The Order-to-Cash Process, Step by Step

What is the order-to-cash process?

The order-to-cash process, often shortened to O2C, is everything your company does between agreeing terms with a customer and having their money in the bank, with the month closed on it. It runs in six steps: the terms are agreed, the order is fulfilled, the invoice is sent, the revenue is recorded, the cash is collected and the month is closed. If you close the books, your job is to make each step agree with the one before it, so that every fee the customer agreed to is billed, every credit is explained and each sale sits in the month it was earned. Most of what goes wrong happens at the hand-offs, where one person’s record becomes the next person’s starting point.

What are the steps of the order-to-cash cycle?

The six steps follow the money in order, and each one leaves a record the next one relies on. The terms become the price on the invoice, the delivery record becomes the date of the revenue, and the invoice becomes the balance the customer owes until the cash arrives.

Each step below says what it needs, what goes wrong in it and what to check before the next step begins. Some companies add a separate credit check or an order entry step at the start; the six here are the ones every company has, whether it sells parts, software or advice.

Who owns each step of order-to-cash?

In most mid-sized companies sales owns the terms, operations owns the delivery, billing or accounts receivable owns the invoice and the cash, and the accountant owns the revenue and the close. In a small team two or three people may do all six, which is where errors slip through, because nobody checks their own work as hard as someone else’s.

The COSO Internal Control Integrated Framework’s executive summary describes control activities as the authorizations, approvals, verifications and reconciliations that make sure instructions are carried out, and it says segregation of duties is usually built into them. Where a team is too small to split duties, it says management chooses other control activities instead. In order-to-cash those alternatives are usually a second person approving credit notes and discounts, and a review of every invoice against its agreement rather than a sample.

Step 1: what do the agreed terms need to say?

The agreed terms need to say what you will deliver, at what price, how and when you will bill for it and how long the customer has to pay. They may sit in a signed contract, an order form, a statement of work, an engagement letter or a price list the customer accepted. Whatever the form, this document is the one every later step is checked against, so it needs to be on file and easy to find before anything is billed.

The FASB’s revenue standard, ASC 606, sets out when a contract with a customer counts for revenue: both parties have approved it and are committed to it, you can identify each party’s rights and the payment terms, it has commercial substance, and it is probable that you will collect what you are owed. Approval can be in writing, spoken or implied by your normal business practice, but an accountant closing the month will want something written to point to.

What goes wrong at this step is usually missing paper rather than bad terms. A salesperson agrees a discount on a call, a renewal goes out at a new rate without a signed order, or the customer’s copy of the agreement differs from yours. The check before billing is simple: for every customer you invoice, is there one document, with its amendments, that sets each price you will charge?

Step 2: what has to happen when the order is fulfilled?

When the order is fulfilled, someone has to record what was delivered and when, because that record sets both the quantity on the invoice and the month the revenue belongs to. For goods it is the delivery note or proof of shipment; for services it is the timesheet, the milestone sign-off or the service dates in the agreement.

Changes made during delivery matter just as much. ASC 606 defines a contract modification as a change in scope or price, or both, approved by the parties, and notes that some businesses call it a change order, a variation or an amendment. If a customer asks for extra work partway through and agrees to pay for it, that change needs to be written down and approved, or it will never reach the invoice.

The check at this hand-off is that every delivery has a record with a date, and every change of scope or price has an approved amendment with its start date. A delivery with no record is a sale you cannot prove; a change with no amendment is either a fee you forget to bill or a dispute waiting to happen.

Step 3: what makes an invoice correct?

An invoice is correct when every line matches the agreed terms as they stood on the date the work was supplied, and the totals add up. That means checking each part of the invoice against the document that sets it, not against last month’s invoice, which may have been wrong too.

• Price: each unit price matches the agreement for that item on that date, after any amendment from its start date and any price notice you sent that the agreement allows.
• Quantity: the number billed matches what the customer ordered or what you delivered, whichever your agreement goes by.
• Fees: every extra fee is one the agreement allows, and every fee the agreement lets you charge is actually billed.
• Deposits and earlier invoices: a final invoice takes off the deposit and the progress invoices the agreement calls for.
• Arithmetic: each line, subtotal, credit and total works out again from the price and the quantity.
• Completeness: every period the agreement lets you bill for has an invoice, including periods after a renewal.

Under-billing is the error that hides best, because no customer complains about it. A price below the agreed rate, a fee left off or a month never invoiced is money you are owed and will not collect unless your own team finds it. Record it as its own figure, never netted against lines billed too high, so you can see what was missed.

Step 4: when does an invoice become revenue?

An invoice becomes revenue when you deliver what it pays for, not when you send it. ASC 606 builds this into five steps: identify the contract, identify the separate promises in it, set the transaction price, share that price across the promises, and recognize revenue when, or as, each promise is met. For a deeper walk through those steps and the mistakes auditors find, see revenue recognition under ASC 606.

Billing and earning often fall in different months, and the standard has a name for each gap. If you bill before you deliver, the customer has paid or owes you for something you have not yet done, and ASC 606 calls that a contract liability, which most teams call deferred revenue. If you deliver before you have the right to bill, you hold a contract asset. A receivable is different again: the standard defines it as a right to payment that is unconditional, meaning only the passage of time stands between you and the cash.

The check at month end is cut-off: is each invoice dated in the month the goods or services were delivered, and is anything billed but not yet delivered shown as owed to the customer? That one schedule, invoice by invoice, answers most of what an auditor asks about revenue. For why an annual invoice, recurring value and revenue are three different numbers, see ARR is not revenue.

Step 5: how is cash collected and applied?

Cash is collected when the customer pays within the terms on the invoice, and applied when your team matches each payment to the invoices it settles. Applying cash correctly matters as much as receiving it, because a payment matched to the wrong invoice leaves one customer looking overdue and another looking paid, and a payment left unapplied makes your receivables look larger than they are.

A short payment is the moment to look closely. When a customer pays less than the invoice, the remittance usually gives a reason: a discount someone promised, a disputed line, a return. Each reason needs a document behind it before the gap is closed. If the discount was approved, issue a credit note that ties to the approval; if it was not, the balance is still owed and should be chased.

Overdue invoices follow the terms in the agreement, not a general rule. An invoice due in 30 days and unpaid on day 41 is 11 days overdue, and the person chasing it needs the amount, the days and the agreement that set the terms, so the conversation with the customer starts from facts.

How should credit notes and disputes be handled?

Every credit note should tie to a reason you can show, such as a return, a dispute, a rebate or a term in the agreement, and someone other than the person who issues it should approve it. A credit note reduces what the customer owes, so it reduces revenue too, and ASC 606 treats discounts, rebates, refunds, credits and price concessions as variable consideration that changes the transaction price.

Credit notes and discounts are also where receivables fraud tends to hide, because a credit note can quietly cover cash that was taken, and a discount can be a favor to a customer nobody approved. The patterns, and how to spot them in your own billing, are in where receivables fraud hides.

Disputes need a clock. Many agreements give the customer a set number of days to dispute an invoice, and knowing that window tells you when an unresolved query becomes a balance the customer has accepted. Keep the dispute, the reply and any credit note with the invoice, so the next reviewer can see how it ended.

Step 6: what happens to receivables at month end?

At month end the receivables ledger, the list of what each customer owes, is reconciled to the accounts receivable balance in the general ledger, and every difference is explained. Then the aging report, which sorts each open invoice by how long it has been unpaid, shows which balances need chasing and which may not be collected at all.

Not every receivable will be paid, and the balance sheet has to show the amount you expect to collect. The FASB’s credit losses standard, ASU 2016-13 (ASC 326), covers trade receivables and requires them to be shown net of an allowance for expected credit losses. It bases the estimate on past experience, current conditions and reasonable forecasts, rather than waiting for a loss to happen.

Your auditor will test the same balance from the outside. The PCAOB’s standard on confirmation, AS 2310, says the auditor should perform confirmation procedures for accounts receivable from sales to customers, or otherwise get the evidence directly from a knowledgeable outside source. A customer who confirms a different balance from yours is a question you would rather answer at month end than during fieldwork.

Why do auditors look so closely at order-to-cash?

Because order-to-cash produces revenue, and revenue is where auditors are told to expect trouble. The PCAOB’s risk standard, AS 2110, tells the auditor to presume a fraud risk involving improper revenue recognition and to work out which kinds of revenue give rise to it. A private company’s auditor follows the AICPA’s standards, and the AICPA’s announcement of SAS No. 151, its new fraud standard, says the presumption is left unchanged.

In practice the auditor will pick invoices and trace them back to the agreement and the delivery record, check that revenue near the year end sits in the right period, confirm balances with customers and look hard at credit notes issued after the year end. The record that answers all of that is the one this process produces when every hand-off is checked: each invoice, the terms behind it, the delivery that earned it and the cash that settled it.

Worked example: one engagement at Larch & Plover, from terms to cash

Larch & Plover Advisory is an invented company, one of the Demo companies Ressura uses to show its checks, and every figure below is made up for the example. It is a Denver management consultancy, and Owen Kettleby, its Director of Finance, closes the month. This is one client engagement traced through all six steps, with the check made at each hand-off.

Terms. Larch & Plover signs an engagement letter with Summit County Lodging Partners for a financing readiness project. The letter sets a fixed fee of $24,000, invoiced in four equal monthly installments of $6,000 as the work is delivered, each payable within 30 days. The check: one signed letter is on file, setting the fee, the billing pattern and the payment terms.

A change during delivery. In the second month the client asks for a cash-flow model for its lender, and both sides sign an amendment adding $3,500, to be billed with the final installment. The check: the amendment is on file with its start date, so the extra fee has a document behind it.

Invoices. The first three invoices each bill $6,000. The final invoice is drafted at $6,000 too, because it was copied from the third, and the $3,500 from the amendment is left off. Checked against the letter and the amendment before it is sent, the gap shows up as a fee the agreement lets Larch & Plover charge that was not billed. Owen corrects it, and the final invoice goes out at $9,500, which brings the total billed to $27,500.

Revenue. In the third month the client pauses the work for two weeks while it gathers data. By the end of that month Owen measures the work delivered against the scope at $15,000 of the $24,000 fee, while three installments, $18,000, have been billed. The difference, $3,000, has been billed but not yet earned, so it is shown as owed to the customer, a contract liability, and it moves into revenue in the fourth month when the work is done.

Cash. Summit County pays the second invoice short, $5,400 instead of $6,000, and its remittance mentions a discount agreed with Nadia Ferreira, the managing partner. The letter has no discount clause and no approval is recorded, so the $600 gap is flagged rather than written off. Nadia confirms she offered it for the delayed start, Owen records her approval and issues a credit note for $600 that ties to it, and the invoice is settled. The third invoice is paid 41 days after its date, 11 days past the terms, and it shows as overdue with the amount and the days until the money arrives.

Close. When the project ends, the record reads $27,500 billed, a $600 credit note, $26,900 collected and nothing still owed. Revenue for the engagement is $26,900, because the approved discount lowered the transaction price, and none of it is still deferred. The line Owen takes to the managing partner is short: one engagement, every invoice checked against its terms, one fee caught before it went out, one discount approved on the record, and the balance settled.

Without the checks, two things in this example would have gone unnoticed. The $3,500 would have gone uncollected, and nobody at Summit County would have pointed it out. The $600 would have been written off with no approval behind it, which is exactly the kind of credit an auditor asks about.

Which order-to-cash measures should you track?

Track days sales outstanding, the aging of your receivables and the money found at each check, because together they show whether cash is arriving on time and whether what you bill is right. Days sales outstanding is your receivables at the end of a period divided by the revenue for that period, multiplied by the days in it; a rising figure means customers are paying more slowly or invoices are going out late.

The aging report shows where that slowdown sits, by customer and by how far past due each invoice is. A measure most teams lack is the under-billing found: fees left off, prices below the agreement and periods never invoiced, added up in dollars. It is the one number that shows whether the invoices themselves were right, and not just whether they were paid.

How does Ressura check the order-to-cash process?

Ressura’s Order-to-Cash Module checks every invoice you send against what the customer agreed to pay. It checks each price against the agreement on the invoice date, applies amendments from their start dates and price notices only to orders placed after them, and confirms that every fee you charge is one the agreement allows and that every fee it lets you charge is billed. It also checks quantities against orders or deliveries and adds every invoice up again.

At month end it sets what each invoice billed against what was earned, shows anything billed but not yet delivered as owed to the customer, checks invoice dates against delivery and service dates, and raises a period the agreement lets you bill for with no invoice. It ties each credit note to a return, a dispute or an agreement term, asks for a clause or a recorded approval behind any price below the agreed one, and shows each invoice past its terms with the days overdue.

You start by adding the agreement and the invoices you sent, with any amendments, delivery notes and credit notes; there is nothing to connect. Once you have your first Finding you can connect QuickBooks Online or Xero, and every invoice is then checked as you send it. Any gap is shown in dollars with the agreement beside it, and if everything matches, the result says so and lists what was checked, which is the record you hand to your boss or your auditor.

Sources

1. COSO Internal Control Integrated Framework’s executive summary
2. ASC 606
3. ASU 2016-13 (ASC 326)
4. standard on confirmation, AS 2310
5. AS 2110
6. AICPA’s announcement of SAS No. 151