The Revenue Cycle:
Sales and Cash Collections
Chapter 11
Learning Objectives
1. Describe the basic business activities and related
data processing operations performed in the
revenue cycle.
2. Discuss the key decisions that need to be made in
the revenue cycle and identify the information
needed to make those decisions.
3. Document your understanding of the revenue
cycle.
4. Identify major threats in the revenue cycle and
evaluate the adequacy of various control
procedures for dealing with those threats.
5. Read and understand a data model (REA diagram)
of the revenue cycle.
Introduction
Alpha Omega Electronics (AOE) is a
manufacturer of consumer electronic
products.
For three years, AOE lost market share.
Cash-flow problems have necessitated
increased short-term borrowing.
Introduction
Elizabeth Venko, the controller, Trevor, and Ann
were asked to investigate several issues:
How could AOE improve customer service? What
information does Marketing need to perform its tasks
better?
How could AOE identify its most profitable customers
and markets?
How can AOE improve its monitoring of credit
accounts? How would any changes in credit policy
affect both sales and uncollectible accounts?
How could AOE improve its cash collection
procedures?
Revenue Cycle
Business Activities
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.
Revenue Cycle
Business Activities
What are the four basic revenue cycle
business activities?
Sales order entry
Shipping
Billing and accounts receivable
Cash collections
Revenue Cycle Business Activities:
Sales Order Entry
Sales order entry process entails three
steps:
1. Taking the customer’s order
2. Checking and approving the
customer’s credit
3. Checking inventory availability
Revenue Cycle Business Activities:
Shipping
The second basic activity in the revenue
cycle – filling customer orders and
shipping the desired merchandise –
entails two steps:
1. Picking and packing the order
2. Shipping the order
Revenue Cycle Business Activities:
Billing and Accounts Receivable
The third basic activity in the revenue
cycle involves:
1. Billing customers
2. Updating accounts receivable
Revenue Cycle Business Activities:
Cash Collections
The fourth step in the revenue cycle is
cash collections. It involves:
1. Handling customer remittances
2. Depositing remittances in the bank
Revenue Cycle –
Key Decisions
The revenue cycle’s primary objective is
to provide the right product in the right
place at he right time for the right price.
How does a company accomplish this
objective?
• To accomplish the revenue cycle’s primary
objective, management must make the
following key decisions:
Revenue Cycle –
Key Decisions
To what extent can and should products be
customized to individual customers’ needs
and desires?
How much inventory should be carried, and
where should that inventory be located?
How should merchandise be delivered to
customers? Should the company perform
the shipping function itself or outsource it to
a third party that specializes in logistics?
Revenue Cycle –
Key Decisions
Key decisions, continued
Should credit be extended to customers?
How much credit should be given to
individual customers?
What credit terms should be offered?
How can customer payments be processed
to maximize cash flow?
Sales Order Entry (Activity 1)
This step includes all the activities involved
in soliciting and processing customer
orders.
Key decisions and information needs:
decisions concerning credit policies,
including the approval of credit
information about inventory availability and
customer credit status from the inventory
control and accounting functions,
respectively
Sales Order Entry (Activity 1)
The sales order entry function
involves three main activities:
Responding to customer inquiries
Checking and approving customer
credit
Checking inventory available
Information Needs
and Procedures
The AIS should provide the
operational information needed to
perform the following functions:
Respond to customer inquires about
account balances and order status.
Decide whether to extend credit to a
customer.
Sales Order Entry (Activity 1)
Regardless of how customer orders are
initially received, the following edit checks
are necessary:
Validity checks
A Completeness test
Reasonableness tests
Credit approval
• General authorization
• Credit limit
• Specific authorization
• Limit checks
Sales Order Entry (Activity 1)
Next, the system checks whether the
inventory is sufficient to fill accepted
orders.
Internally generated documents
produced by sales order entry:
sales order
packing slip
picking ticket
Information Needs
and Procedures
Determine inventory availability.
Decide what types of credit terms to
offer.
Set prices for products and services.
Set policies regarding sales returns
and warranties.
Select methods for delivering
merchandise.
Shipping (Activity 2)
Warehouse workers are responsible
for filling customer orders by removing
items from inventory.
Key decisions and information needs:
Determine the delivery method.
– in-house
– outsource
Shipping (Activity 2)
Documents, records, and procedures:
The picking ticket printed by the sales order
entry triggers the shipping process and is used
to identify which products to remove from
inventory.
A physical count is compared with the
quantities on the picking ticket and packing
slip.
Some spot checks are made and a bill of
lading is prepared.
Billing and Accounts
Receivable (Activity 3)
Two activities are performed at this stage
of the revenue cycle:
Invoicing customers
Maintaining customer accounts
Key decisions and information needs:
• Accurate billing is crucial and requires
information identifying the items and
quantities shipped, prices, and special sales
terms.
Billing and Accounts
Receivable (Activity 3)
The sales invoice notifies customers of the
amount to be paid and where to send
payment.
A monthly statement summarizes
transactions that occurred and informs
customers of their current account balance.
A credit memo authorizes the billing
department to credit a customer’s account.
Billing and Accounts
Receivable (Activity 3)
Types of billing systems:
In a postbilling system, invoices are
prepared after confirmation that the items
were shipped.
In a prebilling system, invoices are prepared
(but not sent) as soon as the order is
approved.
The inventory, accounts receivable, and
general ledger files are updated at this time.
Billing and Accounts
Receivable (Activity 3)
Methods for maintaining accounts
receivable:
open invoice method
balance-forward method
To obtain a more uniform flow of cash
receipts, many companies use a
process called cycle billing.
Information Needs
and Procedures
What are examples of additional information
the AIS should provide?
response time to customer inquires
time required to fill and deliver orders
percentage of sales that require back orders
customer satisfaction
analysis of market share and trends
profitability analyses by product, customer,
and sales region
Cash Collections (Activity 4)
Two areas are involved in this activity:
The cashier
The accounts receivable function
Cash Collections (Activity 4)
Key decisions and information needs:
Reduction of cash theft is essential.
The billing/accounts receivable
function should not have physical
access to cash or checks.
The accounts receivable function must
be able to identify the source of any
remittances and the applicable
invoices that should be credited.
Cash Collections (Activity 4)
Documents, records, and procedures:
Checks are received and deposited.
A remittance list is prepared and
entered on-line showing the customer,
invoice number, and the amount of
each payment.
The system performs a number of on-
line edit checks to verify the accuracy
of data entry.
Control: Objectives,
Threats, and Procedures
The second function of a well-
designed AIS is to provide adequate
controls to ensure that the following
objectives are met:
Transactions are properly authorized.
Recorded transactions are valid.
Control: Objectives,
Threats, and Procedures
Objectives, continued
Valid, authorized transactions are
recorded.
Transactions are recorded accurately.
Assets (cash, inventory, and data) are
safeguarded from loss or theft.
Business activities are performed
efficiently and effectively.
Threats and Applicable Control
Procedures to Sales Order Entry
Threat Applicable Control Procedures
1. Incomplete or Data entry edit checks
inaccurate customer
orders
2. Credit sales to Credit approval by credit manager, not
customers with poor credit by sales function; accurate records of
customer account balances
3. Legitimacy of orders Signatures on paper documents; digital
signatures and digital certificates for e-
business
4. Stockouts, carrying Inventory control systems
costs and markdowns
Threats and Applicable Control
Procedures to Shipping
Threat Applicable Control Procedures
1. Shipping errors: Reconciliation of sales order with
• Wrong merchandise picking ticket and packing slip; bar
• Wrong quantities code scanners; data entry application
controls
• Wrong address
2. Theft of inventory Restrict physical access to inventory;
Documentation of all internal transfers
of inventory; periodic physical counts of
inventory and reconciliation of counts
of recorded amounts
Threats and Applicable Control
Procedures to Billing and
Accounts Receivable
Threat Applicable Control Procedures
1. Failure to bill customers Separation of shipping and billing
functions;
Prenumbering of all shipping documents
and periodic reconciliation to invoices;
reconciliation of picking tickets and bills of
lading with sales orders
2. Billing errors Data entry edit control
Price lists
3. Posting errors in updating Reconciliation of subsidiary accounts
accounts receivable receivable ledger with general ledger;
monthly statements to customers
Threat and Applicable Control
Procedures to Cash Collections
Threat Applicable Control Procedures
1. Theft of Cash Segregation of duties; minimization
of cash handling; lockbox
arrangements; prompt endorsement
and deposit of all receipts
Periodic reconciliation of bank
statement with records by someone
not involved in cash receipts
processing
General Control Issues
Threat Applicable Control Procedures
1. Loss of Data Backup and disaster recovery
procedures; access controls
(physical and logical)
2. Poor performance Preparation and review of
performance reports
Revenue Cycle Data Model
The REA data model provides one method
for designing a data base that efficiently
integrates both financial and operating data.
A simplified REA data model for the revenue
cycle of a manufacturing company should
include the following information:
the two major resources (cash and
inventory) used in the revenue cycle
Revenue Cycle Information
Needs and Data Model
An AIS is designed to collect, process
and store data abut business activities
to present management with
information to support decision
making.
Revenue Cycle Information
Needs: Operational Data
Operational Data are needed to monitor
performance and to perform the following
recurring tasks:
Respond to customer inquiries about
account balances and order status
Decide whether to extend credit to a
particular customer
Determine inventory availability
Select methods for delivering merchandise
Revenue Cycle Information
Needs: Current and Historical
Information
Current and historical information is needed
to enable management of make the
following strategic decisions:
Setting prices for products and services
Establishing policies regarding sales returns
and warranties
Deciding what types of credit terms to offer
Determining the need for short-term
borrowing
Planning new marketing campaigns
Revenue Cycle Information
Needs: Performance Evaluation
The AIS must also supply the information needed to evaluate
performance of the following critical processes:
Respond time to customer inquiries
Time required to fill and deliver orders
Percentage of sales that required back orders
Customer satisfaction rates and trends
Profitability analyses by product, customer, and sales region
Sales volume in both dollars and number of customers
Effectiveness of advertising and promotions
Sales staff performance
Bad debt expenses and credit policies
Revenue Cycle Data Model
The four major business events in the
revenue cycle (orders, filling the
orders, shipping [sales], and cash
collections)
The primary external agent (customer)
as well as the various internal agents
involved in revenue cycle activities
Revenue Cycle Data Model
Partial REA Diagram of the Revenue Cycle
Inventory order
(0, N)
Inventory
(0, N) fill order
Inventory
(0, N)
Inventory ship
Revenue Cycle Data Model
Partial REA Diagram of the Revenue Cycle
Cash (1, N)
(1, 1)
Deposits in
Collects
(1, 1) cash
by
(1, N) Cashier
Case Conclusion
What are the key points that Elizabeth
Venko proposed?
1. Equip the sales force with pen-
based laptop computers.
2. Improve billing process efficiency by
increasing the number of customers
who agree to participate in
invoiceless sales relationships.
Case Conclusion, con’t
3. Work with major customers to obtain
access to their POS data.
4. Periodically survey customers about
their satisfaction with AOE’s
products and performance.
5. Improve the efficiency of cash
collections by encouraging EDI-
capable customers to move to FED.
