An Accountant's Guide to Order to Cash
This post is the first of a series of blog posts regarding cash reconciliation for accountants. Below are all topics included in this series:
- An Accountant's Guide to Order to Cash
- Introduction to Cash Reconciliation
- 4 Reasons Why Accounting Teams Need Cash Reconciliations
- How to Perform a Cash Reconciliation - A Step-By-Step Guide for Accountants
- How to Perform a Cash Reconciliation: A Real-World Example
- 5 Most Common Problems When Performing a Cash Reconciliation
Overview of Order to Cash
Like most Americans, Spotify is my go-to when it comes to listening to music. I recently decided to subscribe to the paid plan on the Spotify streaming platform. During checkout, I was required to input my payment and billing information. Once the checkout was completed on my end, the order was submitted to Spotify. At that point, the ‘Order to Cash’ process for Spotify begins.*
What is Order To Cash?
At a high level, Order to Cash (AKA OTC or O2C) describes the procedure for processing customer orders, applying payments to invoices, and matching payments to the cash received in a company’s bank account. The principles behind OTC are essentially the same across all businesses and industries. However, the mechanics and ordering of OTC procedures do vary slightly for subscription and Software-as-a-Service (SaaS) business models.
In this discussion, we will walk through a typical SaaS OTC procedure and review the related journal entries at each step.
Let’s take a closer look at each OTC step for a SaaS business:
Step 1: Customer submits order
The OTC process begins when a company receives an order. For many SaaS companies with high transaction volume, orders are made directly on the company’s website and immediately processed by a billing or order management system.
Example: On Jan 1, Customer browses Widget Company’s online store and decides to purchase a one-year subscription for access to Widget’s photo editing software for $500 (SaaS).
Step 2: Company invoices Customer
Step 3: Customer pays invoice
The order in which Steps 2 and 3 occur in the OTC process varies by company and operating model.
For high-volume SaaS companies where orders are placed directly through the company’s website, customers are typically required to submit payment digitally before the order can be successfully processed (e.g. A subscription purchase for Spotify). Once payment information is provided, the customer can complete checkout, submit the order for fulfillment, and receive an invoice for the purchase. Invoices should include order details as well as any discounts or taxes, where applicable.
Note: In traditional non-SaaS or enterprise business models, order fulfillment and delivery may occur prior to invoicing.
Example (cont.): The annual fee of $500 for the one-year subscription is collected upfront by Widget Company. At checkout, Customer submits payment via credit card and submits the order. Next, Customer receives an invoice copy via email.
General Ledger Impact:
|Jan 1||Accounts Receivable*||$500|
We will debit Accounts Receivable on the Balance Sheet instead of Cash, as credit card transactions may take up to 3 days to successfully process.
Step 4: Company fulfills order
Step 5: Company delivers order
After receiving payment and invoicing the Customer, the Company must fulfill and deliver the order. For most SaaS companies, fulfillment and delivery occur simultaneously, simply by provisioning access to the software.
Example (cont.): On Jan 1, Widget Company received the completed order and provisions software access to Customer. The customer now has access to Widget’s photo editing software for one year.
General Ledger Impact:
|No impact to the General Ledger.|
Step 6: Cash payment is recorded in General Ledger
The final step of the OTC process is to record the cash payment in the General Ledger and relieve the Accounts Receivable balance that was initially created upon invoicing in Step 2.
Example (cont.): On Jan 3, the credit card payment is successfully processed, and Widget Company receives cash in the bank. The Accounts Receivable balance can now be relieved against the cash received.
Note: Having a cash reconciliation process in place will allow companies to match sales to cash received. This can provide Accounting teams additional assurance that revenue and deferred revenue are properly recorded in the General Ledger.
General Ledger Impact:
Optimizing the Order to Cash process should be a priority for every company. Streamlining OTC procedures improves margins and enables businesses with high order volume to scale efficiently. At each step, automation is key to creating an effective OTC process. With that accomplished, opportunities abound to automate closely-related processes such as Revenue Recognition and Cash Reconciliations.
Read next: Introduction to Cash Reconciliation