Even a well-run accounting department cannot be expected to apply incoming cash to outstanding receivables in less than one day, using traditional methods. The time required to manually match checks against open receivables, with the attendant problems of incorrect application and deduction management, is simply too great to allow for any notable improvements in process time. A good way out of this trap is to avoid it entirely by automating the bulk of all cash applications. When fully implemented, an automatic cash application system (sometimes known as AutoCash) can apply more than 90% of all cash receipts. This also results in lower days sales outstanding and provides a clear audit trail that may be useful for a Sarbanes-Oxley controls review.
The usual beginning point for an automated cash application is the lockbox. The lockbox operator records the magnetic ink character recognition (MICR) number and total payment amount from each received check, rather than the full remittance detail, and consolidates this information into an electronic feed that is sent directly into the company’s accounting system. When performed manually, the lockbox data entry cost per check is usually in the range of 15 to 30 cents.
The company’s computer system uses the customer’s bank account number (which is located within the MICR number) to match the check payment to the correct customer. The system then uses cash application rules to determine which invoices are being paid. Examples of these rules are:
- Only apply the check to an invoice if the check exactly matches the amount of a single invoice. This is the most simplistic rule, and will result in the majority of all checks being kicked out for manual application.
- Apply the check to multiple invoices that exactly match the check amount. To avoid excessive computer processing time to calculate all possible invoice combinations, this algorithm is usually restricted to just those invoices coming due for payment within the next few days, or which are already overdue.
- In addition to either of the first two options, also match against the total shown on the most recent account statement sent to each customer.
- In addition to any of the first three options, include an allowance for such deductions as freight or advertising allowances, which can be set by amount or percentage of invoice by individual customer.
Automatic cash application does not work with certain customers who continually take outsized deductions or refuse to pay freight charges or sales taxes. In these cases, it is best to flag the customers’ payments for immediate manual application. By doing so, the cash misapplication rate can be greatly reduced, though the overall cash application rate will also decline.
The AutoCash system must also determine if there is a possibility of a duplicate match, where the payment could match any one of several invoices or invoice combinations. Duplicate matches are usually kicked out for manual application.
The overall cash application rate will gradually improve over time, as the user matches more MICR codes to customers, determines how to handle different types of deductions, and incorporates the payment patterns of customers into its system.
AutoCash applications are available on several ERP systems, including SAP and Oracle, and can also be found as an on-line application through 9ci, Inc.