Cash application: matching payments to invoices
Matching Northwind's receipts to its invoices: a short pay, a lump sum with no remittance, and a card payment that arrives net of the processor's fee.
Money arriving isn't the end of an invoice. Cash application is matching each receipt to the invoices it pays, and it's where receivables go wrong. The remittance advice, the payer's note of what the payment covers, is the first thing to read. Northwind's fourth quarter threw up the four cases that cover most of it.
A short pay: Alder deducts two damaged units
On October 14 Alder paid $7,800 against the $8,000 left on INV-1001, with a remittance note: less $200 for two damaged units. That's a short pay, and it needs a disposition. Northwind checked, agreed, and issued a credit note for $200, which closed the invoice. Had it disagreed, the $200 would stay open and disputed. The credit goes to 4100 Sales returns and allowances, a contra-revenue account Northwind adds to its chart.
Alder's payment, applied to INV-1001.
| Account | Debit | Credit |
|---|---|---|
| 1000Cash | 7,800.00 | |
| 1200Accounts receivable (INV-1001) | 7,800.00 | |
| Balanced | 7,800.00 | 7,800.00 |
CN-1: the agreed deduction for two damaged units.
| Account | Debit | Credit |
|---|---|---|
| 4100Sales returns and allowances | 200.00 | |
| 1200Accounts receivable (INV-1001) | 200.00 | |
| Balanced | 200.00 | 200.00 |
A lump sum with no remittance
On November 30 Ridgeway Supply sent $5,000 and nothing else. Until it's matched, it's unapplied cash: it reduces what Ridgeway owes, it is never revenue, and it isn't yet attached to an invoice. The subset finder tries every combination of Ridgeway's open invoices and finds one that adds up exactly: INV-1006 and INV-1007. Northwind applied it the next morning and confirmed it with Ridgeway.
Step 1: Who paid?
Name the payer. A payment only settles that customer's invoices.
Step 2: Read the remittance
Apply exactly what it lists. With none, propose matches and confirm them.
Step 3: Dispose of any difference
A short pay is a dispute, a credit note or a write-off, with a reason and an approver.
Step 4: Park the rest
Leave anything unmatched as unapplied cash. Never post it to revenue.
Step 5: Gross up fees
A processor's fee is an expense, a bank's wire fee is a bank charge. Neither is a short pay.
In this lesson: the third case, a card payment that reaches the bank net of the processor's fee, has its own page below. It's the case most startups get wrong, and the one Form 1099-K is reconciled against.
Pages in this lesson
1 page goes deeper, about 6 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 606-10-32-6 (opens in a new tab)Discounts, credits and price concessions are variable considerationFree after registration
The full map is in US GAAP, and where these rules come from.
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- ApplicationAssigning received cash to specific invoicesConvention
- Unapplied cashCustomer cash received but not yet assigned to an invoice. It reduces that customer's AR; only a net credit balance is reclassified to a liability at period end
- Remittance adviceThe payer's note of which invoices a payment covers and of any deduction taken — the first thing cash application readsConvention
- Short payA customer payment for less than the invoices it settles, the customer having deducted the difference — a dispute, a credit not yet recorded, or an amount to write off. It needs a reason and a disposition; it never just disappearsConvention
- Credit noteA reduction of what a customer owes
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Order to cash (AR)The receivables stack from quote to revenue: quote → order → fulfillment → invoice → collection → cash application → revenue.
- Cash & treasuryCash is the only balance sheet account where an independent third party, the bank, says what the balance should be. That makes it the easiest account to verify and the one where a break hurts most.
- Which invoices make this deposit?Find which open items add up to a deposit, to the cent.
- Two-list matcherMatch bank against ledger and list what's left unmatched on each side.
- Journal entry for a customer short paymentDebit Cash for what arrived and credit Accounts receivable for the same amount. If the deduction is agreed, issue a credit note: debit Sales returns and allowances, credit Accounts receivable. If it is not, leave the difference open on the invoice, marked disputed.
- Journal entry for unapplied customer cashDebit Cash and credit Accounts receivable for the customer, unapplied, on the day the money arrives. When the invoices it pays are identified, apply it to them; the entry is already made, so only the subledger changes. Never credit revenue.
- Journal entry for a customer refundTo refund a paid invoice, issue a credit note (debit Sales returns and allowances, credit Accounts receivable), then pay the refund (debit Accounts receivable, credit Cash).
- Card and ACH payments: applying and reconciling themHow customer card and ACH payments land in the bank net of fees, how to apply them to invoices, handle partial payments and reconcile the deposit.
- CashApplicationThe highest-value screen in AR. Every case is a first-class path.
- PaymentSuggestionInvoice combinations summing exactly to a lump sum.
- UnappliedCashPanelNever revenue; net credit balances flagged as liabilities.
- CreditNoteFormDistinct from a refund and from a write-off.