What is cash application?
Matching incoming customer payments to the right open invoices. The sale is already on the books; this step only clears the receivable.
Definition
Cash application is the work of matching a customer payment to the open invoices it is meant to clear. In the books, cash goes up and accounts receivable goes down by the same amount.
The sale was already earned when you billed. This step only records that the customer paid, and it tells you which bills are no longer open.
Where it shows up
Balance Sheet: Located in the current assets section, as cash up and the receivable down.
Cash flow: Related to the collection hitting operating cash.
P&L: Related to nothing extra; the sale was already earned.
See also: Remittance Advice · Accounts Receivable · Invoice
When you look at the Balance Sheet, the payment sits in the current assets section as more cash and less receivable. The totals can stay the same size while the mix changes.
The Income Statement does not record the payment as new revenue. That revenue was booked when the invoice was issued.
Operating cash on the Statement of Cash Flows rises when the collection is applied. That is the cash event, not the original sale.
An aging report should drop the invoices you just cleared. If a payment sits unmatched, those invoices still look open and days sales outstanding stays high.
How it works
A payment arrives as a check, a card deposit, an ACH, or a lockbox batch. Someone has to decide which open invoices that money belongs to.
A remittance advice from the customer is the usual guide. It lists invoice numbers and amounts, and you apply the cash to those lines.
If there is no note, you match by amount, date, and customer. A $400 check against two $200 invoices is a clean match when those two are the only open bills.
The journal is simple. Debit cash, or debit a holding account if the money is not at the bank yet, and credit accounts receivable.
You stay on the match itself. Phone calls about a missing payment are a later step, and this page is only the posting that clears the bills.
A short pay needs a decision. You can leave a remainder open, or you can post a separate adjustment for a discount or a dispute.
A payment you cannot match yet is unapplied. Cash is in, but the invoices still show as unpaid until you finish the match.
If you apply the cash to the wrong invoices, one customer looks paid when they are not. The aging then lies, and the next statement you send will be wrong.
Example
A florist has two open bread invoices for a cafe, $250 and $150. The cafe sends a $400 check with a note listing both invoice numbers.
The florist applies the $400 to those two bills.
Debit: Cash $400
Credit: Accounts receivable $400
Cash on the Balance Sheet rises $400. Accounts receivable falls $400.
The Income Statement does not change. The two invoices now show as paid.
If the florist had left the check unmatched, cash might still be in a holding account. Both invoices would still look open.
Common mix-ups
Cash application is not the original sale. The sale created the receivable when you invoiced, and this step only clears that receivable when the money arrives.
Cash application is not a holding account for undeposited funds. That account is where a payment can sit before the bank deposit, and application is the match to invoices.
Cash application is not follow-up on unpaid bills. Follow-up is the work of asking for money that has not arrived, and application is the work of assigning money that has arrived.
Cash application is not a bank reconciliation. The reconciliation proves book cash against the bank statement, and application decides which customer invoices the incoming cash belongs to.
Related terms
- Remittance Advice: The note from a customer explaining which invoices a payment covers.
- Accounts Receivable: Money customers owe the business for goods or services already delivered.
- Invoice: The document that bills a customer and creates a receivable.
- Unapplied Payment: A received payment not yet matched to an invoice.
- Undeposited Funds: A holding account for customer payments received but not yet deposited at the bank.
- Lockbox: A bank service that receives and processes customer payments on your behalf.
- Bank Reconciliation: Matching the book cash balance to the bank statement and explaining every difference.
- Collections: The process of following up on unpaid customer invoices.