A revenue cycle covers the flow of transactions through four departments that are needed to ensure that a customer order is properly billed, paid for, and cleared through the accounting system. A revenue cycle describes the initial transaction, in which the customer places an order, has an acceptance or rejection of credit, a transfer of shipment documentation to the accounting department for billing, and subsequent collection efforts. Unfortunately, this seemingly simple process flow hides a plethora of potential system failures. Sometimes, revenue cycle problems are very hard to spot and cannot be reliably found through traditional measurement systems. This post reveals the most common problems that arise on revenue cycle of a business and a better measurement approache for earlier problem ctaching. By knowing the common problems one [financial manager, controller, CFO or a business owner of small medium business] should be able to prevent it from real happening with better approaches. In addition one would be able to diagnose and identified the problems faster when the revue reports showing some odd numbers or your best customer calls and complaints about the bill or credit note.
Most Common Problems On Revenue Cycle
Here are the most common problems arise on revenue cycle:
Problem#1: Customer Order Is Incorrectly Entered
An exceptionally common issue is that the order entry staff does not properly enter the customer’s order into the computer system, possibly resulting in the wrong address, part quantities, or part numbers. The results can be orders that are shipped to the wrong location or incorrect parts or wrong quantities shipped, all of which result in an unhappy customer and a very difficult collection job by the accounting staff.
Problem#2: Customer Order Is Entered Without A Purchase Order
Any customer order that results in a shipment without a corresponding customer authorization in the form of a purchase order results in a possible bad debt, because the customer is under no obligation to pay for the item shipped nor to return it. This is a problem at the point of order entry, where orders should not be accepted without such a form of authorization.
Problem#3: Customer Credit Is Incorrectly Granted
A customer may have a terrible credit history and yet be granted an excessively high credit level. This is frequently the result of undue pressure by the sales staff, which has already obtained the customer’s order and wants the credit approved in order to earn a commission. Given the undue level of pressure, the finance staff caves in and grants the request. Unfortunately, a really large sale not only earns the largest commission for a salesperson, but also lands a customer in the largest amount of credit trouble, because it may have no way to pay the company such a large amount of money.
Problem#4: Customer Orders Shipped Without Credit Approval
It is entirely possible for a customer order to be entered into the computer system, subject to credit approval, and still have it produced and shipped to the customer—without any credit approval. The usual breakdown in the process is when no “hold” flag is assigned to an order, so that downstream operations within the company do not know that the order is on hold and proceed as though it is a normal order. The worst case of all is if there is no “hold” feature in the computer system at all, in which case the company must rely on a separate, manual system that operates alongside the computer system to track credit hold situations.
Problem#5: Wrong Product Is Shipped To A Customer
A customer may receive the wrong product due to several breakdowns in the process cycle. One is that the initial order was entered incorrectly; another is that the product that reaches the warehouse for shipment is incorrectly labeled; and a third possibility is that the warehouse simply ships the wrong product. This is a classic process cycle problem, because the error can originate in three separate departments!
Problem#6: Invoice Is Incorrectly Prepared Or Not Prepared At All
Even if the product is correctly shipped, there is still the issue of getting an invoice to the customer for payment, before the revenue cycle can be successfully closed. If there is an incorrect transfer of information between the shipping dock and the billings staff, then it is possible that no invoice will be prepared at all. Another issue is that, if quantities or part numbers listed by the shipping personnel on the bill of lading are incorrect, then this improper data will also be used in the invoice. Further, if a deposit or prepayment was made at the time of order entry and incorrectly accounted for, this information will not be recorded in the invoice. If all of these errors are present, it can be a surprise when the accounting staff issues a correct invoice.
Problem#7: Cash Is Incorrectly Applied
If cash is received by the order entry or sales staffs as a prepayment or deposit, it is possible that the money will be lost in transit to the accounting staff, or that it will not be correctly identified when sent there. Also, when cash is received at the mailroom in payment for an invoice, the same problems may apply. In either case, the cash will be incorrectly applied to the customer account, which can result in an incorrect customer account receivable balance and additional and unnecessary collection calls.
Problem#8: Collection Efforts Are Not Made
If the preceding cash application process results in incorrect customer balances, the collections staff will not know that it is supposed to undertake collection efforts, resulting in customer nonpayment. Though this may seem like a shortcoming of just the collections staff, the preceding point shows that the underlying issue can originate as far away as the order entry process or the mailroom.
Problem#9: Accounts Receivable Are Improperly Credited
Any of the preceding problems can result in improper credits to customer accounts. For example, an incorrect entry of a customer order or shipping of the wrong product may result in a credit to the customer’s account to eliminate the incorrect shipment, but does not reflect the additional shipment, at no cost to the customer, of the correct product. Whenever there is a secondary shipment to a customer to correct an earlier problem, it is all too common to clear out the customer’s original account receivable balance without billing for the new shipment.
What Measurement to Use to Spot Problems On Revenue Cycle?
A major flaw in the revenue cycle that a controller can easily measure is the proportion of invoices issued for which there is no customer purchase order. This measure reveals the extent to which orders are being taken without appropriate customer approval, and points toward potential difficulties later on, when the collections staff tries to collect payment on the invoice. It is very useful to feed back the details of each case to the order entry manager, so that this person can follow up with the order entry staff to ensure that the problem does not arise again.
Another simple measure is the proportion of customers with open accounts receivable but no assigned credit limit. This measure is useful when a controller suspects that there is a problem with shipping orders without first assigning a credit limit. If the problem appears to be a severe one, a secondary measure is to create a subset of just those customers without assigned credit limits, and to then determine their average levels of accounts receivable—a low average level points toward a minimal problem, but high levels should lead to immediate action to clamp down on what may be a severe credit granting problem.
Another measure that is oriented more toward the adequacy of existing credit levels is a comparison of current customer accounts receivable balances to their preassigned credit levels, preferably tracked on a trend line. If this percentage is near 100 percent, it may be time to review credit granting policies and extend more credit, especially if there is little evidence of bad debt or excessive payment periods by customers. All of these measures are designed to give a high-level perspective on any potential credit problems in the revenue cycle.
A difficult measure for a controller to track, but one that requires at least an occasional measurement, is the proportion of shipments made that are not billed. Though a problem in this area can have major repercussions, it is difficult to accurately measure. The only way to reliably do so is to compare the shipping log to the invoice register and spot any shipments for which there is not a corresponding invoice. The resulting list of shipments must then be investigated and further reduced by the number of free samples, warranty replacements, or other shipments for which there is a valid reason for not having invoiced. The remaining set of shipments must be reviewed in great detail to ensure that the nonbilling problem does not recur.
Sometimes, revenue cycle problems are very hard to spot and cannot be reliably found through traditional measurement systems. Instead, it is best to obtain clues from customers, who are more than happy to call in with complaints about the revenue cycle. These complaints typically include issues with overbillings, incorrect pricing, incorrect credit hold situations, inappropriate collection calls, or shipments that are incorrect for any number of other reasons. By entering this information into a customer complaints database, one can easily summarize the types of complaints and track them to see if there are improvements in the various kinds of revenue cycle problems. This is frequently the best method for measuring the effectiveness of the overall revenue cycle, and is an excellent way to determine the key problem areas that require more extensive measurement systems.
This post has covered a number of problems that can arise in the revenue cycle, as well as the more common types of measures one can use to determine the extent and severity of the problems.
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