To cancel an order, it must be both unpaid and unfulfilled. You can't change the payment status from paid to unpaid, but you may change the fulfillment status this way:
Then, find the More actions dropdown in the top-right and click Cancel order:
Finally, confirm order cancelation.
NOTES:
If you track inventory, products are restocked automatically
Order cancelation can't be undone, i.e., you won't be able to return the order to its previous state
You won't be able to create an invoice for a canceled order, but if the invoice has been created earlier (before canceling the order), you can still view, download, print, or send it to your client