What is Cash Application and How AI is Revolutionizing Cash Application Management?

What is Cash Application and How AI is Revolutionizing Cash Application Management?

Managing cash flow efficiently is the lifeblood of any business, especially for companies dealing with high volumes of transactions. Cash application has emerged as one of the most critical functions for businesses, as it directly impacts both cash flow and customer relationships. But what is cash application process, and how is AI transforming this fundamental process to enhance speed, accuracy, and efficiency?

Why Cash Application is Crucial for Companies

Cash application, while often overshadowed by other financial processes, is an essential part of accounts receivable (AR) management. It entails matching incoming customer payments to open invoices, and keeping accounts current and precise. When cash application management is done efficiently, it ensures that businesses maintain healthy cash flow, avoid disruptions, and provide superior customer service. Conversely, poor cash application management can lead to customer dissatisfaction, increased operational costs, and strained cash flow.

In mature as well as fast-growing markets, medium to large-scale businesses operate with complex payment systems, and the stakes are even higher. Delayed or inaccurate cash application management can result in collection inefficiencies, with businesses wasting time chasing already settled invoices. Moreover, mismanagement of the cash application process can tarnish a company’s reputation, as frustrated customers deal with errors like duplicated collection efforts or unapplied payments.

What is Cash Application Process?

Cash application is the process of matching incoming customer payments with the respective invoices. In a typical B2B setup, customers pay their bills or invoices via various payment methods, including checks, ACH (Automated Clearing House) transfers, and online payments. Each payment must be reconciled with the correct invoice to ensure the customer’s account is updated accurately.

The cash application process can be broken down into key steps:

1. Data Collection: Data is pulled from multiple sources like ERPs (Enterprise Resource Planning), billing systems, bank statements, and customer payment advices. Payments may also arrive through various channels such as check payments, wire transfers, and online transactions.
2. Matching Payments to Invoices: Payments are matched to open invoices based on the remittance advice from customers. This requires close attention to discrepancies like deductions, credit notes, and partial payments.
3. Reconciliation: Once matched, payments are reconciled against the company’s bank statements to ensure accuracy.

4. Handling Discrepancies: Issues such as short payments, overpayments, deductions, and disputed amounts must be resolved to maintain accurate records.

Common Challenges in Manual Cash Application

“Manual cash application processes are time-consuming and prone to human error. This process can be broken down into two main categories: Payment Reconciliation and Cash Posting.“

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Payment Reconciliation

The most time-consuming part of the cash application process is payment reconciliation. This involves matching invoice amounts with remittance information and bank statements. For cash application specialists, visibility into accounts receivable and expected payments is crucial. This information is typically available in the accounts ERP. Keeping track of these payments ensures they are received in a timely manner and properly allocated to the appropriate accounts.

At the ground level, one major challenge with payment reconciliation is dealing with different file formats for customer remittance information, which can come in the form of Excel sheets, PDFs, Word files, or emails.  

Depending on the payment mode and channel, these formats will vary. For instance, lockbox formats differ from ACH payment reports, and online payment information differs from wire transfers. Additionally, if the payments involve multiple currencies, FX conversion rates can further complicate the process. While bank formats are generally standard, the data still needs to be retrieved for payment reconciliation from either PDFs or Excel sheets.

During the payment reconciliation process, it’s key to segregate mismatched transactions from matched transactions by taking inputs from ERP data, customer remittance information, and bank statements. 

Common types of mismatches are due to following:

1. Deductions: Deductions occur when customers reduce the payment amount due to various reasons like returns, discounts, or allowances. Reconciling these requires matching the deduction details with the corresponding invoice and ensuring the justification for the deduction is valid.

2. Short Payments: Short payments happen when customers pay less than the invoiced amount. These discrepancies need to be investigated to understand the cause—whether it’s an error, a dispute, or an approved discount.

3. FX Differences: When dealing with international transactions, FX (foreign exchange) differences arise due to fluctuations in currency exchange rates. Accurate reconciliation involves converting payments to the base currency and accounting for any exchange rate discrepancies.

4. Tax Holds: Tax holds can occur if there’s an issue with the tax calculations on an invoice. These need to be reviewed to ensure compliance with tax regulations and to adjust the accounts accordingly.

5. Refunds & Chargebacks: Refunds and chargebacks require meticulous tracking. Refunds are payments returned to the customer, while chargebacks are transactions disputed by the customer and reversed by the bank. Proper documentation and validation are essential for reconciling these entries.

6. Payment Processing Charges: When using payment gateways or ACH processing services, fees are often deducted from the payment amount before it reaches the company’s account. Reconciling these charges involves matching the net payment with the gross amount and the associated fees.

Once these mismatches are identified and addressed, the transaction-level payment reconciliation provides a clear picture, enabling accurate cash posting entries into the ERP system. This clarity ensures that all payments are correctly allocated, improving cash flow management and financial reporting accuracy.

What is Cash Posting :

Cash posting is a critical step in the cash application process where payments are recorded in the ERP system to reflect accurate account balances. 

What are Cash Posting Challenges

Some of the main challenges businesses face include:

Unapplied Payments: Payments that remain unapplied for days or weeks after receipt cause significant delays. These unapplied payments can create redundancy in collection efforts, as the finance team might continue to contact customers for payments that have already been made but not yet matched and applied.

Misapplied Payments: Incorrectly posting payments to the wrong account or invoice can lead to extensive rework. This mistake requires manual corrections, consumes valuable time, and frustrates customers, potentially leading to disputes and delayed future payments.

Payment Without Remittance Advice: When customers do not provide clear instructions on how their payments should be applied, businesses may struggle to identify the correct account or invoice. This often results in unapplied or misapplied payments, further complicating the reconciliation process.

Multiple Payment Channels: Companies dealing with various payment gateways (e.g., Stripe, PayPal, and Dwolla) or handling both online and traditional check payments face the challenge of reconciling payments in different formats. The diverse formats increase the risk of mismatched data and complicate the reconciliation process.

These challenges create inefficiencies, directly affecting cash flow and customer satisfaction. Research shows that companies with poor cash application processes can experience a 20-30% delay in receiving payments due to manual errors and system inefficiencies. Streamlining and automating the cash posting process can significantly improve the accuracy and speed of payment reconciliation, leading to better financial management and enhanced customer relationships.

The Role of AI in Cash Application Process

Enter AI: artificial intelligence is now revolutionizing cash application process by automating much of the manual work and improving accuracy. Let’s understand how AI powered cash application process will create an impact on your cash flow management:

1. Automated Matching: AI powered cash application process can process vast amounts of payment data from multiple sources and automatically match payments to open invoices, eliminating the need for human intervention. This drastically reduces the time it takes to apply cash and ensures accuracy.
2. Error Reduction: AI powered cash application automation software reduces the risk of human error, particularly with misapplied or unapplied payments. By leveraging machine learning, AI systems can learn from past applications and improve their matching algorithms over time.
3. Handling Payment Discrepancies: AI powered cash application process can flag discrepancies such as short payments, overpayments, or missing remittance advices, and automatically suggest resolutions. For instance, if a payment doesn’t match the invoice amount, the system can identify potential deductions or adjustments based on past transactions.

4. Faster Reconciliation: AI powered cash application automation software accelerates the reconciliation process by matching payments with bank statements in real-time, minimizing delays and ensuring accurate financial records.

5. Handling Complex Payment Structures: AI powered cash application process systems can manage various payment types (check payments, ACH, online payments) and integrate with multiple payment gateways (like PayPal, Stripe, and Aydan), providing a seamless cash application process regardless of the payment method used.

Benefits of AI-Powered Cash Application Process

The introduction of AI into cash application automation software offers numerous benefits:

• Speed: What once took days or even weeks can now be accomplished in minutes. AI significantly reduces processing times by automating the matching and reconciliation process.
• Accuracy: AI systems are highly accurate, meaning fewer errors, less rework, and improved cash flow.
• Scalability: AI can easily scale to accommodate growing transaction volumes, making it ideal for large businesses with high payment frequencies.
• Cost Reduction: By automating processes, AI reduces the need for large accounts receivable teams, saving on labor costs.

Should Cash Application Be Outsourced?

While outsourcing cash application to third-party providers is an option, businesses must weigh the pros and cons. Outsourcing can reduce the need for in-house expertise and can be a more affordable option in the short term. However, it may introduce delays and limit control over sensitive financial processes.

On the other hand, AI-driven cash application solutions can offer a middle ground by automating processes while keeping them in-house. This provides greater control and ensures that the company maintains direct oversight of payment processing, while still reaping the benefits of automation.

Conclusion

The adoption of AI powered cash application automation software is transforming how businesses handle one of their most critical functions. By eliminating manual errors, speeding up payment processing, and ensuring accurate application of payments, AI offers a robust solution that allows businesses to streamline their operations and improve cash flow. As AI continues to evolve, it is poised to become an indispensable tool for finance departments looking to stay competitive in the fast-paced world of business.

Investing in AI powered cash application automation software can lead to improved customer relationships, faster cash cycles, and enhanced operational efficiency, positioning companies for long-term success in an increasingly digital economy.