash application process).

And here’s where things get difficult—your customer happened to pay 10 invoices, half of which had discounts applied to them. On top of this, the invoice numbers in the remittance advice your customer sent over don’t match your standard format.

Because of all these factors, your cash application specialist will spend hours trying to find the matching invoices in your system. They'll also need to check with Sales if the discounts were valid and email the customer for confirmation.

And all this for one payment.

Multiply this process for the dozens of payments you have coming in every day, and this workload quickly becomes unmanageable for an accounts receivable (AR) team of any size.

If your cash application process is anything like what we’ve described, then you’re likely taking on more manual work than you should. And you’re certainly not alone. 84% of business and finance leaders we surveyed with SSON stated that their AR team manually matches payments and remittance data at least some of the time. Nineteen percent responded that their team does so always.

In this blog, we’ll explain the typical steps in the cash application process and how you can simplify them with automation.

Jump to a section:

• Introduction to cash application
• Why cash application matters
• The steps in the cash application process
• The problems with manual cash application processes
• How automation improves the cash application process

What is cash application?

Cash application is the process of recording revenue once you’ve received a payment. It involves matching incoming payments to the correct remittance information, invoices, and customer accounts so you can deduct the amounts from your remaining unpaid receivables.

Your business might receive payments through a combination of:

• Wire transfers
• ACH
• Credit and debit cards
• Checks and lockboxes
• Other electronic funds transfers such as corporate trade exchange (CTX)

Meanwhile, the associated remittance advice (which lets your team know what a payment is for) might arrive in the form of an:

• Email
• Image or PDF
• Excel sheet
• Web portal (such as an accounts payable system)
• Electronic data interchange (EDI)

As your business grows and you accept more payments from more channels, the cash application process becomes harder to scale. This is especially the case if your processes are highly manual.

Why does cash application matter?

Until you’ve recorded an incoming payment in your accounting systems, you can consider that cash non-existent. By applying payments to their corresponding invoices, you are ensuring the business has a right to those funds.

How fast you’re able to apply payments can have a direct impact on your potential sales, too. If you enforce credit limits, for example, then a delay in your cash application process could mean a customer’s credit won’t be replenished even though they’re up to date on their payments. This prevents customers from being able to make more purchases from you, which can have a domino effect on their businesses.

Before implementing Versapay, TireHub, a distributor of Goodyear and Bridgestone tires, had this exact problem.

“We won’t release an order if the account is on hold,” said Matt Marin, TireHub’s Senior Manager of Financial Processes and Data Management. “If there’s a delay in us applying payment, that can impact our operations and ultimately the customer’s ability to serve their own customers.”

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What are the steps in the cash application process?

Step 1: You receive the payment and remittance (sometimes separately)

When you receive a customer’s payment, you’ll usually also receive some form of remittance advice. This lets you know which invoice(s) the payment is for. Checks might include remittance information in the memo line or in an accompanying document (usually attached to the check).

Electronic payments, however, are less straightforward. With ACH, EFT, wire transfers, and virtual cards, the remittance advice will arrive separately in an array of possible formats.

And because buyers aren’t technically required to send remittance advice (although it is courtesy), a payment might come in without an associated remittance.

Step 2: You match the payment with the appropriate invoice

After you’ve received a payment from a customer, you’ll cross reference it with your accounting system to associate the correct payment with the correct invoice(s).

Even when a payment arrives with the remittance attached, matching the right payment with the right invoice can still get complicated.

A single payment can cover multiple invoices—in some cases upwards of 40 to 50. Or you might find that the payment amount doesn’t match any invoice amount exactly. This usually happens because a customer has short paid due to a discount or an issue with their order. These scenarios require more investigation from your accounts receivable team.

Step 3: You post the payment to your ERP

The final mile of cash application is posting the payment to your enterprise resource planning (ERP) system or accounting software, signaling that the accounts receivable entry is no longer open.

If you’re not using any kind of integrated payment system that can update journal entries in your ERP as payments come in, then posting payments is probably a very manual exercise for your team. It might involve you flipping between multiple Excel spreadsheets and manually keying everything into your ERP. This is not only inefficient but also introduces more opportunities for error.

The process we’ve described here is a simplified view of the cash application cycle. More pragmatically, as you’ll see in the flowchart below, applying payments to invoices involves several intervening steps like reaching out to the customer to request missing remittance information or clarify the reason for a discrepancy between the payment and the invoice(s).

What’s wrong with typical (read: manual) cash application processes

Relying on a manual process for cash application will only get you so far. As your business grows there will come a point where you can’t throw any more full-time employees at the problem.

“In modern payments, there are myriad payment flows taking place. You’ve got checks and papers going back-and-forth, digital payments and remittance forms, lockboxes, invoices posted to AP systems, and remittances that are decoupled from payments,” Versapay’s Senior Vice President of Sales Tim Stahl told PYMNTS. “The more forms of payment flows that exist, the more complicated cash application becomes for AR teams.”

Beyond this, manual cash application processes aren’t ideal because:

1. They’re time-consuming

When doing cash application manually, you’ll need to assign staff to painstakingly parse and enter remittance data—that is if it’s not omitted or hard to read. Many businesses prefer their customers pay them by check as the remittance advice is usually provided along with it. But, these documents aren’t always the most legible.

With electronic payments like ACH, the remittance information does not travel with the payment. As a courtesy, a customer will usually provide an additional document for the remittance advice, but this isn’t always the case.

Reaching out to customers to confirm how to apply their payment (because of split, illegible, or missing remittances) delays the whole process even further.

2. They introduce more errors

Even if you have detail-oriented staff, having to manually key in data means errors will inevitably pop up. If a customer sees errors crop up more than once, you could be putting the relationship in jeopardy.

For instance, if delays or misapplied cash make it look like a customer’s balance is overdue even when they’ve already paid, this might lead your collections team to mistakenly contact them to inquire about the missing payment. This creates a frustrating experience for the customer and can even be enough for them to take their business elsewhere.

In our survey of over 1,000 C-level executives with Wakefield Research, 82% of respondents stated their company has lost work due to miscommunications in the payment process like this.

3. They slow down your cash flow

With a manual cash application process, the time between a sale and the recording of a payment is longer, which can inflate your days sales outstanding.

Cash application delays also make it difficult to get an accurate, up-to-date picture of your outstanding receivables. This compromises your ability to see which accounts are truly delinquent, and which ones simply haven't had their payments recognized yet.

All this ultimately slows down your cash flow, by keeping money trapped on the balance sheet and preventing you from being as proactive with your collections as possible.

The benefits of cash application automation

Cash application automation software can help you avoid having to hire more cash application specialists just to stay afloat.

The most advanced cash application automation solutions are equipped with capabilities like machine learning, robotic process automation (RPA), optical character recognition (OCR), and artificial intelligence (AI). This helps you achieve straight-through processing for incoming payments, as they can get matched to the right invoices without your cash application team having to intervene.

Here’s a breakdown of the benefits cash application software offers accounts receivable teams:

1. Less time spent retrieving remittances from various sources

Cash application software can aggregate remittances from various sources like lockboxes, AP portals, emails, and PDFs, saving you the trouble of rounding them up yourself. These platforms can also digest the data to find invoice numbers, dates, and dollar amounts.

Cash application software can also analyze, normalize, and add structure to irregularly formatted remittance data.

What’s more, cash application software equipped with AI can remember those weird formatting issues and correct them on future payments. If you receive a payment without remittance advice but have been paid by that customer before, AI-enabled cash application software can match it with the right account based on data like the numbers at the bottom of a check.

2. Payments automatically matched with invoices

With automated cash application, you can match a high volume of payments and invoices—without human intervention. Cash application software has advanced significantly in recent years, allowing for match rates of over 90%.

In cases where a one-to-one match isn’t possible (as with payments covering multiple invoices), AI-enabled software can guess which invoices are being paid. It does this by working through potential invoice combinations, considering customers’ available credits as well.

And when you still aren’t sure how to apply customer payments, the easiest way to request clarification is with software that offers in-platform collaboration. This allows you to leave a comment directly on an invoice for your colleague or customer to answer, avoiding disruptions to your workflow. No need to get on the phone or fire off an email.

3. No need to manually key data into your ERP

The best cash application automation solution for your business is one that supports your ERP instance and can be closely integrated with it. This allows you to post payments automatically once they’ve been matched. Integrating with your ERP also allows the software to make guesses for matches based on data like current open invoices, payment history, and available credits.

Integration with your ERP also allows you to carry out the cash application process all in one place. No more switching between countless open windows and no more manually keying in data for hundreds of invoices.

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Beyond the time savings and reduced chance of error, automated cash application also improves employee happiness. The work of manually matching payments and invoices is often grueling and monotonous. On average, B2B businesses dedicate 15% of their staff to supporting cash application or reconciliation full time.

But with technology taking most of that work out of your team’s hands, AR staff can be freed up to work on more strategic—and personally fulfilling—work.

To learn more check out The Ultimate Guide to Cash Application, which includes our cash application software checklist.