Order to cash is a term that describes the process that a product or service goes through, from the point at which it is purchased or ordered by the customer to the end point, when payment is received.
While the order of and payment for an item or service might seem like a simple one-two process, in the business world, many steps comprise order to cash. Each step is a process, which has a significant impact on the business and its finances, and therefore must be managed effectively.
Order to cash can be a complex process that encompasses many individual steps or processes. They usually follow a particular order:
Order management begins as soon as the customer selects an item or service for purchase through the sales department. Once the purchase has been made, a cycle begins which triggers the fulfillment of that order. How order management is conducted will depend on the type of product or service that is purchased, the size and nature of the business, and how it delivers its product. How effectively orders are managed will impact all of the subsequent steps in the order to cash process.
Credit Management: once an order is placed, the second step in the cycle involves credit management. The business’s credit department will evaluate the customer’s credit worthiness or credit risk. This is an involved process that operates according to established principals and policies about extending credit to customers. The business will have rules in place that govern how and to whom credit is extended, how much, how much interest to charge on the credit, and the pay back terms.
Order Fulfillment: this involves tracking and maintaining inventory and an efficient means for communicating between sales and inventory departments. If an item is not in stock, an order must be canceled. Ideally, the sales department will have this information in real-time, to avoid executing sales that can’t be fulfilled or that will need to be canceled later.
Shipping: once the inventory managers are notified of the transaction, the next step in the process is order shipping. This involves logistics which must be proficient and efficient, so that customers get their orders delivered on time. Accuracy in the shipping phase depends heavily on up-to-date and accurate data about the product and the receiving party, as well as efficient communications of that information to the shipping department.
Invoicing: after a product or service has been provided or delivered, the business will invoice the customer for payment. Customer invoicing also relies on accurate and timely information that matches the order and provides the customer with all the important details of the transaction.
Accounts Receivable Management: businesses manage all purchases that are made on credit as accounts receivable. This is an accounting term that refers to sales for which payment has not yet been made. Typically, payment is received in two months or less. How a business manages its accounts receivable reflects its credit policies and collection practices. The process comprises several functions and tasks. They include the extension of credit, customer relations, invoicing, monitoring, and analysis of payment trends, collections, and reconciling of payments received.
Payment Collections:payments that have not been paid on time will go to collections. The business will have policies and practices in place for the accounts receivable team to follow through with customers who have fallen behind. A business will want to exercise flexibility without being too lenient. Having too many customers who are behind on payments is not good for the business.
Cash Application: once payment is received, the business will perform cash application. This is the process by which accountants in the accounts receivable department match incoming payments to outstanding invoices and to the proper account where they can be entered. Cash application is an essential process for businesses to track cash flow and capital so that funds can be utilized efficiently, accurately, and quickly.
Reporting and Data Management: when all other phases in the cycle are complete, the business will perform reporting and data management. This is a point where automation and the effective use of software applications can be extremely helpful. The business will want to generate and analyze data pertaining to each and every preceding phase of the process to make informed evaluations about performance. For example, Days Sales Outstanding (DSO) and Accounts Receivable Turnover Ratio are important metrics that reflect on the business’s ability to process and convert sales to cash in a timely manner.
Order to cash is an important way to understand how the business operates because it is a reflection of how proficiently a business can process orders and produce cash, or revenue. It is a composite of many different processes, all of which contribute significantly to the overall performance of the business. Credit policies, inventory management, logistics, invoicing, and collections play an important role in the business’s ability to follow through on sales and collect payment. A business that cannot fulfill these functions and generate revenue in a timely manner is not sustainable.
The challenges facing order to cash are the same challenges that confront the individual processes that make up the overall cycle. Internal and external communications, logistics, gathering and processing accurate data, maintaining workable credit policies, and managing different software platforms all contribute to a challenging cycle. Automation and digital solutions have made the process more proficient.
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