What Is Unapplied Credit and How to Resolve It?

Introduction

Accurate accounting is essential for efficient financial management and requires meticulous tracking of every transaction and credit. However, unapplied credit in accounting can disrupt a business’s entire cash flow. These credits are payments received but not yet allocated to specific invoices or accounts.

In this article, we’ll explore what unapplied credit is, its impact on financial operations, and discuss practical strategies for managing unapplied credit balances to enhance financial management.

What Is Unapplied Credit? 

Unapplied credit is a credit not yet assigned to a specific invoice or account balance. It is the amount of money that a company receives from the customer but has not yet been applied to a specific invoice, account, or transaction. In other words, it’s a credit sitting idle in your financial records.

For instance, suppose a customer has made an advance payment or overpaid their invoice, and the company has not yet allocated this payment to any specific outstanding invoice or account balance. This excess amount is considered “unapplied credit.”

Unapplied credit, while often seen as a minor bookkeeping detail, plays a pivotal role in a company’s financial management and flexibility. This flexibility can be especially useful for managing cash flow, as businesses can use these credits to offset sudden expenses or unexpected financial shortfalls.

When Do Unapplied Credits Occur?

Unapplied credits on a company’s balance sheet can arise from various situations, impacting accounting and creating cash flow problems. Here’s a closer look at some common causes for unapplied credits:

1. Customer overpayments

This is one of the common scenarios where your customers might end up paying you more than the amount invoiced. This extra money doesn’t automatically get applied to any particular invoice. Instead, it remains as an unapplied credit until it’s matched with a future invoice or used for another purpose. This situation can often happen if the customer isn’t aware of the exact invoice amount or if they simply choose to overpay.

2. Prepayments and deposits

Another case where you might encounter unapplied cash is when clients make payments before receiving an invoice. These prepayments are recorded as unapplied credits. For example, suppose a company requires a deposit before beginning a project. When the client sends this deposit, it’s logged as an unapplied credit. It remains in this status until the invoice for the completed work is issued.

3. Adjustments and refunds

Refunds or adjustments processed for returned goods or services without an existing invoice to apply them against result in unapplied credits. These credits are essentially waiting to be linked to an invoice or future charge. This scenario often occurs when dealing with customer returns or correcting billing mistakes. An example of this is a case where a customer returns a product, and you issue a refund. If this refund isn’t linked to an open invoice or a specific billing record, it is recorded as an unapplied credit.

4. Incomplete payment information

Sometimes, unapplied credits occur because the customer has not provided sufficient details with their payment. The missing info can be an invoice number, account reference, etc. As a result, the payment might not be easily linked to the corresponding invoice. It becomes difficult for businesses to identify and match the amount-specific invoice, and thus, the credit remains unapplied. This situation often arises with generic payments or when the payment details are incomplete.

5. Recording errors

Occasionally, accounting errors can lead to unapplied credits. For example, if a payment is recorded incorrectly or applied to the wrong invoice, the resulting credit remains unapplied until the error is corrected. Such mistakes can happen during manual data entry or when transferring data between systems. However, efficient accounting methods can eliminate these kinds of scenarios. 

What Is the Difference Between Applied Payments and Unapplied Credits?

Applied payments are amounts that have been directly assigned to specific invoices. Once a payment is applied, the outstanding balance of the invoice is reduced, making it clear which invoices have been settled. This ensures accurate tracking of paid amounts and helps maintain up-to-date financial records. Applied payments are crucial for reflecting a customer’s payment history and for managing accounts receivable efficiently.

As we know, unapplied credit is a payment that is not reconciled properly; it can lead to inaccuracies in your accounts receivable. These credits can also affect your financial statements and cash flow management. Here are some reasons why regularly reviewing and applying them is essential for businesses:

To improve cash flow management

With unapplied credits, gaining a clear picture of organizational cash flow becomes difficult. If these credits aren’t resolved properly, understanding and forecasting your business cash flow can become challenging. As a result, it can potentially impact your financial planning and decision-making. 

To maintain accurate financial statements

Inaccuracy in financial statements is the last thing any company wants. Unapplied credits can lead to discrepancies in reported revenue and account balances, compromising the integrity of your financial reports.

To optimize operational efficiency

Unapplied credits often create a lot of confusion and disrupt the entire cash application process. They delay reconciliation and consume significant time and effort from finance professionals, slowing down operations and increasing the risk of errors.

To enhance customer experience

Unapplied credits can lead to billing errors and confusion, impacting the customer experience. When these credits are not promptly addressed, customers might receive incorrect statements or encounter delays in resolving their accounts.

How to Resolve Unapplied Credit?

Here are the steps to manage unapplied credits:

1. Review the unapplied credit: Start by reviewing your accounting system for unapplied credits. Gather all the relevant details and information possible related to these unapplied credits. Ensure that you have complete and accurate information about the payment. 
2. Match with invoices: Next, try to match the unapplied credit balance with an existing invoice. If the credit cannot be matched to any invoices, investigate why it remains unapplied. This may involve reviewing payment details, checking for errors, or contacting the customer for additional information.
3. Communicate with customers: In case of overpayments or prepayments, inform your customers about how the credits will be handled. This transparency builds trust and prevents confusion.
4. Document and Adjust Accounts: Finally, document all actions taken to resolve the unapplied credit. Update your accounting records to reflect any adjustments or reapplications of the credit. Ensure that your financial system accurately reflects these changes, maintaining clear and precise records.

Tips to Prevent Unapplied Credit

Maintaining a proactive approach to avoid unapplied credit is better than resolving the unapplied credit. Here are some of the tips that can help businesses do the same:

• Clearly communicate with customers about proper payment terms, and procedures, and how to reference invoices.
• Request detailed payment information from customers, including invoice numbers or references with each payment.
• Regularly review and reconcile payments and accounts to identify and address discrepancies early.
• Use cash application software to automate the matching of payments to corresponding invoices.

Streamline Your Financial Operations with HighRadius Solutions

HighRadius provides a powerful, cloud-based Order to Cash software designed to automate and streamline your financial operations. Our comprehensive suite includes Collections Management, Cash Application, Deductions Management, Electronic Invoicing, Credit Cloud, and dotOne Analytics, enhancing the efficiency of your team and optimizing workflows.

Global leaders like P&G, Ferrero, Johnson & Johnson, and Danone trust HighRadius to automate cash posting, reduce invalid deductions, and eliminate bank key-in fees. Our solutions help businesses achieve tangible results:

Collections Management: Our AI-powered collections software helps prioritize worklists for your top 20% of customers and automates collections for 80% of long-tail customers. Experience a 20% reduction in past-due accounts and a 30% increase in collector productivity.

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Credit Management: Gain real-time credit visibility and manage global portfolios with our AI-based credit solution. See a 20% reduction in bad debt and a 90% improvement in credit application approval time.

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HighRadius seamlessly integrates with leading ERPs like SAP and Oracle, ensuring a smooth and comprehensive O2C process. This integration allows businesses to leverage existing systems and data, significantly enhancing overall efficiency and accuracy.

FAQs

1. What is an unapplied payment?

An unapplied payment is the amount of money received from a customer that hasn’t been assigned to a specific invoice or account. It’s essentially a payment that is waiting to be linked to an outstanding balance or invoice in your financial records, requiring further action to resolve.

2. What is an applied credit?

An applied credit is a credit or payment that has been assigned to a specific invoice or account. It directly reduces the outstanding balance on that invoice, helping to clear or lower the amount due and accurately reflect the payment status. As a result, overall financial clarity is improved.