How to automate and streamline your cash application process
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Many business-related financial and bookkeeping processes are best left to accountants. But there are certain critical processes that are so critical to your day-to-day operations that it's integral for you to achieve some mastery of them. Cash application is one of these processes.
The term cash application is used to describe the matching of a cash or cash equivalent payment to an outstanding invoice. It also includes remittance advice, which is a notice sent to the customer to confirm receipt of payment.
In this article, we’ll explain why these are important, where you can automate cash applications, and how processing speed can affect your company’s financial outlook.
What is a cash application in accounts receivable?
Cash application is an attribution process. Your customers may pay you with a check, ACH, credit card, SEPA, BACS, or old-fashioned currency. The cash application process is the series of steps that follow that customer action. The payment needs to be registered in the general ledger and attributed to the accounts receivable invoice it belongs to.
This sounds simple, but there are several factors that can disrupt the cash application process. A customer or client payment that can’t be matched to an open invoice is recorded as an exception. Partial payments require an extra step where a new invoice is generated for the balance due. Overpayments need to be processed and then refunded back as cash or credit.
Another potential issue in the cash application process is the manual matching of remittance slips with payments and invoices. Companies that accept mail-in checks often send remittance advice by mail, but electronic remittance might go out as an email or through an AP portal. That makes the matching process more labor intensive.
The companies and individuals that your business pays also do cash application, like matching a vendor payment to an open vendor invoice. Your accounts payable department should receive remittance advice from vendors you pay to confirm the payment. If not, ask why. That documentation could come in handy at some point if you’re audited.
Why the cash application process is crucial for startups and finance teams to streamline
Cash application directly affects financial reporting, particularly the balance sheet. Accounts receivable doesn’t change until the customer payment has been registered. That causes the cash number to go up, which affects the income statement and statement of cashflows. None of this happens without cash application. We’ll show you more on that below.
For startups, cashflow is the lifeblood of the company, but it’s meaningless without attribution and proper budgeting. Incoming revenue that’s not attributed to a specific invoice can appear to be free cash. That money could be easily spent without considering the cost of goods sold (COGS) or operating expenses required to generate that revenue.
Finance teams don’t like mystery money. Neither do banks and lending institutions. Taking in revenue without a cash application process can affect a company’s ability to get a loan or merchant cash advance. Part of the lender’s due diligence is to determine where your revenue comes from, not just how much of it you have coming in.
Owners, shareholders, and investors want to see accurate financial reporting. They need it to make informed business decisions. Think of cash application as a “check and balance” system to ensure reporting accuracy. In the next section, we’ll go over exactly how it works and then offer some suggestions for automating and making it more efficient.
Cash application process: step-by-step
An auditor, whether hired internally or assigned by the IRS, will need documentation of the following steps if they perform a spend analysis on your company. A failure to have that available could lead to the denial of certain deductible expenses or even fines and penalties. Cash application helps ensure financial reporting accuracy, so it’s a big deal.
Step #1: Payment is received
As we mentioned above, customer payments come in all shapes and sizes. A check mailed to your office is easy to process. Credit card payments are handled by a payment processor. ACH payments go through the bank. There’s a paper trail for all these items if you know how to look for it.
Ignoring the cash application process when payments come in electronically is a common mistake made by new business owners. They assume that the payment processor or bank will keep track of any relevant details and provide a report. Certain ecommerce platforms may do that, but it’s your AR/AP team who help compile financial reports.
Step #2: Remittance advice
There are three pieces to every payment. The payment itself is the first. The remittance advice is the second. Think of it as a “receipt” that notifies the customer their payment has been received. In the cash application process, the payment and the remittance advice need to be matched with the open invoice. Accountants need all three to resolve the transaction.
Remittance advice is not a legal requirement. You could just register the payment and show it on the client’s next monthly statement. Unfortunately, human beings sometimes make mistakes. An error recording the payment could lead to a customer service issue later. Getting the remittance advice out immediately can help prevent those problems.
Step #3: Payment is matched to invoice
We dove into this in depth in our article on billing vs invoicing, but bills are generally provided for a one-time service that is paid for up front. Those don’t require remittance advice, but your company should have a copy of the receipt you gave the customer. That’s why diners get multiple slips with the same info at the restaurant. The merchant copy is the company’s record of the transaction.
An invoice is issued for sales made on credit, so payment needs to be matched to it when it’s received. Organizing invoices in chronological order and by customer makes this easier to do. Automating your invoicing and payment processing takes all the worry out of it. Ramp has several tools that can help you do this. We’ll cover those in a bit.
Step #4: Cash application is resolved
Match the payment, the remittance advice, and the invoice. With those three pieces in place, you can resolve the transaction and move on to the next. If you’re keeping paper records, staple copies of all three together. Modern companies use digital archiving. Progressive firms automate everything. Do this manually for a while and you’ll understand why.
Cash application challenges to overcome
Even the simplest accounting processes come with some challenges. In a perfect world, the payment amount will match the amount on the invoice and the remittance advice will be automatically generated when you enter the payment into the system. If your company isn’t doing it that way, you may have one or more of the following problems.
Human beings often fear automation, but they admit the possibility of human error in manual accounting and record-keeping. These “human” mistakes could cost your company a chance to borrow money through invoice discounting or merchant cash advances. Inaccurate reporting from those errors could undermine investor and lender confidence in your business.
Seasoned accountants can tell you horror stories about reconciliation errors caused by payment discrepancies. Cash application is a preventative exercise to eliminate those. If the amount doesn’t match the invoice, an exception needs to be created. That generally means closing out the old invoice and generating a new one for the balance due.
Organizational problems could mean inefficient management or poor record keeping. Those paper filing systems we mentioned above can be a real problem if people don’t put files back in their proper place. Inefficiencies on the part of managers and directors trickle down into the employee ranks, making their jobs more difficult to do properly.
How automation can transform cash application
There are a lot of moving parts in the cash application process. It’s not like years ago when a paper check was matched to a paper invoice and a form letter was sent out for remittance. Today’s business world is more complicated, particularly for ecommerce businesses. Automating invoicing and payment processing is the best way to eliminate mistakes.
Automation isn’t limited to tracking and recording incoming payments. Ramp offers invoice matching software to automate your expenses as well.
SAP cash application is a fully automated way to handle cash application using cloud micro-services to organize the order-to-cash process for accounts receivable. SAP cash application utilizes machine learning. Contact a Ramp team member to learn more.
The four elements of cash application are the payment, the remittance advice, the invoice match, and the resolution or finalizing of the transaction.
Ramp can help with cash application by automating your invoicing and connecting you via API to accounting and ecommerce platforms. There are several ways to configure this.