What is Order to Cash (O2C) Process: Meaning, Steps, Flow Chart, Benefits, Examples

Every Finance leader, irrespective of industries, scales or the size of their order books, understands the importance of cash in the balance sheet. Even with ready availability of business credits, cash is one of the key metrics that determines a business’s health. And a company’s capability to generate cash flow depends on its order-to-cash process flow. But this is also one of the complex business processes to master. 

This article discusses everything about what is order to cash process and related concepts you must know for better efficiency and manageability. Stay with us. 

What is the Order to Cash (O2C) Process?

The Order to Cash process is a chain of individual operational processes, beginning with a customer placing an order and ending with the business receiving the payment. This chain of processes includes order management, checking customers’ creditworthiness, invoicing, inventory management, delivery shipping, and payment collection. Monitoring and ensuring efficiency throughout this process is essential for any business that allows credit to its customers.  

A lapse in any part of the O2C process can impact a business in multiple ways, starting from losing competitive edge in the market, increase in debt burden to inability to deliver orders in time. 

Importance of the O2C Process

The O2C process is important from a management perspective in any B2B and B2C business, extending credit to its customers.  

• It helps to track the steps of cash flow generation. The Order-to-cash process tracks the transition of ordered goods and services into cash flow for a company. It offers the much-needed visibility and metrics for improving cash flow. 
• An efficient O2C process improves customer satisfaction - Efficiency in O2C process leads to improved order fulfilment, reduces errors in order handling, minimises chances of disputes and enhances customer experience.  
• This process can explain the reasons for deterioration in a company’s financial wellbeing. Cash flow is a major indicator of the financial health of a company. The O2C process helps identify reasons behind any disruption to cash flow. 
• O2C process can help minimise the impact of any business disruption by channelising it across the process. For example, an unwarranted disruption in shipment and delivery can cause a customer delaying payments beyond the approved credit period. This can have cascading effects on receivable and collection management processes. In such cases, a company can accommodate a lenient collection process to deliver better customer experience and improve overall customer satisfaction. 

Benefits of the Order to Cash Process

• Achieving better sales and profitability—Efficiency in the order-to-cash process improves cash flow, helping companies offer better credit terms to customers. This can boost sales and profitability. 
• Improved customer satisfaction—A well-managed O2C process can help overcome factors causing delays in order fulfilment. This helps deliver a better customer experience and improve customer relations. 
• Cost efficiency across the cash flow generation process - The visibility across the steps in an O2C process can help identify cost-saving opportunities. A company can extend this cost-saving to customers and increase sales. This can also improve profitability.  
• Better control over supply chain management—Monitoring the Order-to-Cash flow cycle offers better internal control over supply chain management for e-commerce companies. 

Steps in the Order to Cash Process

Individual business operations that come under the O2C process flow are: 

• Order management- It is the first step of the Order to Cash process cycle that begins with a customer placing an order. Order placements can happen in several ways, including e-commerce sites, through offline stores or official order notification through an email.   
• Credit management- Most of the B2B sales happen on credits. High value B2C sales may also require extending options of purchase on credit. So, once a customer places an order, it becomes necessary to decide on allowing purchase on credit, duration of credits and its terms and conditions per the company policy. Managing credit involves evaluating customers’ creditworthiness, cost of credits, and company’s cash flow health. 
• Customer order fulfilment—This process also begins with customers placing orders. To fulfil an order, a business may need to manage several other sub-processes, like sourcing the ordered goods, receiving, storage, order processing, and shipping. 
• Invoice management- A customer placed an order for purchasing on credit and the fulfilment process has begun. It is now time to issue an invoice to the customer for the sale, mentioning order details. An invoice also includes tax-related information. Any flaw in an invoice may complicate recovery of payments despite timely delivery.   
• Account receivable management- Account receivable are legal rights of a business to receive payments for goods supplied on credit. Depending on the payment terms and approved credit terms, this process involves monitoring dues from customers, initiating payments collection for over dues and minimising collection time and bad debt. 
• Collection management - At this step, a business expects the customer to make the payment. Problems may arise when receivable overdue for a credit purchase reaches a predefined threshold. It has direct implications on credit management and account receivable management and cash flow in the business. 
• Data reporting and management - An efficient and flawless O2C process is possible only when all thesteps are interconnected and information flows seamlessly across those steps. It requires reporting of data gathered within each step and management of the entire process based on data insights. 

Order to Cash Process Internal Controls

One of the key benefits of the Order to Cash process is the internal control it offers for improving cash flow, delivering better customer experience and achieving better cost efficiency. Some of these internal controls are:

• Managing credit limits - It involves following standard procedure for credit approval, setting credit limits, establishing criteria of creditworthiness and related terms and conditions for each customer. Based on payment performance and business volume, these limits can be adjusted.  
• Pricing strategy - For urgent needs of cash flow, companies can offer special discounts on cash purchases and try to attract customers who will purchase at lower credits. Similarly, a company can quote higher prices to customers looking for longer credit periods.  
• Shipping procedure - Faster shipping requires higher costs. Companies planning to improve the order to cash process can adopt different shipping procedures depending on customer expectations, payment history and cash flow health. 
• Appropriate invoicing - An invoice should reflect every information relevant order fulfilment, receivable management and payment collection. The quality of invoice and its enforceability can directly impact control over dues and bad debts. 

Order to Cash Process Journal Entries

From accepting an order for credit sales to receiving the cash payment requires multiple journal entries for bookkeeping.   

Suggestive journal entries in a complete O2C process cycle will be: 

Step 1 - A customer submits an order.  

• No journal entry created at this stage because submission of order inherently does not generate an asset or liability 

Step 2 - Invoice raised for credit sales.   

• Debit a customer account or create a debtor account. It represents the amount of dues from the said customer.  
• Credit the payment receivable account. If it was a cash sale, the accountant needed to debit the cash account and credit the sales account.  

Step 3 - Order is shipped.  

• Debit cost of goods sold account. It is an expense account and a debit entry increases the expense.  
• Credit inventory. Ordered goods are shipped from inventory. A credit entry decreases the total amount of inventory maintained.    

Step 4 - Customer makes the payment as per the credit terms 

• Debit bank account or cash account. A cash/bank account represents the asset in the book.  
• Credit customer account. Earlier, we debited customer accounts and created account receivables. We credit that account after receiving the payment.  

Order to Cash Process KPIs

It is important to keep track of the KPIs or Key Performance Indicators on Order to Cash for effective management and to ensure continuous improvement. 

Some of the popular Order-to-Cash process KPIs:

1. O2C process revenue contribution - The major source of earning for a company should be the revenue from selling its goods and services. This KPI measures how much O2C process contributes to the business revenue. The higher the value, the better is the business prospect. 
2. Average delinquency days (ADD) - It measures the performance of your receivable, condition of your overdues and the implication on the size of bad debt in your balance sheet. 
3. Collection effectiveness index (CEI) - The formula is {(collection / pending collection)*100}. It shows a company’s ability to collect payment from customers with over dues. The higher the index value, the better the health of the collection process. 
4. Days of sales outstanding (DSO) - The formula is {(total accounts receivable for a period/total credit sales for the period)*number} of days in the period}. It indicates the time a company takes to recover payments for credit sales. The lower the DSO, the better the efficiency in collecting receivables.    

Order to Cash Process Best Practices

A sub-optimally managed O2C process can deprive a business of its true revenue and profitability potential. So, it is important to implement the best practices in your order-to-cash process, regardless of the size of your operations. 

1. Collect data from existing O2C process steps. Many small companies experience a lack of sufficient data reporting from each step of the Order to Cash process. So, any initiative to implement best practices must start with collection and reporting of data.  
2. Analyse the performance and find the loopholes. Once you are confident about data availability, it’s time to measure KPIs. They will help analyse O2C process performance and find issues. For example, if CEI is poor, then you should understand that the problem is within the collection management.   
3. Begin fixing smaller issues in the process. Introducing a change to an existing process can always be challenging. So, begin implementing necessary changes with smaller issues and gradually move to issues requiring significant restructuring.  
4. Integrate and automate the O2C process - Efficiency and efficacy of an order-to-cash process depend on interconnectedness between its individual steps. And the best way to integrate these steps is automation. Business process automation technologies can accommodate operation of any scale. 

Order to Cash Process Examples

Assume a company XYZ Ltd sells laptops. Another company ABC Associates places an order for 10 laptops of specific configuration. 

1. XYZ Ltd confirms receiving the order to ABC Associates. 
2. XYZ checks past transactions with ABC. If the customer is new, then the selling company checks its creditworthiness through standard procedures. If ABC is an existing customer, the selling company checks the previous payment history and accordingly offers a quotation for 10 laptops to ABC with credit terms. This is part of order management and credit management. 
3. ABC accepts the quotation and places the final order. 
4. The seller begins the accounts receivable management. 
5. XYZ also begins the order fulfilment process, which includes inventory management and shipping.   
6. ABC confirms receiving the supplied goods. 
7. The purchaser makes payment. 
8. The seller confirms receiving the payment, and the O2C process for the particular transaction ends.   

Key Risks in the Order to Cash Process

• Wrong data entries into the enterprise management system can be a significant risk for companies following manually entering business data.  
• Unanticipated cost inflation during the O2C process that cannot be collected from the customer. 
• Breach of invoice terms and conditions because of unanticipated shipping delays or other issues. 
• Invisible and unreported gaps in the process because of manual interventions. An example could be manually overriding the standard credit management or collection management procedure.   
• Information security risk because of a breach of enterprise data can cause legal repercussions and disruptions to cash collection for supplied goods and services.
• Unanticipated legal issues related to goods supplied can also make an O2C process vulnerable.