How do I cancel an order when the customer never paid?

Open the order from Orders → Manage Orders. In the status dropdown at the top, choose Cancelled. A reason list appears next to it. Pick Payment declined and click Update Status.

The reason is saved on the order and in its timeline, so your cancellation reports show it as a payment problem, not a customer change of mind.

Cancelling also gives back anything the customer used on that order: wallet balance, reward points, and the coupon's usage.