Module 4: The Revenue Cycle: Sales to Cash Collections

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. The primary external exchange of information is with customers. Information about revenue cycle
activities also flows to the other accounting cycles. For example, the expenditure and production cycles
use information about sales transactions to initiate the purchase or production of additional inventory
to meet demand. The human resources management/payroll cycle uses information about sales to
calculate sales commissions and bonuses. The general ledger and reporting function uses information
produced by the revenue cycle to prepare financial statements and performance 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.

Four basic revenue cycle activities

1. Sales order entry

2. Shipping

3. Billing

4. Cash collections

Revenue Cycle Information System

Process

1. Take customer orders

- via internet - AOE’s customers can place orders directly via the Internet

- via outbound sales calls - salespeople use laptops to enter orders when calling on
customers.

- sales department enters customer orders received over the telephone, by fax, or by
mail.

2. Approve customer credit

o The system quickly verifies customer creditworthiness

3. Checks inventory availability

o notifies the warehouse and shipping departments about the approved sale

o warehouse and shipping employees enter data about their activities as soon as they are
performed

4. Respond to customer inquiries

o invoice program runs in batch mode, generating paper or electronic invoices for
customers who require invoices.
5. Remittance

- AOE’s customers use their bank’s online bill-paying service

1. Sales Order Entry

The revenue cycle begins with the receipt of orders from customers. The sales department, which
reports to the vice president of marketing, typically performs the sales order entry process, but
increasingly customers are themselves entering much of this data through forms on a company’s Web
site storefront.

The sales order entry process entails three steps:

1. taking the customer’s order

Customer order data are recorded on a sales order document. In the past, organizations used paper
documents; today, the sales order document is usually an electronic form displayed on a computer
monitor screen (interestingly, many ERP systems continue to refer to these data entry screens as
documents).

In the past, customer orders were entered into the system by employees. Increasingly, organizations
seek to leverage IT to have customers do more of the data entry themselves. One way to accomplish this
is to have customer scomplete a form on the company’s Web site. Another is for customers to use
electronic data interchange (EDI) to submit the order electronically in a format compatible with the
company’s sales order processing system. Both techniques improve efficiency and cut costs by
eliminating the need for human involvement in the sales order entry process.

2. checking and approving customer credit

Most business-to-business sales are made on credit. Therefore, 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. Thus, for existing customers,
credit approval simply involves checking the customer master file to verify the account exists, identifying
the customer’s credit limit, and verifying that the amount of the order plus any current account balance
does not exceed this limit. This can be done automatically by the system.

To be effective, credit approval must occur before the goods are released from inventory and shipped to
the customer. Nevertheless, problems will occur, and some customers will end up not paying off their
accounts. Therefore, careful monitoring of accounts receivable is extremely important. A useful report
for doing this is an accounts 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 credit limit for specific customers, and for
estimating bad debts.

3. checking inventory availability

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.
Information typically available to the sales order staff:

o quantity on hand

o quantity already committed to other customers, and

o quantity available

If sufficient inventory is available to fill the order, the sales order is completed, and the quantity-
available field in the inventory file for each item ordered is reduced by the amount ordered.

If there is not sufficient inventory on hand to fill the order, a backorder authorizing the purchase or
production of those items must be created

Once 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.

4. Responding to customer inquiries

The objective is to retain customers. This is important because a general marketing rule of thumb is that
it costs at least five times as much to attract and make a sale to a new customer as it does to make a
repeat sale to an existing customer.

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

The second basic activity in the revenue cycle is filling customer orders and shipping the desired
merchandise. This process consists of two steps: (1) picking and packing the order and (2) shipping the
order. The warehouse and shipping departments perform these activities, respectively. Both functions
include custody of inventory and report ultimately to the vice president of manufacturing.

1.picking and packing the order

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. Warehouse workers record the quantities of each item actually picked, either
on the picking ticket itself (if a paper document is used) or by entering the data into the system (if
electronic forms are used). The inventory is then transferred to the shipping department.

2.shipping the order

After the merchandise has been removed from the warehouse, it is shipped to the customer.

The shipping department should compare the physical count of inventory with the quantities indicated
on the picking ticket and with the quantities indicated on the sales order. Discrepancies can arise either
because the items were not stored in the location indicated on the picking ticket or because the
perpetual inventory records were inaccurate. In such cases, the shipping department needs to initiate
the back ordering of the missing items and enter the correct quantities shipped on the packing slip.

After the shipping clerk counts the goods delivered from the warehouse, the sales order number, item
number(s), and quantities are entered using online terminals. This process updates the quantity-on-
hand field in the inventory master file. It 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, and it indicates who (customer or vendor)
must pay the carrier. A copy of the bill of lading and the packing slip accompanies 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. In other cases, the freight bill is a separate
document.
3. Billing Process

The third basic activity in the revenue cycle involves billing customers. This involves two separates, but
closely related, tasks: invoicing and updating accounts receivable, which are performed by two separate
units within the accounting department.

Invoicing

The invoicing activity is just an information processing activity that repackages and summarizes
information from the sales order entry and shipping activities. It requires information from the shipping
department identifying the items and quantities shipped and information about prices and any special
sales terms from the sales department.

The basic document created in the billing process is the sales invoice, which notifies customers of the
amount to be paid and where to send payment.

Maintain Accounts Receivable

The accounts receivable function, which reports to the controller, performs two basic tasks: It uses the
information on the sales invoice to debit customer accounts and subsequently credits 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, and the format of the monthly statement sent to
customers.
Under the open-invoice method, customers typically pay according to each invoice. Usually, two copies
of the invoice are mailed to the customer, who is requested to return one copy with the payment. This
copy is a turnaround document called remittance advice. Customer payments are then applied against
specific invoices.

In contrast, under the balance-forward method, customers typically pay according to the amount
shown on a monthly statement, rather than by individual invoices. The monthly statement lists all
transactions, including both sales and payments, that occurred during the past month and informs
customers of their current account balances.

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.

Adjustments to a customer’s account are sometimes necessary. To credit a customer’s account for
returned goods, the credit manager 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, which authorizes the
crediting of the customer’s account. If the damage to the goods is minimal, the customer may agree to
keep them for a price reduction.

4. Cash Collections

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. The accounts receivable function, which is responsible for recording customer
remittances, should not have physical access to cash or checks. Instead, the cashier, who reports to the
treasurer, handles customer remittances and deposits them in the bank.

A remittance list, which is a document identifying the names and amounts of all customer remittances,
and send it to accounts receivable may be prepared by the mailroom personnel as monitoring.

 A lockbox is a postal address to which customers send their remittances.

 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.

 An 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.

 Financial electronic data interchange (FEDI) is the combination of EFT and EDI that enables both
remittance data and funds transfer instructions to be included in one electronic package.