Revenue cycle: sales to cash collections - Chapter 12

  Chapter 

The revenue cycle is a recurring set of business activities and related information processing operations associated with providing goods and services to customers and collecting cash in payment for those sales. Information about revenue cycle activities also flows to other accounting cycles. The general ledger and reporting functions uses information produced by the revenue cycle to prepare financial statements and financial reports.

The revenue cycle’s primary objective is to provide the right product in the right place at the right time for the right price. To accomplish this objective, the management must make a few decisions. There are four basic revenue cycle activities:

  1. Sales order entry

  2. Shipping

  3. Billing

  4. Cash collections

This chapter explains how an organization’s information system supports each of those activities. See page 353 figure 12.3 for the level 0 data flow diagram from the revenue cycle.

Most large organizations use an enterprise resource planning (ERP) system. The process starts when an organization receives customer orders via the internet from various retail websites. The sales department enters customer orders received over the phone, by fax, or email. The system quickly verifies customer creditworthiness, checks inventory availability, and notifies the warehouse and shipping departments about approved sale. This is only a small part of the entire sales process.

  • The first general threat is inaccurate or invalid master data. Errors in customer master data could result in shipping merchandise to the wrong location, delays in collecting payments or making sales to customers that exceed their credit limits. One way to mitigate this threat is to use the various processing integrity to minimize the risk of data input errors. It is also important to restrict access to that data and configure the system so that only authorized employees can make changes to master data.

  • The second general threat is unauthorized disclosure of sensitive information. One way to mitigate the risk is to configure the system to employ strong access controls that limit who can view such information. It is also important to configure the system to limit employees’ ability to use the system’s built-in query capabilities to access only those specific tables and field relevant to performing their assigned duties.

  • The third general threat is concerns the loss or destruction of master data. The best way to mitigate this risk is to employ the backup and disaster recovery procedures. A best practice is to implement the ERP system as three separate instances.

The revenue cycle begins with the receipt of orders from customers. The sales departments typically performs the sales order entry process. There are three steps in this process: taking customer’s orders, checking and approving customer credit and checking inventory availability.

Today, most organizations use sales order documents. This is usually an electronic form displayed on a computer monitor screen. The sales order contains information about item numbers, quantities, prices, and other terms of the sale.

Customers can use electronic data interchange (EDI) to submit the order electronically in a format compatible with the company’s sales order processing system. This improve efficiency and cut costs.

Websites also provide opportunities to increase sales. It is possible to use history information to create marketing messages tailored to the individual customer. Another useful technique involves the use of interactive sales order entry systems that allow customers to customize products to meet their exact needs.

  • A basic threat during sales order entry is that important data about the order will be either missing or inaccurate. This not only creates inefficiencies, but also may have an negative affect customer perceptions and affect future sales.

  • The second threat is concerns the legitimacy of orders. If a company ships merchandise to a customer and the customer later denies having placed the order, there is a potential loss of assets.

  • Another revenue cycle threat is the possibility of making sales that later turn out to be uncollectible. Requiring proper authorization for each credit sale diminishes this threat. A credit limit is the maximum allowable account balance that management wishes to

allow for a customer based on that customer’s past credit history and ability to pay.

Careful monitoring of accounts receivable is very important, because some customers will and up not paying off their accounts. A useful report for doing this is an account receivable aging report, which lists customer account balances by length of time outstanding. The information provided by such reports is useful for projecting the timing of future cash inflows related to sales, deciding whether to increase the limit for specific customers, and for estimating bad debts.

In addition to checking a customer’s credit, salespeople also need to determine whether sufficient inventory is available to fill the order, so that customers can be informed of the expected delivery date. If there is not sufficient inventory on hand to fill the order, a back order for those items must be created.

Once the inventory availability has been determined, the system then generates a picking ticket that lists the items and quantities of each item that the customer ordered. The picking ticket authorizes the inventory control function to release merchandise to the shipping department. Picking tickets today are often electronic forms that may be displayed on portable handheld devices or on monitors built into forklifts.

Accurate inventory records are important to prevent both stock outs and excess inventory. Stock outs may result in lost sales if customers are not willing to wait and instead purchase from another source. Excess inventory increases carrying cost and may even require significant markdowns that reduce profitability.

Customer service is so important that many companies use special software packages, called customer relationship management (CRM) systems, to support this vital process. Customer relationship management systems help organize detailed information about customers to facilitate more efficient and more personalized service. CRM systems also help generate additional sales.

The second basic activity in the revenue cycle is filling customer orders and shipping desired merchandise. The first step in filling a customer order involves removing the correct items from inventory and packaging them for delivery.

The picking ticket generated by the sales order entry process triggers the pick and pack process. Warehouse workers use the picking ticket to identify which products, and the quantity of each product, to remove from inventory. When the quantity was recorded, the inventory transferred to the shipping department.

One potential problem is the risk of picking the wrong items or in the wrong quantity. The automated warehousing technologies can minimize the chance of such errors. Another threat involves the theft of inventory. theft losses can be extremely large, and the perpetrators can be either outsiders or employees. Theft also makes inventory records inaccurate, which can lead to problems in filling customers’ orders.

The inventory master file also produces a packing slip and multiple copies of the bill of lading. The packing slip lists the quantity and description of each item included in the shipment. The bill of lading is a legal contract that defines responsibility for the goods in transit. It identifies the carrier, source, destination, and any special shipping instructions.

A copy of the bill of lading and the packing slip accompany the shipment. If the customer is to pay the shipping charges, this copy of the bill of lading may serve as a freight bill, to indicate the amount the customer should pay to the carrier.

The third basic activity in the revenue cycle involves billing customers. It is about invoicing and updating accounts receivable.

Accurate and timely billing for shipped merchandise is crucial. The invoicing activity is just an information processing activity that repackages and summarizes information from the sales order entry and shipping activities.

The basic document created in the billing process is the sales invoice. This invoice notifies customers of the amount to be paid and where to send the payment. A well designed accounting system can entirely eliminate the need to create and store invoices, at least with customers that have sophisticated systems of their own.

One threat associated with the invoicing process is a failure to bill customers, which results in the loss of assets and erroneous data about sales, inventory and accounts receivable. segregating the shipping and billing functions is an important control to reduce the risk that this occurs intentionally.

Another potential threat is a billing error. Overbilling can result in customer dissatisfaction, and under billing results in the loss of assets. Pricing mistakes can be avoided by having the system retrieve appropriate data from the pricing master file and by restricting the ability of employees to make changes to that data.

The accounts receivable function performs two tasks. It uses the information on the sales invoice to debit customer accounts and subsequently credit those accounts when payments are received.

The two basic ways to maintain accounts receivable are the open-invoice and the balance forward methods. The two methods differ in terms of when customers remit payments, how those payments are applied to update the accounts receivable master file.

Under the open invoice method, customers typically pay according each invoice. Two copies of the invoice are mailed to the customers, who is requested to return one copy with the payment. This copy is a turnaround document called a remittance advice. Customer payments are then applied against specific invoices.

Under the balance forward method, customers typically pay according the amount shown on a monthly statement, rather than by individual invoices. The monthly statement lists all transactions that occurred during the past month and informs customers of their current account balances.

One advantage of the open invoice method is that it is conductive to offering discounts for prompt payment, as invoices are individually tracked and aged. A disadvantage of the open invoice method is the added complexity required to maintain information about the status of each individual invoice for each customer. The open invoice method is typically used by business whose customers are primarily other businesses, because the number of individual transactions is relatively small and the dollar value of those transactions is high.

Many companies that use the balance forward method use a process called cycle billing to prepare and mail monthly statements to their customers. Under cycle billing, monthly statements are prepared for subsets of customers at different times. Cycle billing produces a more uniform flow of cash collections throughout the month and reduces the time that the computer system is dedicated to printing monthly statements.

To credit a customer’s account for returned goods, the credit managet must obtain information from the receiving dock that the goods were actually returned and placed back in inventory. Upon notification from the receiving department that the goods have been returned, the credit manager issues a credit memo. This memo authorizes the crediting of the customer’s account.

Errors in maintaining customer accounts can lead to the loss of future sales and also may indicate possible theft of cash. The data entry edit checks can minimize the risk of errors in maintaining customer accounts.

Another threat is that an employee may issue credit memos to write-off account balances for friends or to cover up theft of cash or inventory. Proper segregation of cuties can reduce the risk of this threat. To prevent employees making sales to friends are then written off.

The final step in the revenue cycle is collecting and processing payments from customers.

Because cash and customer checks can be stolen so easily, it is important to take appropriate measures to reduce the risk of theft. This means that the accounts receivable function should not have physical access to cash or checks.

One method to identify the source of any remittances involves mailing the customer two copies of the invoice and requesting that one be returned with the payment. This remittance advice is then routed to accounts receivable, and the actual customer payment is sent to the cashier.

Another option is to have mailrooms personnel prepare a remittance list, which is a document identifying the names and the amounts of all customer remittances, and send it to accounts receivable.

An alternative option is to photocopy all customer remittances and send the copies to accounts receivable while forwarding the actual remittances to the cashier for deposit.

Another way to speed up the processing of customer payments involves the use of a lockbox arrangement with a bank. A lockbox is a postal address to which customer send their remittances. The participating bank picks up the checks from the post office box and deposits them in the company’s account. Establishing lockbox agreements with foreign banks reduces the time it takes to collect the payments from sales to international customers.

Information technology can provide additional efficiencies in the use of lockboxes. In an electronic lockbox arrangement, the bank electronically sends the company information about the customer account number and the amount remitted as soon as it receives and scans those checks.

With electronic funds transfer (EFT) customers send their remittances electronically to the company’s bank and thus eliminate the delay associated with the time the payment is in the mail system. EFT also reduces the time lag before the bank makes the deposited funds available to the company.

Financial electronic data interchange (FEDI) solves problems by integrating the exchange of funds (EFT) with the exchange of remittance data (EDI). The customer send both remittance data and funds transfer instructions together. The seller receives both pieces of information simultaneously. FEDI completes the automation of both the billing and the cash collection process.

Companies can also speed the collection process by accepting credit cards or procurement cards. The benefit is that the card issuer usually transfers the funds within two days of the sale.

The primary objective of the cash collections function is to safeguard customer remittances. Segregation of duties is the most effective control procedure for reducing the risk of theft. There are three pair of duties that should be segregated.

The first one is handling cash or checks and posting remittances to customer accounts. A person performing both of these duties could commit the special type of embezzlement called lapping.

The other one is handling cash or checks and authorizing credit memos. A person performing both of these duties could conceal theft of cash by creating a credit memo equal to the amount stolen.

The last one is handling cash or checks and reconciling the bank statements. An important detective control is reconciliation of the bank account statement with the balance of cash recorded in the company’s information system.

The best control procedures to reduce the risk of unanticipated cash shortfalls is to use a cash flow budget, which provides estimates of cash inflows and outflows. A cash flow budget can alert an organization to a pending short term cash, thereby enabling it to plan ahead to secure short-term loans at the best possible rates.

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