The Revenue Cycle: Sales to Cash Collections Chapter 12 The Revenue Cycle: Sales to Cash Collections

INTRODUCTION The revenue cycle is a recurring set of business activities and related information processing operations associated with: Providing goods and services to customers Collecting their cash payments The primary external exchange of information is with customers.

INTRODUCTION Information about revenue cycle activities flows to other accounting cycles, e.g.: The expenditure(acquisition) and production(conversion) cycles Receive information about sales transactions so they’ll know when to initiate the purchase or production of more inventory.

INTRODUCTION Information about revenue cycle activities flows to other accounting cycles, e.g.: The expenditure and production cycles The human resources/payroll cycle Uses information about sales to calculate commissions and bonuses.

INTRODUCTION Information about revenue cycle activities flows to other accounting cycles, e.g.: The expenditure and production cycles The human resources/payroll cycle The general ledger and reporting function Uses information produced by the revenue cycle in preparing financial statements and performance reports.

The Revenue Cycle

Revenue Cycle Activities Sales order entry Shipping Billing Cash collections

Overview of ERP System to Support Revenue Cycle

General Revenue Cycle Threats/Controls Inaccurate or invalid master data Controls Data processing integrity controls Restriction of access to master data Review of all changes to master data

General Revenue Cycle Threats/Controls Unauthorized disclosure of sensitive information Controls Access controls Encryption

General Revenue Cycle Threats/Controls Loss or destruction of master data Controls Backup and disaster recovery procedures Poor performance Managerial reports

Sales Order Entry Take order Check and approve credit Check inventory availability

Sales Order Threats/Controls THREAT NO. 5—Incomplete or inaccurate customer order (Table 12-1) Why is this a problem? It’s inefficient. The customer has to be re-contacted, and the order has to be re-entered. Causes customer dissatisfaction and may impact future sales. Controls Data entry edit controls (see Chapter 10) Restriction of access to master data

Sales Order Threats/Controls THREAT NO. 6—Orders that are not legitimate Why is this a problem? You can’t make good credit decisions or collect from a customer you haven’t properly identified. Traditionally, legitimacy of customer orders is established by receipt of a signed purchase order from the customer. Digital signatures and digital certificates provide similar control for electronic business transactions. Online credit card transactions with retail customers are fraught with issues. Authentication issues Repudiation issues

Sales Order Threats/Controls THREAT NO. 6—Orders that are not legitimate Controls Digital signatures or written signatures For online credit card transactions(card holder not present) See next slide

Sales Order Threats/Controls Some actions companies are taking with online or phone-order retail customers(cardholder not present transactions): Requiring the three-digit code on the back of the credit card for confirmation that the customer physically possesses the card. Billing zip code Checking to see if billing address and shipping address are the same Sending emails to the customer to confirm the transaction. Verified by Visa/ MasterCard secure Addresses authentication and non repudiation issue

Sales Order Threats/Controls THREAT NO. 7—Uncollectible accounts (Sales to customers with poor credit) Why is this a problem? Results in lost assets or revenues. Controls Credit limits Specific authorization to approve sales to new customers or sales that exceed a customer’s credit limit Aging of accounts receivable

Sales Order Threats/Controls THREAT NO. 8—Stockouts, carrying costs, and markdowns Why is this a problem? If you run out of merchandise, you may lose sales. Can’t sell empty shelf space If you carry too much merchandise, you incur excess carrying costs and/or have to mark the inventory down to sell it.

Sales Order Threats/Controls THREAT NO. 8—Stockouts, carrying costs, and markdowns Controls Perpetual inventory control system Use of bar-codes or RFID Training Periodic physical counts of inventory Sales forecasts and activity reports

Sales Order Threats THREAT NO. 9—Loss of Customers Why is this a problem? Rule of thumb: It takes 5 times as much effort to attract a new customer as it does to retain an existing one. Controls CRM systems, self-help Web sites, and proper evaluation of customer service ratings

Shipping Picking and packing the order Shipping the order

Shipping Threats/Controls THREAT NO. 10 & 12—Picking Wrong Items/Quantities, Shipping errors Why is this a problem? Customer dissatisfaction and lost sales may occur if customers are shipped the wrong items or there are delays because of a wrong address. Shipping to the wrong address may also result in loss of the assets.

Shipping Threats/Controls THREAT NO. 10 & 12—Picking Wrong Items/Quantities, Shipping errors Controls Bar-code and RFID technology Reconciliation of picking lists to sales order details Reconciliation of shipping documents with sales orders, picking lists, and packing slips Use RFID systems to identify delays Data entry via bar-code scanners and RFID Data entry edit controls (if shipping data entered on terminals) Configuration of ERP system to prevent duplicate shipments

Shipping Threats THREAT NO. 11—Theft of Inventory Why is this a problem? Loss of assets. Inaccurate inventory records (because thieves don’t generally record the reduction in inventory). Controls Restriction of physical access to inventory Documentation of all inventory transfers RFID and bar-code technology Periodic physical counts of inventory and reconciliation to recorded quantities

Shipping Threats/Controls Additional Threat. —Damage/Lost in transit Why is this a problem? Added costs Customer dissatisfaction and lost sales may occur if goods are damaged

SHIPPING Threats/Controls A major shipping decision is the choice of delivery methods: Some companies maintain a fleet of trucks. Companies increasingly outsource to commercial carriers. Reduces costs. Allows company to focus on core business. Selecting best carrier means collecting and monitoring carrier performance data for: On-time delivery. Condition of merchandise delivered.

Billing Invoicing Updating accounts receivable

BILLING This function performs two basic tasks: Debits customer accounts for the amount the customer is invoiced. Credits customer accounts for the amount of customer payments. Two basic ways to maintain accounts receivable: Open-invoice method Balance forward method

BILLING Open-invoice method: Customers pay according to each invoice. Two copies of the invoice are typically sent to the customer. Customer is asked to return one copy with payment. This copy is a turnaround document called a remittance advice. Advantages of open-invoice method: Conducive to offering early-payment discounts Results in more uniform flow of cash collections Disadvantages of open-invoice method: More complex to maintain

BILLING Balance forward method: Customers pay according to amount on their monthly statement, rather than by invoice. Monthly statement lists transactions since the last statement and lists the current balance. The tear-off portion includes pre-printed information with customer name, account number, and balance Customers are asked to return the stub, which serves as the remittance advice. Remittances are applied against the total balance rather than against a specific invoice.

BILLING Advantages of balance-forward method: It’s more efficient and reduces costs because you don’t bill for each individual sale. It’s more convenient for the customer to make one monthly remittance.

BILLING Cycle billing is commonly used with the balance-forward method. Monthly statements are prepared for subsets of customers at different times. EXAMPLE: Bill customers according to the following schedule: 1st week of month—Last names beginning with A-F 2nd week of month—Last names beginning with G-M 3rd week of month—Last names beginning with N-S 4th week of month—Last names beginning with T-Z

Advantages of cycle billing: Produces more even cash flow. Produces more even workload. Doesn’t tie up computer for several days to print statements.

Billing Threats/Controls Failure to bill Billing errors Customer account errors Posting errors in accounts receivable Inaccurate or invalid credit memos

Billing Threats/Controls THREAT NO. 13—Failure to bill customers Why is this a problem? Loss of assets and revenues. Inaccurate data on sales, inventory, and accounts receivable. Controls Separation of billing and shipping functions Periodic reconciliation of invoices with sales orders, picking tickets, and shipping documents

Billing Threats/Controls THREAT NO. 14—Billing errors Why is this a problem? Loss of assets if you under-bill. Customer dissatisfaction if you over-bill. Controls Configuration of system to automatically enter pricing data Restriction of access to pricing master data Data entry edit controls Reconciliation of shipping documents (picking tickets, bills of lading, and packing list) to sales orders

Billing Threats/Controls THREAT NO. 15 &16—Errors in maintaining customer accounts/Inaccurate or invalid credit memos Why is this a problem? Leads to customer dissatisfaction and loss of future sales. May indicate theft of cash.

Billing Threats/Controls THREAT NO. 15 &16—Errors in maintaining customer accounts/Inaccurate or invalid credit memos Controls Data entry controls Reconciliation of batch totals Mailing of monthly statements to customers Reconciliation of subsidiary accounts to general ledger Segregation of duties of credit memo authorization from both sales order entry and customer account maintenance Configuration of system to block credit memos unless there is either corresponding documentation of return of damaged goods or specific authorization by management

CASH COLLECTIONS The final activity in the revenue cycle is collecting cash from customers. Because cash and checks are highly vulnerable, controls should be in place to discourage theft.

CASH COLLECTIONS Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable. The mailroom opens customer envelopes and forwards to accounts receivable either: Remittance advices. Photocopies of remittance advices. A remittance list prepared in the mailroom.

CASH COLLECTIONS Possible approaches to collecting cash: Customers remit payments to a bank P.O. box. The bank sends the company: Remittance advices. An electronic list of the remittances. Copies of the checks. Advantages: Prevents theft by company employees. Improves cash flow management. Lockboxes may be regional, which reduces time in the mail. Checks are deposited immediately on receipt. Foreign banks can be utilized for international customers. Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable. Lockbox arrangements.

CASH COLLECTIONS Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable. Lockbox arrangements. Electronic lockboxes. Upon receiving and scanning the checks, the bank immediately sends electronic notification to the company, including: Customer account number Amount remitted

CASH COLLECTIONS Possible approaches to collecting cash: Customers remit payment electronically to the company’s bank. Eliminates mailing delays. Typically done through banking system’s Automated Clearing House (ACH) network. PROBLEM: Some banks do not have both EDI and EFT capabilities, which complicates the task of crediting the customer’s account on a timely basis. Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable. Lockbox arrangements. Electronic lockboxes. Electronic funds transfer and bill payment.

CASH COLLECTIONS Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable. Lockbox arrangements. Electronic lockboxes. Electronic funds transfer and bill payment. Financial electronic data interchange (FEDI). Integrates EFT with EDI. Remittance data and funds transfer instructions are sent simultaneously by the customer. Requires that both buyer and seller use EDI-capable banks.

Cash Collections Threats/Controls THREAT NO. 17—Theft of cash Why is this a problem? Loss of cash. Controls Separation of cash handling function from accounts receivable and credit functions Regular reconciliation of bank account with recorded amounts by someone independent of cash collections procedures Use of EFT, FEDI, and lockboxes to minimize handling of customer payments by employees Prompt, restrictive endorsement of all customer checks Having two people open all mail likely to contain customer payments Use of cash registers Daily deposit of all cash receipts

Cash Collections Threats/Controls THREAT NO. 18—cash flow problems Why is this a problem? Inability to pay bills, buy resources etc. Controls Lockbox arrangements, EFT, or credit cards Discounts for prompt payment by customers Cash flow budgets