Controls for Order Entry, Part 1 (#1)
/In this episode, we cover the full range of controls associated with a manually-operated order entry function, dealing with controls for both verbal and written customer orders. The main control areas noted in the episode are noted below.
Verbal Order Controls
First off, a customer order can come in either verbally, perhaps over the telephone, or as a purchase order. Now, if you get a verbal order, you immediately have a problem, which is – is this an order that’s for real, or is someone perhaps calling in with an order that is incorrect or unauthorized? And what if you then ship it, and then you’re stuck with not being paid, because you didn’t verify up front that it’s a real order. So you need an up front control, which is verifying that the order is correct. This control usually means that you have to call them back, or request something on paper that’s signed by an authorized manager.
Purchase Order Controls
The second type of order that can come in is the purchase order, which is usually signed by someone whom you presume to be an authorized person. In this case, you have the same problem. Yes, it’s now on paper, so the information on it is more likely to be accurate. But on the other hand, how do you know that it’s really coming from the company that it says it’s coming from? So this one again can involve a control, which is verifying that the person who signed off on it is in fact an approved buyer. This is easy enough if the customer is a long-term one, and you know the person who placed the order. But if the order is a large one, and especially if it’s from a new customer, you’ll have to make additional inquiries.
Price Controls
Now, once you’ve figured out that the order is a real one, you still have some additional problems, each of which needs a control. One issue is the price, either what was quoted to them or which they specified in a purchase order.—is that the correct price? It may very well not be the correct price. There are a number of issues here, such as, did they place such a large order that they’re entitled to special price breaks, and if so, is the person who took that order using the most up-to-date information about special pricing deals. If not, this needs another control to verify that the pricing is correct.
To take the concept one step further, this may also require verification of freight charges, taxes, and possibly shipping insurance.
Credit Limit Controls
So there you are already with a bunch of controls, and you haven’t even written down the order or sent it elsewhere within the company. So… let’s keep going. What if a customer has exceeded its credit limit? Well, the person taking the order has to review the open accounts receivable report to see if the limit has been exceeded. Though, keep in mind that it’s not so easy to keep track of open receivables in a paper-based environment, because it’s so difficult and time-consuming to summarize all of the open invoices and cash receipts in one place.
If the credit limit has been exceeded, then the order entry person has to get back to the customer and tell them they can only order up to that limit, or they have to pay down their existing receivable balance with the company before they can order anything else. So there you have another control.
Stock Checking Controls
In some cases, the customer expects to have something shipped to them right away, and that may not happen because you don’t have the inventory on hand. So, another control needed to make sure that the order is processed properly is to go to the warehouse and make sure that you have it in stock. Or, alternatively, that it’s within a day or two of either being received from a supplier or being manufactured in-house.
And if any of these issues I’ve already described cause problems, this requires a feedback loop back to the customer to ensure that they agree with any revisions in the contents or terms or timing of the order.
The main point of the controls so far are to make sure that the terms of the order are accurate, though it’s also possible that you may spot a shell company that’s trying to get goods delivered to it that it has no intention of paying for. Yes, this would be a case of fraud. Nonetheless, the main issue with these controls is to ensure that incoming orders are as clean as possible.
The Sales Order
At this point, we can move on to another transaction step, which is creating a sales order. Now, a sales order usually comes in five parts in a paper-based environment. One of them the order entry staff will keep on file, just in case something goes wrong later in the process, and they want to refer back to the original document.
So, one copy is stripped off and put away in a filing cabinet. Another copy usually goes to the customer, and that’s because the customer wants to know that what it orders is what it eventually receives.
Two copies go to the credit department. Now, one of those copies will be stamped by the credit staff – if they approve of the order – and then will be sent to the shipping department, which uses that as authorization to ship to the customer. The credit department will retain the other copy, so they can verify, if necessary, that what was later shipped was what they authorized for shipment.
The fifth copy goes to the billing staff. This is not always used, because some companies feel that the billing staff should just wait for a copy to be forwarded to them from the shipping department after a product ships. However, it might make sense to exercise a bit more control by having the billing department track what’s supposedly going to be shipped. This can be a good way to make sure that every shipment is eventually billed. Otherwise, it’s more likely that some items will be shipped, but the paperwork never arrives in the billing department, and an invoice is never created.
So the billing staff is essentially being proactive in using this documentation to ensure that they do eventually bill what was ordered.
So there you have five copies of the sales order floating around the company, each one of which has to be tracked to some degree. The customer will use its copy to ensure that what shows up at the door is what was ordered. The credit department wants to make sure that what the company ships is what it authorized. – so they may run a cross-check later on to ensure that that happens. The order entry department may, at some point in the future, want to verify that what was shipped is what was ordered, especially if they’re looking at any remainder items that need to be back ordered. And the fifth copy of the sales order is used by the billing department to anticipate and monitor shipping documentation coming to them from the shipping department to ensure that none of it is lost.
That covers the initial orders required for a paper-based order entry system – but, there are a few more that could be added onto this.
One of them is to lock up your blank sales orders. Why do that? If someone from outside the company, or someone on the inside with access to the forms storage area, were to steal a sales order, they could circumvent some of the order entry systems, such as filling out the sales order, and stamping it with a fake credit approval stamp, and send it to the shipping department. The product then ships, the company sends an invoice to a fake customer, and it never gets paid. So this is one of the more convoluted ways to steal goods from a company.
Another control is to track sales order numbers. Sales orders are frequently pre-numbered. By doing so, it is much easier to locate documents, or alternatively, to figure out if documents are missing.
Product Return Controls
Another order entry control is to investigate product returns. If something comes back from a customer that was technically never shipped or never listed anywhere on a sales order, then one should be suspicious – probably very suspicious – and start doing a Sherlock Holmes routine to figure out what happened.
Unshipped Remainder Controls
Another control is to track unshipped remainders. What this means is that you compare the amount invoiced to customers against the amount they initially ordered. Occasionally, you’ll find some small quantities that were never shipped, and the customers may still be waiting for them. So this is a possible source of small revenue increases if you were to track down each remainder, call the customer, see if they still want it, see if you have it in stock, and then ship it. So this is a control that increases your revenue.
Order Entry Policies
There are also a couple of policies to consider. An obvious one is that someone from management should formally approve of any price changes from the standard corporate price list. There should also be a recurring internal audit procedure to verify that price changes have been properly approved by management.
Another policy is to look for extended return rights granted to customers. – usually right on the sales order – and if there are some, this could indicate an aggressive sales approach called channel stuffing. This means that you’re pushing more product onto customers than they really need, and the evidence of this is that you’re allowing them a number of months in which to return the goods if they don’t actual sell or use them.
Channel stuffing is usually started by management, because they’re trying to meet some rather difficult sales targets. Because management is causing it, they may also be trying to hide it. An internal audit procedure is needed to look for it.
Here’s another policy. You should cross-check the existence of customers when their orders are over a certain dollar size. Unfortunately, some customers who are intentionally trying to defraud the company will try to figure out what that policy is, and then place orders just beneath it. But nonetheless, it does help to have a policy that requires someone to run a Dun & Bradstreet credit report, just to see if the customer has been around for a while, and that they seem to be a valid business, so that you can expect to be paid.