Expenditure Cycle

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21 Aug, 2024

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The expenditure or purchasing cycle is a series of business activities that involve acquiring goods and services from external vendors or suppliers. Its purpose is to complete procurement successfully, including selecting a vendor, negotiating terms and conditions, placing an order, receiving the goods or services, and making payments to the vendor.

The expenditure cycle is crucial to a company's financial management system. Proper management of this cycle can help ensure the company can acquire the goods and services it needs to operate efficiently and effectively. Effective management of the expenditure cycle involves establishing and following policies and procedures to ensure that purchases are made at the best possible price and terms, that goods and services are received promptly, and that payments are made accurately and promptly.

What Is Expenditure Cycle?

The expenditure cycle is a series of business activities involving acquiring goods and services from external vendors or suppliers.
The expenditure cycle includes several stages, such as identifying a need for goods or services, requesting quotes or proposals from vendors, selecting a vendor, negotiating terms and conditions, placing an order, receiving the goods or services, and making payments to the vendor.
Effective management of the expenditure cycle can result in several benefits, including cost savings, timely delivery of goods and services, accurate financial records, and improved vendor relationships.
Companies can establish policies and procedures to manage the expenditure cycle effectively, including vendor selection criteria, purchase order approvals, and payment terms.

Expenditure Cycle Explained

The expenditure cycle is a process that companies use to purchase goods and services from external vendors or suppliers. This cycle includes several steps, such as identifying the need for goods or services, selecting a vendor, negotiating terms, placing an order, receiving goods or services, and making payments. Thus, proper management of this cycle is important for a company's financial management system as it can help ensure that purchases are made at the best possible price and terms, that goods and services are received promptly, and that payments are made accurately and promptly.

Activities

Activities involved in the expenditure cycle are as below:

Identifying a need for goods or services: The first step is identifying the need for goods or services. Also, this may be initiated by a department or an individual within the company.
Requesting quotes or proposals from vendors: Once the need is identified, the company may request quotes or proposals from vendors to compare prices and the quality of goods or services.
Selecting a vendor: After reviewing the quotes or proposals, the company selects a vendor based on various factors such as price, quality, reputation, and delivery time.
Negotiating terms and conditions: The company negotiates the terms and conditions of the purchase with the vendor, including payment terms, delivery schedule, and warranties.
Placing an order: The company places an order with the selected vendor, which includes details such as the quantity, price, and delivery date.
Receiving the goods or services: Once they are delivered, the company receives them and confirms that they match the order placed.
Verifying the goods or services received match the order placed: The company verifies that the goods or services received match the order placed and meet the quality standards.
Approving the invoice: After verifying the goods or services received, the company approves the invoice received from the vendor.
Recording the transaction in the accounting system: The transaction is recorded in the accounting system, which includes details such as the date, vendor name, invoice amount, and payment terms.
Payment to the vendor: Thus, the final step is to make the payment based on the agreed payment terms. Proper management of the expenditure cycle ensures that the company can acquire the goods it needs to operate efficiently.

Flowchart

The flowchart of a general expenditure cycle typically starts with identifying the need for goods or services. The company then requests quotes or proposals from vendors and selects a vendor based on various factors. Next, the terms and conditions of the purchase are negotiated with the vendor.

After it's agreed, the purchase order is placed. Next, the vendor delivers the goods or services to the company. Then after the company verifies that the goods or services received match the order placed. The company then approves the invoice and records the transaction in the accounting system. Finally, the payment is made to the vendor based on the agreed payment terms.

Examples

Let us look at the examples to understand the concept better.

Example #1

Suppose EatWell Restaurant is a popular eatery. It requires various supplies to run its operations, including food ingredients, cleaning supplies, and kitchen equipment. Then, the head chef identifies the need for fresh vegetables and contacts several vendors for quotes. Once the purchasing manager selects a vendor based on price, quality, and delivery time.

Next, the purchasing manager negotiates the terms and conditions of the purchase with the vendor. It includes payment terms, delivery schedules, and quality standards. After the rules are agreed upon, the purchase order is placed, and the vendor delivers the vegetables to the restaurant.

The head chef inspects the vegetables to ensure they meet the required quality standards and quantity. Upon approval, the purchasing manager approves the invoice from the vendor and records the transaction in the accounting system.

Finally, the payment is made to the vendor based on the agreed payment terms. This process is repeated for other supplies required by the restaurant to ensure smooth operations. Proper management of the expenditure cycle ensures that ABC Restaurant can acquire the necessary supplies to run its operations effectively.

Example #2

BuildSolid Construction is a company that specializes in building homes and offices. The company requires various materials, tools, and equipment to complete its projects. Then the project manager identifies the need for a specific type of cement and contacts several vendors for quotes. Next, the purchasing manager selects a vendor based on price, quality, and delivery time. Next, the purchasing manager negotiates the terms and conditions of the purchase with the vendor. It includes payment terms, delivery schedules, and quality standards.

Once the terms are agreed upon, the purchase order is placed. Then the vendor delivers the cement to the construction site. Next, the project manager inspects the cement to ensure it meets the required quality standards and quantity. Thus, upon approval, the purchasing manager approves the invoice from the vendor and records the transaction in the accounting system. Finally, the payment is made to the vendor based on the agreed payment terms. So, this process is repeated for other materials, tools, and equipment the construction company requires to complete its projects.

Importance

The expenditure cycle is an important part of a company's financial management system, and proper management of this cycle can have several benefits, including:

Ensuring that purchases are made at the best possible price and terms: Effective management of the expenditure cycle can help a company negotiate better prices and payment terms with vendors, resulting in cost savings.
Ensuring that goods and services are received promptly: Proper management of the expenditure cycle can help ensure that goods and services are received promptly, which can help avoid delays in production or operations.
Maintaining accurate financial records: The expenditure cycle involves recording transactions in the accounting system, which is important for maintaining accurate financial records and tracking expenses.
Improving vendor relationships: Thus, effective management of the expenditure cycle can help improve vendor relationships by ensuring that vendors are paid on time and that the company adheres to agreed-upon terms and conditions.

Frequently Asked Questions (FAQs)

1. What is expenditure cycle in accounting information system?

The expenditure cycle in an accounting information system is when a company acquires goods and services from external vendors. Thus, it records the related financial transactions in the accounting system.

2. What is auditing the expenditure cycle?

Auditing the expenditure cycle involves reviewing the processes and procedures involved in acquiring goods and services, ensuring compliance with policies and regulations, and verifying the accuracy and completeness of financial transactions recorded in the accounting system.

3. Name the major subsystems of the expenditure cycle?

The major subsystems of the expenditure cycle include the requisition system, the purchase order system, the receiving system, the accounts payable system, and the cash disbursement system.

4. What is expenditure cycle internal controls?

Internal controls for the expenditure cycle include policies and procedures for vendor selection, purchase approvals, segregation of duties, verification of goods received and invoices, and authorization and monitoring of payments.