Your Work Isn't Finished Even Though the Customer Has Paid
Efficient Remittance Processing is a Critical Back Office Function
Remittance processing is a true “back office” process. If everything goes according to plan, nobody notices. However, any departure from the routine can lead to posting delays in addition to impacting future revenue and cash flow, alienating customers, and increasing administrative costs. Who would’ve thought?
Remittance Processing (also know as Cash Application or Cash Posting) is the process of recording customer payments and applying them to the corresponding open invoices (not yet paid) in the accounts receivable ledger. It needs to be performed quickly (same day or next morning after receipt of customer payment) and accurately (as the customer directs in their “remittance advice”).
The result of timely and accurate Remittance Processing is an accurate Accounts Receivable (AR) Ledger, which provides the current status of every customer’s balance owed to you. Cash posting errors, in contrast, result in an inaccurate AR Ledger, which can have the following negative effects on your company:
A delay in fulfilling customer orders which in turn can delay revenue and cash flow. This problem evolves from orders incorrectly held because of invoices that appear not to have been paid. In reality, those invoices have been paid, but appear to still be open and possibly past due because the customers’ payments have not been applied to the open invoices.
Alienation of customers whose orders are unjustly held up because their payment has not yet been applied. To add insult to injury, the situation is exacerbated by collection calls from the supplier, albeit innocently made in an attempt to get the order released from the credit hold queue.
Having to pay somebody overtime to clear a backlog of not yet posted remittances or to correct misapplied payments.
Higher delivery costs caused by overnight shipments to customers whose orders were inadvertently delayed due to a remittance processing lag. These costs cannot be charged to the customer.
Additional costs (overtime pay) in Customer Service, Logistics and Sales to expedite orders inadvertently delayed.
Wasted Collection effort – contacting customers to pay invoices they’ve already paid.
Who would have thought slow and/or inaccurate Cash Posting could have such a large negative impact on your company? Prompt and accurate Cash Application is an absolute requirement for running a successful, profitable business.
Please feel free to share this newsletter with your small business customers . . . it just might help them pay you sooner!
A Cautionary Tale
An apparel company with annual sales of $200 million had approximately 5,000 small and medium size customers. In an effort to reduce the amount of past due receivables, the Controller required that all customer payments be applied to the oldest open invoices, disregarding the customers’ instructions (remittance advice).
Customers subsequently received collection calls on invoices they had previously paid. The apparel company’s AR Ledger showed those invoices to be unpaid because they disregarded the customers’ remittance advice. This problem affected most of their customers. As it compounded, a substantial number of customers declared that they were not going to make any more payments until the ones they made were applied properly. This caused a big drop in cash flow.
To solve the problem prior payment applications had to be reversed, then re-applied as the customer intended. The company had to hire, train, and retain a team of 15 people for eight months to accomplish this task, a considerable expense compounded be the reduction in cash flow. Clearly, an illustration of “what not to do.
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Keys to a Clean AR Ledger
It goes without saying that invoices need to be accurately posted to the AR. Here are two more steps that ensure an accurate AR:
Apply Customer Payments Accurately: Customer payments must be applied to the open invoices specified by the customer – no exceptions. It is their right to specify which invoices they are paying. It’s their money. If they do not specify which invoices they are paying, or their instructions are unclear, you must secure that information from them. This avoids “Misapplied” cash, which causes many of the problems listed above. We once worked with a Fortune 50 client whose penalty for any staff member disregarding client remittance instructions was dismissal.
Apply Customer Payments Promptly: Promptly is defined as same day or next morning. This minimizes the chance of incorrectly holding a customer order because of it exceeding acceptable past due parameters or its specified credit limit, and prevents all the customer relationship and cost damage caused by delays applying customer payment to the AR ledger.
Your Virtual Credit Manager is available to answer your remittance processing questions and help you find the best solution for your circumstances.
What’s the Best Remittance Processing Solution for Your Situation?
At low payment volumes, payments can be posted manually in your AR system. As payment volumes grow, and the application of payments becomes a full-time clerical job, automated remittance processing solutions should be explored.
Cash Application involves reading the customer’s remittance advice, then applying cash received to open invoices. When invoices are paid in full, the payment is easily matched to the open invoice(s), the invoice status is then changed from “open” to “paid,” and ultimately is no longer visible on the customer’s account in your AR Ledger. Transaction completed and closed.
However, if the payment is less than the invoice amount, the amount of the payment should be matched to the appropriate invoice(s), and the residual amount (also known as a short payment, deduction, or chargeback), posted to the AR Ledger as an open obligation owed.
If you have sufficient check volume, your bank’s lockbox service can help by providing a detailed remittance file. This will come in a BAI2 file format, which stands for the second iteration of the Bank Administration Institute file standard.
How detailed the file will be is dependent on the amount of information your company needs to drive your automated process. At a minimum, the bank lockbox will generate a daily file of all payments received on your behalf, and if you are willing to pay for the data entry of the remittance details (also known as the payment advice), you also get the specific invoices being paid and for how much for each customer. You can use this file to manually or automatically apply the customer payments to your open invoices.
Most ERP or accounting software systems have auto-cash capabilities. “Bolt-on” software applications are also available to facilitate automated remittance processing. Using machine learning (ML) and artificial intelligence (AI), the most advanced solutions will electronically read the customer check and accompanying remittance advice, thereby eliminating the need and cost of data entry by your lockbox bank.
The advantages of auto-cash solutions are:
Speed — most cash can be applied the same day it is received
Productivity — match rates using modern technology regularly achieve over 90 percent match rates (remittances correctly applied to the AR with an automated solution), but even a 50-60 percent match rate, which is today considered to be low, saves much of the manual effort
Labor Savings — the application applies the cash, not your employee, and even at low match rates, labor savings are substantial due to the productivity gained
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The Bottom Line…
The remittance processing solution you deploy should directly correlate to the complexity of your payment posting environment and your labor costs. Complexity increases with the variety of payment types (check, ACH, credit card, EDI, wires, etc.), multiple invoices being paid at the same time, line item as opposed to invoice level deductions, and remittance advice delivered by a different channel than the actual funds. For example, when multiple invoices are being paid, the ACH transmittal format often cannot handle all the remittance details, requiring them to be sent separately. In this case, typically by company email, which is wholly separate from the payment sent to your bank. This is why volume and complexity largely determine the time and effort that is required to post payments.
In addition, mail tends to catch up on the weekend and be delivered on Mondays, requiring much more work on Monday afternoons and/or Tuesday mornings than during the rest of the week. So in addition to complexity and volume issues, you also need to consider your internal workflows. With a limited staff, remittance processing can get in the way of credit approval and as previously mentioned, failure to apply cash in a timely manner can interfere with collection activities. Bottom line . . . automated remittance processing solutions can eliminate a lot of workload management headaches.