RAJALAKSHMI INSTITUTE OF TECHNOLOGY

CCD332 – FINANCIAL MANAGEMENT

UNIT 5 – CASH MANAGEMENT

Cash Management: Motives for Holding cash, Speeding Up Cash Receipts, Slowing Down Cash
Payouts, Electronic Commerce, Outsourcing, Cash Balances to maintain, Factoring. Accounts
Receivable Management: Credit & Collection Policies, Analyzing the Credit Applicant, Credit
References, Selecting optimum Credit period.

INTRODUCTION

What Is Cash Management?

The term cash management refers to the process of collecting and managing cash flows. Cash
management can be important for both individuals and companies. It is a key component of a company's
financial stability in business. Cash is also essential for people's financial stability while also usually
considered as part of a total wealth portfolio. Individuals and businesses have different options to help
them with their cash management needs, including banks to hold their cash assets.

Cash management may also be known in some parts of the financial industry as treasury management.

How Cash Management Works?

Cash is among the primary assets that individuals and companies use to pay their obligations and invest.
Managing cash is what entities do on a day-to-day basis to take care of the inflows and outflows of their
money. Proper cash management can improve an entity's financial situation and liquidity problems.

For individuals, maintaining cash balances while also earning a return on idle cash is usually a top
concern. In business, companies have cash inflows and outflows that must be prudently managed in
order to:

• Meet payment obligations

• Plan for future payments

• Maintain adequate business stability

Corporate Cash Management involves the use of business managers, corporate treasurers, and chief
financial officers (CFOs). These professionals are mainly responsible to implement and oversee cash
management strategies and stability analysis. Many companies may outsource part or all of their cash
management responsibilities to different service providers. Regardless, there are several key metrics
that are monitored and analyzed by cash management executives on a daily, monthly, quarterly, and
annual basis.
The Importance of the Cash Flow Statement in Cash Management

The cash flow statement is a central component of corporate cash flow management. While it is often
transparently reported to stakeholders on a quarterly basis, parts of it are usually maintained and tracked
internally on a daily basis.

The cash flow statement comprehensively records all of a business’s cash flows. It includes:

• Cash received from accounts receivable (AR)

• Cash paid for accounts payable (AP)

• Cash paid for investing

• Cash paid for financing

The bottom line of the cash flow statement reports how much cash a company has readily available.

The cash flow statement is broken down into three parts:

➢ Operating,
➢ Investing, and
➢ Financing.

The operating portion of cash activities tends to vary based heavily on the net working capital which is
reported on the cash flow statement as a company’s current assets minus current liabilities.

The other two sections of the cash flow statement are somewhat more straightforward with cash inflows
and outflows pertaining to investing and financing.

Managing Cash Through Internal Controls

There are many internal controls used to manage and ensure efficient business cash flows.

Internal controls are various accounting and auditing mechanisms that companies can use to ensure that
their financial reporting is compliant with regulations.

These tools, resources, and procedures improve operational efficiency and prevent fraud.

Some of a company’s top cash flow considerations include the:

• Average length of Accounts Receivable

• Collection processes

• Write-offs for uncollected receivables

• Liquidity and rates of return (RoR) on cash equivalent investments

• Credit line management

• Available operating cash levels

Cash Management of Working Capital

Cash flows pertaining to operating activities are generally heavily focused on working capital, which is
impacted by Accounts Receivable and Accounts Payable changes. Investing and financing cash flows
are usually extraordinary cash events that involve special procedures for funds.

A company’s working capital is the result of its current assets minus current liabilities.

Working capital balances are important in cash flow management because they show the number
of current assets a company has to cover its current liabilities.

Working capital generally includes the following:

• Current Assets: Cash, accounts receivable within one year, inventory

• Current Liabilities: All accounts payable that are due within one year and short-term debt
payments that come due within one year.

Companies strive to have current asset balances that exceed current liability balances. If current
liabilities exceed current assets a company would likely need to access its reserve lines for its payables.

Companies usually report the change in working capital from one reporting period to the next
within the operating section of the cash flow statement. If a company has a positive net change in
working capital, it increases its current assets to cover its current liabilities, thereby increasing the total
cash on the bottom line. A negative change means a company increases its current liabilities, which
reduces its ability to pay them efficiently and its total cash on the bottom line.

There are several things a company can do to improve both receivables and payables efficiency,
ultimately leading to higher working capital and better operating cash flow. Companies that operate
with invoice billing can reduce the days payable or offer discounts for quick payments. They may also
choose to use technologies that facilitate faster and easier payments such as automated billing and
electronic payments.

Advanced technology for payables management can also be helpful. Companies may choose to
make automated bill payments or use direct payroll deposits to help improve payables cost efficiency.

Cash Management and Solvency Ratios

Companies can also regularly monitor and analyze liquidity and solvency ratios within cash
management. External stakeholders find these ratios important for a variety of analysis purposes as
well.

The two main Liquidity ratios analyzed in conjunction with cash management include the Quick ratio
and the Current ratio.

The quick ratio is calculated from the following:

Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable) ÷ Current Liabilities

The current ratio is a little more comprehensive. It is calculated from the following:

Current Ratio = Current assets ÷ Current Liabilities

Solvency ratios look at a company’s ability to meet all its obligations in the long term. Some of the most
popular solvency ratios include debt to equity, debt to assets, cash flow to debt, and the interest coverage
ratio.

Why Is Cash Management Important?

Cash management is the process of managing cash inflows and outflows. This process is important for
individuals and businesses because cash is the primary asset used to invest and pay any liabilities. There
are many cash management options available such as using excess cash to pay down lines of credit with
a credit sweep. Cash management not only provides entities with a window into their financial situations
but it can also be used to improve their profitability by fixing their liquidity problems.

How Can You Improve Your Cash Management?

There are a number of ways an individual or business can improve their cash management. Some of
these steps include:

➢ improving their accounts receivables (increasing income, encouraging clients to pay early/on
time), investing excess cash,
➢ seeking out better financing rates on debt,
➢ safeguarding bank accounts to prevent fraud, and
➢ implementing better accounts payable processes.

Example of Cash Management

Cash management can come in various forms, including the improvement of accounts payable
processes.

Let's say a business has an existing (and good) relationship with a vendor.

Shashank & Co,., have been doing business with Prakash & Co., for the last five years. The vendor
ships supplies to the business every month and requires payment on its invoices every 30 days. Since
the two have an amicable relationship, the business negotiates payment for invoices every 45 days.

Why Do Businesses Need Cash Management?

Cash is an important current asset when running a business. Cash is always needed to run a business
enterprise.

A reasonable cash balance is always preferred. It should not be less than the demand nor more than the
reasonable demand.

The lower the quantity of cash, then legitimate needs will disturb daily business routines.

Similarly, holding excess cash is unwise because it can undermine the profitability of the organization.

The cash balance is the most unproductive asset of an organization. However, it is important because it
is used to pay liabilities. Thus, it is recommended that a reasonable cash balance be maintained to
optimize liquidity and profitability.
What Is Included in Cash Management?

The word cash is used in two senses: first, in a narrow sense referring to coins, currency notes,
checks, bank drafts, and demand deposits; and second, in a broader sense.

Cash in the broader sense refers to near-cash assets, including marketable securities and time deposits
with the bank.

These assets are considered cash in the broader sense because they can be converted into cash easily.

Thus, cash management deals with:

• Meeting cash disbursement as per the payment schedule

• Minimizing the idle cash balance

Problems of Cash Management

The following are the major problems that cash management seeks to address:

• Controlling the level of cash

• Controlling cash inflows

• Controlling cash outflows

• Optimum investment of surplus cash

1. Controlling the Level of Cash

The basic objective of cash management is to minimize the level of cash balance within the
organization. This can be achieved by preparing a cash budget.

2. Controlling Cash Inflows

Once the cash budget is prepared, the financial manager should ensure that a gap does not exist between
actual cash inflows and outflows. Due importance must be given to cash collection techniques.

3. Controlling Cash Outflows

Fast collection and slow disbursement of cash are helpful to control cash outflows. Cash collection
should be accelerated, while cash disbursement must be as slow as possible.

Outflows can be controlled if a centralized system for cash disbursement is used. Payments must be
made on the due date (i.e., not before and not after the due date).

4. Optimum Investment of Surplus Cash

Excess cash is the surplus cash available with the finance manager after meeting all outflows. Surplus
cash is the excess cash available over the minimum cash balance.

Such excess should be invested in the purchase of temporary (short period) investments.

The excess cash should be invested in securities where the funds are safe and liquid, and the fund should
be available whenever required.
BENEFITS / MOTIVES FOR HOLDING CASH OR OBJECTIVES OF CASH
MANAGEMENT

The following are the main objectives of cash management:

1. Useful in Making Payments According to a Schedule

The main objective of cash management is to ensure that a company's liabilities are paid on the due
date.

Payments and purchases may include raw materials, wages, salaries, interest, dividends, taxes, and
other routine payments.

2. No Danger of Insolvency

Sufficient cash holdings will increase the goodwill of the organization and ensure that it can pay
creditors and taxes on the due date. Hence, there is no danger of insolvency under effective cash
management.

3. Positive Relationship with Bank

A reasonable cash balance will be helpful in paying customers on the due date. This means that there is
no need to secure bank credit in the form of cash credit, bank overdrafts, and discounting bills.

4. Usefulness of Cash Discount

A reasonable cash balance will benefit large-scale purchases. In particular, payment of large-scale
purchases in cash can be useful in exploiting cash discounts.

5. Good Supplier Relations

A good cash balance is always desirable to ensure that suppliers are paid on the due date. This will
increase the creditability of the firms, which will yield benefits in terms of the organization's future
profitability.

6. Helpful in Odd Situations

When a firm has a reasonable cash balance, it can exploit odd and unexpected business situations.

For example, deflation occurs when there is a shortage of currency in circulation. In the context of
deflation, commodities will be cheaper, and so a firm with a sufficient cash balance can benefit by
purchasing commodities and other assets.

FACTORS AFFECTING CASH MANAGEMENT OR LEVEL OF CASH

The following are the factors that affect an enterprise's cash requirements:

1. Matching of Cash Flows

➢ Cash management is required in order to match cash outflows with cash inflows. The financial
manager should ensure that there is parity between the two.
➢ When cash outflows are greater than inflows, proper cash planning is needed; otherwise, the
firm will have to deal with the possibility of insolvency or closure.
2. Non-recurring Expenditure

These are the expenses needed to purchase or expand fixed assets. The planning of such projects occurs
every few years, and significant amounts of cash are usually needed around these times.

3. Cash-short Costs

These expenses are caused due to cash paucity. The cash budget is a forecast of cash requirements and
the specific period over which cash will be needed.

Examples of cash-short costs include the sale of securities, their brokerage, and the cost of borrowings
such as interest on debentures.

4. Cost of Excess Cash Balance

When a firm keeps more cash than its reasonable requirement, this will reduce the chances of investing
any surplus cash balance.

The organization may suffer from a loss of interest, which is known as the cost of excessive cash
balance.

5. Management Cost

These are the costs that are incurred for cash management, including salaries and clerical expenses.
Management costs are always of a fixed nature.

6. Uncertainty

There are cases when cash inflows may be uncertain (e.g., when payments have yet to be received from
debtors). Firms should keep some margin for such emergencies and uncertainties.

7. Repayment of Loans

The firm may be liable to redeem its long-term loans, and this must be kept in mind when estimating
cash requirements. In general, long-term loans are repaid by issuing either new shares or debentures.

8. Capacity to Borrow in an Emergency

When a firm has the ability to borrow in emergencies, it can operate with a smaller cash balance.

However, a firm's borrowing capacity depends upon its relationships with the banks, the nature of the
fixed assets to be mortgaged, the rate of interest, and the demand and supply of short-term loans.

9. Management Attitudes and Policies

The attitudes and policies of management with regard to liquidity, risk of insolvency, and credit
sales are largely affected by cash requirements.

Sometimes, management prefers liquidity over profitability, and in such situations, the cash requirement
will be high.

10. Efficiency of Management in Managing Cash

When a firm's management follows and practices the policy of realizing debts on the due date (not
before or after) and accelerating payments from debtors, smaller cash balances are acceptable.
What are the risks associated with Cash Management?

Cash management involves certain risks such as inadequate liquidity, credit risk exposure from
investments or loans, foreign exchange rate fluctuations, and interest rate volatility. Companies should
assess potential risks before creating a cash management program to ensure their strategy best meets
their business needs.

Who is responsible for overseeing cash management activities?

The CFO or other senior financial officer typically oversees the overall implementation of the
organization’s cash management strategy. However, in some organizations, the task may be delegated
to a treasury manager, who would then be responsible for day-to-day operations.

What type of activities does cash management involve?

Cash management typically involves activities such as budgeting, forecasting, analyzing cash flow
statements, and developing investment strategies. Additionally, it may include tasks such as collecting
receivables, managing accounts payable, and actively investing excess funds.

SPEEDING UP CASH RECEIPTS

You’ve got high sales numbers, but you’re still finding yourself short on cash. What’s the problem?

Shortening the time, it takes for you to collect receivables could be an easy solution. While getting paid
in full, up front, or in advance would obviously be ideal, that’s not the case with most business models.
Depending on the goods or services that you’re offering, it may require you to extend credit to your
customers. This is inevitable. We could see so many businesses that are just happy to get paid that they
don’t care when it happens. But an outstanding invoice that’s going to be paid in a few months won’t
help your cash flow problems that you’re dealing with today.

How to Speed Up Accounts Receivable Collections?

what you need to do to speed up the time it takes for you to collect your accounts receivables.

Increase Invoicing Frequency

When do you send invoices to your customers?

➢ If you’re waiting until the end of the week or the end of the month, you’re just extending the
time it takes for you to get paid.
➢ Sure, it might be easier to manage just one invoice per month as opposed to four or five. But
invoices should be generated and sent as soon as the goods or services have been delivered.
➢ If you’re shipping a product to a client on August 3rd, don’t wait until September 1st to send
an invoice. That customer might order another product on August 7th, but you can send a second
invoice for that order when it happens.
➢ For those of you who are doing projects at a large scale that take a long time to complete, you
can take advantage of milestone invoicing principles.
 ➢ Here’s an example. Let’s say Mohanraj & Co., is doing a construction project that takes six
months to finish. Rather than waiting six months to send a bill, you can invoice your client at
certain milestones along the way. This can be based on specific periods of time, goals, or
whenever you need to order more supplies. Just make sure these terms are agreed upon prior to
the project being started.

Generate Transparent Invoices

➢ Sometimes invoices aren’t paid simply because they are too vague or confusing. If you’re just
sending an amount due without an invoice date, due date, invoice number, or payment terms,
your customers may not know what to do.
➢ For the most part, people don’t like to go out of their way to pay money. So, don’t leave them
with questions like how they can pay or where checks should be mailed to.
➢ Another way to convey transparency is by itemizing your invoices.
➢ This is not a requirement for all businesses, but it can be helpful for some of you. By having a
brief description of each charge, it shows the customer exactly what they’re being billed for, so
they won’t have any doubts about the amount due or think that they’re being charged for a
product or service that they didn’t receive.

Offer Flexible Payment Options

➢ Not every customer will have the same preferred payment method. If you only accept cheque
or direct deposit, it may not be ideal for your clients.
➢ Maybe they only write cheque once per month and prefer to pay online or over the phone using
a credit card.
➢ By offering as many payment options as possible, it’s more likely that you can accommodate
all your customers.
➢ A client might be willing to pay as soon as they get the bill if your business accepts credit cards
online. But if you’re forcing them to drive to your office and pay with cash, you can’t expect
that to happen in a reasonable time frame.
➢ Its true that adding different payment options will potentially cost you more money in
transaction fees. But getting paid faster and improving your cash flow is well worth the
marginal cost.

Define a Credit Approval Process

➢ Don’t just blindly extend credit to anyone who wants to buy. Each individual customer should
have certain credit limits based on your approval process.
➢ Otherwise, a client can potentially end up with an outstanding balance that’s much higher than
you’re comfortable with.
➢ For those of you who have a sales team that gets rewarded for making sales, make sure someone
else in your company handles the credit approval process for their clients.
➢ If a customer has exceeded their credit limits or falls behind on payments, don’t be afraid to
limit their credit moving forward or prevent them from buying more until the balance is settled.
Follow-Up with Unpaid Invoices

➢ At first, it may feel awkward or uncomfortable. But you shouldn’t be afraid to ask for payment,
especially when it’s overdue.
➢ You can even follow-up with unpaid invoices before the due date to get paid faster.
➢ For example, let’s say you’re shipping physical goods to a customer on credit. As soon as their
order gets placed, an invoice gets automatically sent to them via email. Another copy of that
bill could be sent to them through the mail, or when with the product when it gets delivered.
➢ Then you can automatically send a payment reminder a week before the invoice is due.
➢ After the due date has passed, you should be sending weekly reminders until the balance has
been paid. This is part of establishing an effective invoicing process.
➢ Don’t assume that your clients are intentionally avoiding payment. That’s typically not the case.
➢ Sometimes an invoice could get lost in the shuffle or fall through the cracks. A friendly reminder
will usually be enough to get paid on time.

Offer Payment Incentives

Offering incentives varies for each business, but let’s say that by default, all your invoices are due
within 30 days of the time they are issued. But what happens if an invoice is paid in 4 days? Or what if
it’s paid in 60 days? If the amount of the bill doesn’t change for either of these scenarios, it doesn’t give
your clients an incentive to pay faster or on time.

➢ First, you could offer an early payment discount. For example, invoices paid within one week
will automatically get a 2% discount. For late payers, you could impose late payment fees.
Invoices that are paid after the due date will have additional costs.
➢ These types of monetary incentives will not only encourage your customers to pay on time, but
in some instances, they’ll have a reason to pay early.

SLOWING DOWN CASH PAYOUTS

The following points highlight the top six methods of slowing cash outflows.

They are :

1. Paying on Last Date

2. Payments through Drafts
3. Adjusting Payroll Funds
4. Centralisation of Payments
5. Inter-Bank Transfer
6. Making Use of Float.

# 1. Paying on Last Date:

The disbursements can be delayed on making payments on the last due date only. If the credit is for 10
days then payment should be made on 10th day only. It can help in using the money for short periods
and the firm can make use of each discount also.
# 2. Payments through Drafts:

A company can delay payments by issuing drafts to the suppliers instead of giving cheques. When a
cheque is issued then the company will have to keep a balance in its account so that the cheque is paid
whenever it comes. On the other hand a draft is payable only on presentation to the issuer.

The receiver will give the draft to its bank for presenting it to the buyer’s bank. It takes a number of
days before it is actually paid. The company can economies large resources by using this method. The
funds so saved can be invested in highly liquid low risk securities to earn income thereon.

# 3. Adjusting Payroll Funds:

Some economy can be exercised on payroll funds also. It can be done by reducing the frequency of
payments. If the payments are made weekly then this period can be extended to a month. Secondly,
finance manager can plan the issuing of salary cheques and their disbursements.

If the cheques are issued on Saturday then only a few cheques may be presented for payment, even on
Monday all cheques may not be presented. On the basis of his past experience finance manager can
deposit the money in bank because it may be clear to him about the average time taken by employees
in encashing their pay cheques.

# 4. Centralisation of Payments:

The payments should be centralised and payments should be made through drafts or cheques. When
cheques are issued from the main office then it will take time for the cheques to be cleared through post.
The benefit of cheque collecting time is availed.

# 5. Inter-Bank Transfer:

An efficient use of cash is also possible by inter-bank transfers. If the company has accounts with more
than one bank then amounts can be transferred to the bank where disbursements are to be made. It will
help in avoiding excess amount in one bank.

# 6. Making Use of Float:

Float is a difference between the balance shown in company’s cash book (Bank column) and balance in
pass book of the bank. Whenever a cheque is issued, the balance at bank in cash book is reduced. The
party to whom the cheque is issued may not present it for payment immediately.

If the party is at some other station then cheque will come through post and it may take a number of
days before it is presented. Until the time, the cheques are not presented to bank for payment there will
be a balance in the bank. The company can make use of this float if it is able to estimate it correctly.

What are the most common cash outflow activities in a business?

Cash outflows refer to the purchasing of goods and services, payments to creditors and taxes
paid. In small businesses, the most common cash outflow activities are payroll, inventory expenses,
loan payments, rent/lease payments, repayment of customer invoices, utilities, and taxes.

Examples for managing common cash outflow activities:

Payroll – usually the largest expense for a small business, payroll includes wages, salaries, bonuses,
and employees-related taxes and insurance. To ensure efficient allocation of payroll, it is important to
track wages, salaries or bonuses paid. Businesses should also ensure that all payroll taxes are paid in
full and on time.

Inventory Expenses – this category includes expenses associated with the purchase and storage of raw
materials and finished goods. Businesses can take steps to ensure inventory expenses are aligned with
business needs, such as implementing a re-order system to ensure regular shipments of items and using
inventory management software.

Loan payments – these include payments to lenders for loan repayments, mortgages, and other
financing charges. A sound financial strategy should include a strategy for loan repayment, such as
understanding current and projected cash flow to assess when the loan should be paid and what type of
financing should be used for repayment. Rent/Lease Payments – these usually consist of regular
payments made toward the rental or lease of a business premise. Businesses should research and
compare rental or lease terms before signing any agreement. It may also beneficial to negotiate a lower
or temporary rental rate or flexible payment terms.

Key Takeaways

➢ Review and analyze expenses, and eliminate unnecessary and non-critical expenses.
➢ Negotiate payment terms with vendors and suppliers, and implement cost-cutting measures.
➢ Consolidate spending through the use of a centralized procurement system.
➢ Set realistic budgets and account for seasonal trends.
➢ Plan for unexpected, larger-than-usual costs.
➢ Create contingency plans to help manage cash flow issues.
➢ Have a good understanding of expected outflows to determine cash needs.

What type of cash outflows should a business plan for in advance?

When developing a business plan, it is important to account for the cash outflows that the
business may incur. Cash outflows typically involve any purchases of goods or services that impact
cash flow, as well as loan repayments and any other outgoings. Planning for cash outflows in advance
can help with budgeting, financial forecasting and understanding cash flow movements.

Examples of key cash outflows include:

Operating expenses: recurring costs such as rent, utilities and payroll.

Orders: upfront payment for orders from suppliers, or wages to contractors for services.

Taxes: sales tax, excise tax, payroll tax and other taxes such as income tax.

Loan repayments: scheduled repayments for loans, such as mortgage payments.

Investments: purchase of assets such as new equipment.

Dividends: payments made to shareholders.

It is important to set realistic budgets, take into account seasonal trends, such as reduced
demand in certain months, and plan for any known one-off costs. Additionally, business owners should
prepare for unexpected, larger-than-usual costs and have contingency plans in place to help manage any
cash flow issues. Having a good understanding of expected outflows can help business owners
determine cash needs and create accurate cash flow projections.

How can a business reduce its cash outflows?

Cash outflows are the payments a business makes for its operations. Reducing cash outflows is a critical
component of improving a business's financial health and often requires an understanding of where
money is being spent.

To help businesses reduce their cash outflows, the following tips and examples should be taken into
consideration:

➢ Review and analyze expenses

➢ Eliminate unnecessary and non-critical expenses
➢ Negotiate payment terms with vendors and suppliers
➢ Implement cost-cutting measures
➢ Consolidate spending through the use of a central procurement system.
➢ By taking the time to review and analyze expenses and identify opportunities to reduce
spending, businesses can have a significant impact on their cash outflows.
➢ For example, a business might choose to eliminate non-critical expenses or renegotiate payment
terms with vendors and suppliers to reduce its monthly outflows.
➢ Additionally, cost-cutting measures can be implemented, such as reducing staff levels or
outsourcing non-essential tasks, while consolidating spending through the use of a central
procurement system can help reduce costs and simplify the payment process.
➢ Reducing cash outflows is an important step in improving a business's financial health.
➢ By following the tips and examples outlined above, businesses can make meaningful changes
to their spending and increase their financial flexibility.

What are the main components of cash outflows?

Cash outflows refer to the payments made by an organization to another business or individual. These
payments may include various features such as payments for goods/services purchased, payment for
wages and salaries, loan principal repayments, interest payments, taxes, and any other miscellaneous
expenses. In general, cash outflows are incorporated into financial analysis to compute the net income
or net profit of a company.

Cash outflows are typically classified into three main components:

a) Operating Cash Outflows :

Operating activities involve the daily operations of a business, for example, purchasing inventory,
paying for rent and utilities, producing goods, or providing services.

Examples of operating cash outflows include purchasing inventory, payment of wages and taxes, loan
payments, and rent.

b) Investment Cash Outflow

Investment activities involve the purchase of long-term assets such as property, plant, equipment and
other fixed assets.
Examples of investment cash outflows include purchase of both tangible and intangible assets, payment
of capital lease, and other similar payments.

c) Financing Cash Outflows

Financing activities involve the external sources of financing, such as borrowing and repayments on
borrowed funds, and repurchasing shares.

Examples of financing cash outflows include loan repayments, dividend payments, and repayment of
lease obligations.

It is important for organizations to track their cash outflows, and to plan for necessary cash payments
in a timely manner. By keeping detailed records of the organization’s cash outflows, businesses can
ensure that cash flows are sufficient for the day-to-day operations, and help mitigate any potential
shortfalls.

How are Cash outflows managed?

Cash outflows, or payments to creditors and other third parties, are a common challenge for businesses
and organizations. Managing cash outflows is critical for the financial health of any organization.

How to manage cash outflows effectively:

Develop a Cash Flow Forecast: A cash flow forecast identifies and predicts cash inflow and cash
outflow, which helps business owners stay ahead of repayment demands. Creating and managing a cash
flow forecast involves tracking sources of revenue, incoming payments, and outgoing payments. With
a well-defined cash flow forecast, businesses can anticipate the timing of their payments and plan
accordingly.

Prioritize Payments: Not all cash outflows are the same. Business owners must prioritize payments to
ensure that the most pressing or legally required obligations are satisfied first. This means evaluating
costs and assessing which are essential to the functioning of the business and will have the biggest long-
term implications for the organization.

Negotiate Terms with Vendors: Vendors often allow businesses to extend payments, especially during
periods of financial difficulty. Businesses should attempt to negotiate more favorable terms with
vendors, such as payment plans or discounts, to minimize the impact of cash outflows on the
organization's overall financial health.

By proactively managing cash outflows, business owners can reduce expenses and maximize
profitability. A thorough understanding of cash flow and the ability to make smart financial decisions is
essential for business success.

What are the Long-Term Implications of Cash Outflows?

Cash outflows are a necessary part of running any organization. The implications of outflows
range from the effect on cash flow to the impact on one’s credit score and overall financial health.
Companies should carefully consider all long-term implications of outflows before committing to them.

Below are several potential examples of long-term implications associated with cash outflows
and tips to keep in mind when strategizing:
a) Cash Flow model : Cash outflows have an immediate effect on the amount of cash available on
hand. Companies should make sure they have sufficient cash reserves to cover unexpected expenses
or unanticipated drops in revenue. Having a cash flow forecasting model can also help anticipate
potential cash flow crunches.

b) Credit Score: Cash outflows that are larger than one’s income can lead to the inability to make
payments and poor financial choices. Keeping track of expenses, income and debt payments is a
key component to effective cash management that can help protect one’s credit score.

c) Budgeting: Making and sticking to a budget is essential to avoiding overspending and other long-
term risks associated with cash outflows. Budgeting helps prioritize spending and suggests
strategies for making the most of available funds.

When deciding on cash outflows, companies should ensure that their decisions are both sensible
and fiscally responsible. It is important to factor in potential long-term risks related to cash flows in
order to maintain financial health and stability. With thoughtful planning, organizations can create an
optimal spending strategy while minimizing long-term financial risks.

Are cash outflows tax deductible?

In general, cash outflows are eligible for tax deduction provided they meet certain conditions.

These conditions include but are not limited to:

➢ The outflows must be related to business income.

➢ The outflows must be considered an ordinary and necessary business expense.

Tax deductible cash outflows are categorized as either

a) capital expenses
b) operating expenses.

Examples :

Capital expenses, which are depreciable over a period of time, include machinery, vehicles, and
buildings.

Operating expenses are generally expenses incurred to maintain and run the business such as utilities,
wages, or advertising.

Tips for deducting cash outflows:

➢ Be sure to track all receipts for cash outflows.

➢ Be sure to document the business purpose for all cash outflows.
➢ Be aware of any changing requirements from the Internal Revenue Service (IRS).

In summary, most cash outflows are tax deductible but some conditions must be met and receipts
must be maintained for these deductions. Knowing the broad categories under which cash outflows can
be classified and understanding the need to document receipts and purpose of expenses will provide
clarity and precision when filing taxes.
ELECTRONIC COMMERCE

Ecommerce, or electronic commerce, is the process of buying and selling goods and services over the
internet. It involves the exchange of products or services between businesses, consumers, or both.

Ecommerce can refer to business-to-business commerce or internal business transactions. It can also
apply to, for example:

• The online stores of multichannel retailers with brick-and-mortar locations

• Sharing economy platforms facilitating the purchase of services like rideshares

• Social media sites like Facebook where consumers engage with so-called social commerce.

As the ecommerce industry has developed, it has also grown to encompass related technologies that
facilitate the sales process, such as mobile payment platforms and secure data transfer technologies.

HISTORY OF ECOMMERCE

The origins of ecommerce

While ecommerce has expanded to touch nearly every aspect of business, the first known sale by an
ecommerce company occurred just two decades ago, when a New Hampshire-based online company
sold a Sting CD for USD 12.48 plus shipping in 1994. In the two years following that transaction, both
eBay and Amazon started. By December of 1999, the latter company had shipped 20 million items to
150 countries globally.

The dot-com boom of the late 1990s saw a proliferation of e-commerce startups as well as the
development of online marketplaces and retail websites. During this time, payment platforms like
PayPal were developed, paving the way for a new era of secure, instant online transactions. In 1996,
both Sam’s Club and Wal-Mart debuted online stores.The ecommerce market matured through the early
2000s as other brick-and-mortar retailers recognized the importance of online shops to complement
their physical businesses.

Widespread Adoption of ecommerce

In 2000, the grocery store Safeway made its first foray into home delivery by using online
platforms. Later in the decade, a collection of businesses based entirely on the ecommerce industry
started. These businesses, including Shopify and Magento, helped manage online storefronts. Around
this time, online advertising tools proliferated, allowing marketers to target potential consumers with
precise product suggestions.

The ecommerce industry continued to flourish. It became more complex with the introduction of
streaming services like Netflix, cryptocurrencies like Bitcoin, and a wide variety of sharing-economy
platforms and new payment companies. As mobile technologies became ubiquitous, ecommerce
vendors embraced location-based product recommendations and allowed consumers to shop for or sell
goods anywhere they happened to be. The ecommerce industry has also revolutionized the business of
global retail and trade: By 2016, almost all cross-border transactions had a digital component.
The ecommerce Explosion

The COVID-19 pandemic of 2020 influenced the role ecommerce plays in the global economy. In 2021
alone, the number of ecommerce websites grew from 9.7 million to 19.8 million. Today, there are
roughly 26.5 million ecommerce sites operating across the globe.

Today, retail ecommerce sales have risen to USD 6.3 trillion globally, and by 2026 they’re expected to
make up 24% of all retail sales. Advanced technologies such as artificial intelligence (AI) and machine
learning have again transformed the sector by enabling personalized recommendations, chatbots for
customer service, and predictive analytics.

Evolution of ecommerce strategies

Broadly, the above history of retail ecommerce can be understood through four distinct phases, each of
which has built on the one that came before it.

This evolution can be useful in understanding how and why multi-channel ecommerce solutions and
unified business processes have become the standard across industries:

a) Single-channel

Single-channel commerce is the historical mode of retail commerce as it’s existed for the last century.
In single-channel commerce, an individual purchases goods thought one distribution option (for
example, an online shopping cart, through a catalog, in the mail, or in a brick-and-mortar store).

b) Multichannel

Multichannel commerce has emerged over the last 20 years. It is the practice of selling services or goods
over multiple sales channels. This might include a brick-and-mortar store that uses an online store to
sell its products, or an online-only company operating on both a website and a mobile app.

c) Omnichannel

This type of ecommerce, also known as cross-channel commerce, has become a dominant strategy over
the last 10 years and a major ecommerce trend across industries. Building on multichannel strategies, it
aims to provide goods and services across multiple channels, but organizes those channels to be
complementary and coordinated.

UNIFIED COMMERCE

Unified retail commerce, the latest generation of ecommerce tactics, unifies all sales channels,
processes, and data into a single platform. Instead of coordinating channels across a business, unified
commerce consolidates all back-end processes, from inventory to advertising to sales, creating holistic
sales and marketing environments across platforms.

TYPES OF ECOMMERCE

There are several types of ecommerce, each catering to different types of transactions and participants.
As with other widely adopted technologies, ecommerce is in a constant state of flux and innovation.

The following are the primary types of ecommerce, followed by some emerging types within the
industry.
Primary types of ecommerce

Business-to-Business (B2B):

B2B ecommerce refers to transactions between businesses. In this model, businesses sell products and
services to other businesses. Business-to-Business (B2B) commerce encompasses a broad spectrum of
transactions, from raw materials procurement to finished product distribution and everything in
between. An example of B2B would be as between a wholesaler and a retailer or as between a
manufacturer and a wholesaler. Unlike Business-to-Consumer (B2C) transactions, B2B deals often
involve larger order quantities and more complex negotiations.

Top 20 B2B :

Reliance / Udaan/ Amazon / IndiaMART / ExportersIndia / Trade India / Ninjacart / Upscale /

LoadShare / Larsen & Toubro Limited

Business-to-Consumer (B2C): B2C ecommerce involves transactions between businesses and

individual consumers. It is the most common type of ecommerce, and includes online retail stores that
sell products and services directly to end-users.

Business-to-Government (B2G): B2G ecommerce involves transactions between businesses and

governments. Examples include government procurement portals where businesses can bid on contracts
to provide goods or services to government agencies or departments.

Consumer-to-Business (C2B): C2B ecommerce is the inversion of the traditional B2C model. In this
type of ecommerce transaction, individual consumers offer products or services to businesses. This
model is most often seen in freelance or gig economy platforms, where businesses can hire individuals
for various tasks or projects.

Consumer-to-Consumer (C2C): Consumer-to-consumer ecommerce involves transactions between

individual consumers. In this model, individuals sell products or services directly to other consumers
through online platforms. Examples include platforms Craigslist or Etsy, where individuals can buy and
sell used items or homemade crafts.

EMERGING TYPES OF ECOMMERCE

In addition to these primary types of ecommerce, other business models have emerged in recent years
that deepen or augment the foundational genres and will likely play an outsized role in the future of
retail. These includes:

Direct-to-consumer marketing: D2C marketing connects audiences directly with brands and can
facilitate community-building among customers, as well as involve them in the testing process.

Live commerce: Live commerce, popular in China, blends entertainment with the ability to purchase
goods instantly. During live commerce events, popular on the Chinese platform Alibaba, customers
watch a livestream broadcast that is synced with an ecommerce store.

Social commerce: Social commerce allows consumers to make purchases through social media and
content creation apps. This might include a live shopping event on TikTok or in-app retail purchases
through Instagram.
KEY COMPONENTS OF ECOMMERCE

While the central components of a successful ecommerce strategy vary widely between a small business
and a large international firm, there are some basic concepts that apply to nearly every ecommerce
solution.

Successful ecommerce strategies carefully consider how each of these aspects can best apply to the
needs of an individual business. Those components are:

a) Customer experience

Providing a seamless and streamlined user experience is crucial for the success of an ecommerce
business, from browsing to checkout. This might include intuitive website navigation, product search
functions, responsive customer support, or the ability to order a customized product online and pick it
up in-store. For omnichannel ecommerce businesses, this may also mean to ensure a customer
experience is consistent between mobile and web platforms.

b) Data analytics

Ecommerce platforms can collect significant data on consumer behavior, often in real-time.
Organizations can choose to let this data guide their inventory management or product offerings to
ensure customers and the business are always aligned.

c) Digital payments

Ecommerce transactions are facilitated through various digital payment options. This means that an
organization will likely need to engage several third-party integration and payment processes. This
might include credit cards, digital wallets, online currencies, or other web-based payment systems.

d) Logistics and shipping

Efficient supply chain management is essential for delivering products to customers in a timely manner.
Organizing an effective order management process might be as simple as ordering an item that a
customer requests on a case-by-case basis (as in drop shipping), or tightly integrating a manufacturing
base with the internet-of-things (IoT) to ensure the timely delivery of goods.

e) Marketing and promotion

As with any retail, ecommerce requires effective marketing and promotional strategies to attract
customers and drive sales. This might include search engine optimization (SEO), retargeted email
marketing, brand-building on social media, or other forms of advertising.

f) Mobile commerce (m-commerce)

With the proliferation of smartphones and tablets, a massive number of ecommerce transactions occur
on mobile devices. Mobile-responsive websites and dedicated apps allow customers to browse and
make purchases anywhere they are.

g) Online stores

Ecommerce primarily operates through online stores, digital platforms where businesses showcase their
products and services. These online stores can take various forms: They might be small independent
websites, large online marketplaces, sharing-economy platforms, or venues where customers make
online purchases.
h) Security

Security is a critical aspect of ecommerce, ensuring that transactions remain safe and sensitive customer
information is protected. Secure sockets layer (SSL) encryption, payment gateways, and secure
authentication mechanisms can all be deployed to safeguard personal and financial data.

WHAT TECHNOLOGY IS INVOLVED IN ECOMMERCE?

As ecommerce has grown, it has expanded to incorporate several discrete technologies and platforms
that ideally work in unison to create a seamless ecommerce ecosystem.

Some of the most common technologies that are involved in ecommerce are:

a) AI and machine learning (ML)

AI and machine learning have been increasingly deployed to augment the shopping experience for
ecommerce consumers. These tools may give product recommendations, respond in natural language
to service requests via chatbot, or provide personalized marketing messages based on a customer's
interests or prior purchases.

b) Customer Relationship Management (CRM) software

CRM software helps organizations manage customer data, interactions, or relationships by centralizing
data, unifying customer-facing processes, and prioritizing customer care.

c) Content management systems (CMS)

CMS platforms allow organizations to create, manage, and publish digital content. A CMS might
manage product listings, blog posts, or landing pages for an organization’s ecommerce business.

d) Data Analytics and Business Intelligence tools

A successful ecommerce business will collect and manage vast troves of customer data. To use that
data, an organization might deploy specific tools to gain insights into consumer behavior, sales trends,
or perform advanced analytics.

e) Ecommerce platforms

Designated ecommerce platforms provide ready-made infrastructure for product catalog management,
order processing, payment integration, and customer management. Depending on an organization’s
specific needs, it may opt to join an existing ecommerce platform or build its own from scratch.

f) Inventory Management Systems

Inventory management system, which may be integrated with CRM software or business intelligence
tools, tracks inventory levels and optimizes storage and distribution. Some inventory management
systems also automate certain processes like ordering based on sales or other variables.

g) Payment gateways and digital wallets

These technologies enable secure online transactions by processing payments. Some may integrate with
CMS or mobile technologies, allowing for seamless and secure payments between consumers and
businesses.

h) Security technologies
To protect sensitive consumer information and prevent data fraud, organizations implement an array of
security technologies. These might include encryption, tokenization, firewalls, and fraud detection
systems. Ecommerce companies may also invest in advanced data storage options to efficiently and
securely store collected data.

BENEFITS OF ECOMMERCE

As ecommerce has reshaped the business world, it has created significant value for organizations,
consumers, and the economy at large.

a) 24x7 accessibility

Unlike physical stores with fixed operating hours, ecommerce websites are accessible 24x7, enabling
customers and vendors to do business at their convenience regardless of time zone or location.

b) Customer insights

Ecommerce transactions and platforms generate valuable customer data on users’ behavior, preferences,
and purchasing patterns. Organizations can analyze these insights to make informed decisions about
marketing strategies and product offerings.

c) Economic growth

Ecommerce has contributed to economic growth by creating new business opportunities, stimulating
innovation, and fostering entrepreneurship in the digital economy. It has allowed for heightened
economic activity for those who might have been absent from the global economy, including
entrepreneurs in developing countries and female business owners.

d) Global reach

Ecommerce allows businesses to reach customers worldwide, breaking down geographic barriers and
expanding market reach beyond brick-and-mortar stores.

e) Low startup costs for small businesses

Running an online business typically incurs lower costs compared to maintaining a physical storefront,
saving money on rent and staffing. In this way ecommerce can level the playing field for small- and
medium-sized businesses, allowing them to compete on a global scale without investing in physical
infrastructure

f) Personalized shopping experiences

Ecommerce platforms use data analytics and AI technologies to provide personalized product
recommendations and targeted marketing messages, enhancing the shopping experience for customers.

g) Scale

For large businesses as much as small proprietors, ecommerce provides businesses with the opportunity
to scale their operations and reach a larger customer base, leading to potential increases in sales and
revenue.

h) Streamlined operations
If organized holistically, ecommerce can streamline various aspects of business operation including
inventory management, order processing, and payment processing. This can lead to increased efficiency
and an improved bottom line as disparate processes are centralized. According to the U.S. Census
Bureau, e-commerce sales totalled $253.1 billion during the first quarter of 2023, revealing that more
businesses are embracing e-commerce.

i) Global Marketing Reach

Unlike a physical store that limits a business to its geographical area, an e-commerce website allows
you to reach customers anywhere. Once customers can place orders online and you can ship a product
to their location or provide a service, there’s no limit to your reach.

j) Lower Operating Costs

Building an e-commerce website and maintaining it is cheaper than running a brick-and-mortar store.
You won’t need to rent retail space or a warehouse or worry about building maintenance or property
insurance. Plus, advertising online is cheaper, especially with organic blog posts and social media that
can drive traffic to your site.

k) Convenience and Flexibility

E-commerce websites provide flexibility for their owners and customers. You can offer a wide selection
of products while customers make round-the-clock purchases, regardless of their time zone or location.
And as a business owner, you can earn even while sleeping.

l) Easier Management

Customer segmentation and other marketing and sales processes are easier for an e-commerce business.
For instance, access to customer data (search and purchase history) combined with artificial intelligence
(AI) will give you insight into your target market and help you streamline your marketing strategies,
which increases your revenue. Also, you can expand your e-commerce business without the need to
relocate or renovate a physical store.

CHALLENGES IN ECOMMERCE

While implementing an online store or other ecommerce solution can be a massive boon to an
organization, building an effective online retail environment has its challenges. This has been
particularly true since the market grew drastically in the years after 2020.

Some of these challenges include:

a) Consistency across channels: As omnichannel ecommerce becomes the norm, it’s crucial to
ensure a consistent experience across platforms. This requires creating a seamless, cohesive set of
messages and customer interactions across various channels including social media, live chats,
email, ecommerce stores, and phone calls.

b) Data security: As ecommerce collects some of the most valuable information a consumer might
share – credit cards, bank accounts, and shipping addresses – it's imperative to create solid data
security practices with built-in redundancies and strong encryption. These processes should be
frequently tested to combat fraud, cyberattacks, and data breaches.
c) Global trade and compliance: Many ecommerce organizations sell goods over international
borders, meaning they’ll interact with myriad regional regulations. These might include data
protection laws (such as GDPR), product safety regulations, and local laws around taxation, all of
which need to be assessed and complied with.

d) Market saturation and rising consumer expectations: Particularly since 2020, when the
popularity of online shopping exploded, consumers have high expectations for vendors. Legacy
ecommerce organizations face competition from DTC outfits and smaller vendors, while customers
increasingly want perks like free returns and same-day shipping.

e) Supply chain management: Managing inventory and order fulfilment, depending on the size of
the business, can be a challenge in itself, particularly if an organization is engaging multiple
suppliers.

f) Technical issues: Downtime and technical glitches can be devastating for an ecommerce business,
not only in terms of lost sales but in consumer trust. Managing several channels at once and ensuring
a seamless customer experience is crucial for an ecommerce business.

DISADVANTAGES OF E-COMMERCE

Some businesses avoid e-commerce for the following reasons.

a) Limited Face-to-Face Interaction

Since there’s limited product experience, customers tend to buy products that don’t meet their
expectations or are challenging to use. For instance, a shoe might not fit a customer, or they become
frustrated when they find it hard to use a product. These expectation issues lead to buying indecisions
or refunds that can mess with a store’s inventory or even cost it some money.

b) Technical Challenges

Since e-commerce websites rely on technology, if you experience glitches, a website crash,
a cybersecurity attack or any of your integrated platforms (web builder, web hosting, inventory
management software, etc.) experiences downtime, your business suffers. Your website won’t allow
buying or selling, let alone completing a purchase.

c) Data Security Concerns

E-commerce websites often store customers’ card information to allow faster purchases in the future,
so if a site is hacked, threat actors can acquire such information. Customer data is compromised, and
the website loses sales from a damaged reputation. That’s if the store isn’t even closed down. Last year
alone, e-commerce businesses lost $41 billion to fraud.

MAJOR TYPES OF E-COMMERCE

E-commerce takes several forms. A company can sell to its customers, other businesses or the
government. Customers can also sell to businesses, government agencies or other customers. However,
there are four primary types of e-commerce that describe the electronic transactions that can take place
over the internet.
1. Business to Consumer (B2C)

This popular e-commerce model involves companies selling their products or services directly to the
end user, the consumer who needs it.

2. Business to Business (B2B)

This e-commerce type refers to the exchange that occurs between businesses. Here, an e-commerce
business sells to another business. An example is software-as-a-service, such as web
hosting or accounting software for smooth business operations. B2B e-commerce can also be raw
materials or machinery exchange over the internet.

3. Consumer to Consumer (C2C)

Some e-commerce platforms are like digital marketplaces connecting consumers. An example is eBay,
which allows a consumer to list and sell their products to another consumer.

4. Consumer to Business (C2B)

For this type of e-commerce, consumers sell their products and services to businesses. For example, a
photographer sells their photos to companies so that they can use them for ads or social media
campaigns.

HOW E-COMMERCE WORKS

E-commerce uses electronic channels to connect buyers and sellers. It works like a physical store—
customers visit your e-commerce store to browse your products and make a purchase. However, e-
commerce involves back-and-forth communication between your website and its server host.

10 top ecommerce companies :

Explain the process using a real time example : use any one of the top 10 ecommerce company to
explain the process.

Typically, e-commerce follows these steps:

1. A business lists its products and services.

2. A customer browses the catalog to choose what they want and then adds it to the cart.

3. The customer pays for the item using any of the available payment options.

4. The business receives the order on its dashboard.

5. The payment is processed, and the order is approved.

6. An order manager sends the order to the fulfilment department or warehouse to authorize a
dispatch.

7. The customer receives the notification of order approval and other details, including shipping
and tracking information.

8. The business ships the product or renders the required service.

STEPS TO START AN E-COMMERCE BUSINESS

1. Define your e-commerce business idea

➢ First and foremost, figure out what you’re going to sell.

➢ Ideally, you’d choose a product or service in a very specific niche.
➢ This way, you’ll have less competition and increase your chances of success.
➢ If you decide to sell clothing, for example, you can target young professionals with affordable
suits for young children with comfortable formal wear.
➢ Make sure that you’re passionate about whatever you’re trying to sell and/or can do or make
well.

2. Validate your idea

A business idea is only worth pursuing if you determine it’s actually viable. To do so, consider the
following:

• Market-based criteria: Market-based criteria focus on market factors that will impact your
business. It considers market size, competition, target customers and whether your products or
services are trends or part of a flat or growing market.

• Product-based criteria: Product-based criteria revolves around your products and services. It
examines your potential selling prices, size, weight and durability, how seasonality may affect
demand, product regulations and whether your product caters to a passion or solves a pain point.

Both market-based and product-based criteria can help you understand whether your products or
services have potential. If you believe that there is a market for your offerings, you can move on to the
next steps.

3. Write a business plan

Once you hone is on your business idea and validate it, it’s time to create a business plan. Think of your
business plan as a blueprint that outlines what you hope to accomplish and how you’ll get there. In
general, a business plan involves the following components:

• Executive summary: This is where you discuss your structure, industry, leadership team and
offerings.

• Competitor research: Competitor research is all about your competitors and their tactics.

• Product or service descriptions: Product or service descriptions explain what each offering is
and how customers may benefit from it.

• Marketing and sales strategy: The marketing and sales section should describe what you’ll
do to reach prospective customers and retain the ones you land.

• Financial projections: Here’s where you may want to work with an accountant to estimate
your pricing strategy and profit goals.

4. Set up your business

➢ After you solidify your e-commerce business idea and finalize a business plan,
you can take the plunge and set up your business.
 ➢ You’ll choose a business structure, name your business, apply for an Employer
Identification Number (EIN) and open a business checking account.
➢ It’s also a good idea to get all of the licenses and permits you’ll need to operate
legally. For help with the setup process, don’t hesitate to reach out to an
attorney, accountant or other professionals who can answer any questions you
may have and steer you in the right direction.

5. Develop or source your products

➢ Next, you’ll need to develop the products you plan to sell.

➢ If these are tangible products, you may make them yourself or leave the task to
a manufacturer.
➢ At this point, you should decide whether you prefer to produce or order your
products in bulk so you’ll have inventory in stock.
➢ You may decide to start small and only stock a few products until you get a
better sense for demand and determine whether bulk inventory makes sense.
➢ Another option is drop shipping, which is when products are manufactured and
sourced when orders are placed.
➢ If you’re selling professional services online, such as graphic design or
bookkeeping, you should zero in on what they’ll be and how much you’ll charge
for them.
➢ Drop shipping is a business model primarily used by e-commerce retailers that
do not stock the inventory themselves.
➢ It is a fulfilment method where a retailer receives orders for products listed on
the shop front, which are then forwarded to the supplier for shipping.

6. Create your e-commerce website

➢ Your e-commerce website will be one of your most important assets.

➢ Customers will visit your site to learn about you, explore your offerings and,
hopefully, make purchases.
➢ The easiest way to launch a site is through an e-commerce website builder, such
as Shopify or BigCommerce.
➢ While every builder is different, most of them allow you to market your
offerings, manage inventory, collect payments, ship orders, access analytics and
more.
➢ If you’re limited on funds or don’t want to invest too much in your business at
first, a free e-commerce platform can come in handy.
➢ You may always upgrade to a paid plan or platform as your business grows.
➢ Do your research and compare your options so you can figure out the best e-
commerce tool for your unique budget, preferences and goals.
7. Figure out order fulfillment

Fulfillment is an important part of your e-commerce store because it ensures your

customers receive the products or services they paid for. Fortunately, most e-commerce website
builders come with shipping label printing and allow you to automatically add shipping costs
at checkout. If you want to take the entire fulfillment process off your plate, you might want to
outsource it to a company. Just make sure your potential profits outweigh the fees they’ll
charge.

8. Market your e-commerce business

In a perfect world, you’d launch your e-commerce website and countless customers
would run to it. The reality, however, is that you’ll need to find, attract and convert your target
audience. While your marketing plan will depend on your budget, products or services, and
capabilities, it may include search engine optimization (SEO), social media marketing, paid
search, email marketing and/or influencer marketing. Regardless of which strategies you
choose, be consistent and establish a brand that allows you to stand out from your competitors.

TIPS FOR RUNNING YOUR E-COMMERCE BUSINESS

Once you have all your ducks in a row and your e-commerce store is ready for business,
keep these tips in mind:

• Focus on customer retention: It’s easier and less expensive to retain a current
customer than to land a new one. That’s why you should make every effort to keep your
customers coming back through excellent service, loyalty programs, exclusive
discounts and new products and services.

• Optimize your shipping strategy: While an e-commerce store offers many benefits to
customers, high shipping costs can turn them off. If possible, offer free shipping or
shipping deals for loyal customers or those who spend over a certain amount.

• Offer excellent customer service: In the world of e-commerce, the customer truly is
king. That means that you must be responsive and cater to customer needs and
preferences through friendly agents, live chat and 24/7 availability. Otherwise, your
reputation and profits will likely take a hit.

• Diversify your distribution channels: To raise your likelihood of success, go beyond

your website and use other channels to sell your offerings. Amazon, social media and
affiliate marketing are a few options to consider.

• Upsell and cross-sell: When you upsell, you encourage customers to purchase a
higher-end product or service than the one they were considering. A cross-sell is when
 you encourage customers to buy products that are related to complementary products.
Both strategies can boost profits.

To conclude, an e-commerce business can be very rewarding. It may give you the
opportunity to share your passions, interests or experience with customers near and far while
providing some great income. By following the steps and tips listed above, you’ll put yourself
on the path to success.

OUTSOURCING

What is Outsourcing?

➢ Outsourcing is a strategic decision by a company to reduce costs and increase

efficiency by hiring another individual or company to perform tasks, provide services,
or handle operations that were previously done by employees within the company.
➢ In other words, outsourcing is the practice of getting certain job functions done outside
a company.
➢ The process of outsourcing business functions is also called contracting out.
➢ Outsourcing can involve large third-party providers such as IBM for IT services or
simply hiring temporary office workers or independent contractors.

COMMON TYPES OF OUTSOURCED WORK

The type of outsourcing work depends heavily on the needs of the business and the industry
they operate in. The most commonly outsourced activities include:

➢ Content writing
➢ Customer support service
➢ Marketing
➢ Supply chain management
➢ Human resource management
➢ Accounting
➢ Engineering
➢ Research and design
➢ Computer programming services
➢ Tax compliance
➢ Finance
➢ Training administration

Examples of Outsourcing
Below are several examples of how companies outsource certain functions:
Example 1:
• Company A is rapidly growing and is in need of more office space. However, the
company is situated in a very expensive location and there is no room to expand. The
company can outsource some of the work that takes up office space (for example, data
entry or customer service support) to reduce the need for additional space.

Example 2:
• Company B enjoyed great success over the past year and is currently looking to expand
its product line. However, the company is constrained by a limited amount of workers.
Therefore, to expand its product line in-house, Company B would need to slow down
production on some of its existing products. The company can outsource the work to
an external local factory to lessen its labor constraint.

Example 3:
• Company C is a car manufacturer facing increasing raw material and labor costs.
Therefore, the profit margin on its manufactured goods is steadily decreasing as costs
increase. The company can outsource part of its production process, e.g., the
manufacturing and installing of windows in their cars. Assembling time and costs can
be saved by outsourcing an expensive production process to an external company that
can do it at a cheaper cost.

Example 4:
A manufacturer of personal computers might buy internal components for its machines from
other companies to save on production costs.

Example 5:
A law firm might store and back up its files using a cloud-computing service provider, thus
giving it access to digital technology without investing large amounts of money to actually own
the technology.

Example 6:
A small company may decide to outsource bookkeeping duties to an accounting firm, as doing
so may be cheaper than retaining an in-house accountant.

Example 7 :
Other companies find outsourcing the functions of human resource departments, such as
payroll and health insurance, to be beneficial.

Other Examples :

• Customer service: A company relinquishes the task of customer service to a

specialized company. Often call centres take over a certain call capacity for a fixed
price.
 • Marketing: A company outsources the support of social media channels to an external
service provider (e.g. an agency).
• Manufacturing of products: For many fashion companies it is too expensive to
produce clothes in the US. Therefore, they often opt for production in Asia. After
completed production, the clothing is then shipped to the United States.

When used properly, outsourcing is an effective strategy to reduce expenses and can even
provide a business with a competitive advantage over rivals.

REASONS FOR OUTSOURCING

The most common reasons to outsource include:

• Reducing operating, labor, and overhead costs
• Focusing more on the company’s core competencies, and thus improving its
competitive advantages by outsourcing time-consuming processes to external
companies
• Freeing up internal resources and using the resources for other purposes
• Mitigating risk by sharing risks with external parties and building meaningful
partnerships
• Improving flexibility and efficiency by delegating responsibilities that are difficult to
manage and control to external companies.
• Increased efficiency: Companies can concentrate on their core competencies and work
more efficiently.
• Optimal scalability: Outsourcing increases the availability of labor. As a result,
maximum output can be achieved and production guaranteed – even in the event of
seasonal or non-operational capacity fluctuations.
• Quicker response: You are more responsive to change because you can pass these
tasks on to specialized third-party companies.
• Quality improvement: Outsourcing often brings quality improvements. For instance,
in manufacturing a good factory or workshop can improve the quality of products.
• Save costs: External companies have a high degree of specialization with regard to their
services. They can work much more cost-efficiently and therefore offer discounted
rates.
• Lack of know-how: New processes and operations in companies are often necessary,
but the employees often lack the know-how and implementation skills required.
Outsourcing is an alternative to hiring skilled workers for this.

DISADVANTAGES / CRITISISMS OF OUTSOURCING

Although there are several reasons to outsource, there are also disadvantages to the practice,
such as:
 1. Risk of losing sensitive data and the loss of confidentiality by outsourcing activities or
processes to external parties
2. Loss of management control and the inability to control operations of activities or
processes that are outsourced
3. Outsourcing companies may impose hidden or unexpected costs by creating lengthy
contractual agreements with lots of fine print
4. Lack of quality control, as outsourcing companies are often profit-driven rather than
focused on doing a good job.

Advantages Disadvantages
Core competencies: The company can focus Dependence: You make yourself dependent
on its core competencies. on the respective service provider. If the
service provider gets into economic
difficulties, for example, this can mean
consequential costs for your company.
Cost reduction: The provision of external Loss of knowledge: One consequence of
services is generally more cost-effective than outsourcing is the loss of employee know-
the employment of specialized employees in how.
one's own company.
Time savings: Small businesses and the self- Data protection: Outside service providers
employed need a lot of time to familiarize may gain an insight into sensitive corporate
themselves with new areas of business. data.
Outsourcing saves time and enables
investment in other areas.
Improving quality: The use of outsourcing Expensive reintegration: If you have
strategies often results in qualitative outsourced certain tasks, a later reintegration
advantages. These advantages are due to the into your company can be very time-
high degree of specialization of external consuming. The implementation is
service providers. expensive, time consuming and requires
suitable staff.

Key Takeaways
• Companies use outsourcing to cut labor costs, including salaries for their personnel,
overhead, equipment, and technology.
• Outsourcing is also used by companies to focus on the core aspects of the business,
spinning off the less critical operations to outside organizations.
• On the downside, communication between the company and outside providers can be
challenging, and security threats may increase when multiple parties can access
sensitive data.
• In some cases, companies will outsource as a means to move things around on the
balance sheet.
OUTSOURCING SERVICES
Outsourcing is a business practice in which services or job functions are hired out to a third
party on a contract or ongoing basis. In IT, an outsourcing initiative with a technology provider
can involve a range of operations, from the entirety of the IT function to discrete, easily defined
components, such as disaster recovery, network services, software development, or QA testing.

TYPES OF OUTSOURCING SERVICES

Companies may choose to outsource services such as

a) onshore (within their own country),
b) nearshore (to a neighbouring country or one in the same time zone), or
c) offshore (to a more distant country).
Nearshore and offshore outsourcing have traditionally been pursued to save costs.

Outsourcing services

Business process outsourcing (BPO) is an overarching term for the outsourcing of a specific
business process task, such as payroll.

BPO is often divided into two categories:

a) back-office BPO, which includes internal business functions such as billing or

purchasing, and
b) front-office BPO, which includes customer-related services such as marketing
or tech support.

IT outsourcing is a subset of business process outsourcing, and it falls traditionally into one
of two categories: Infrastructure outsourcing and application outsourcing.

d) Infrastructure outsourcing can include service desk capabilities, data center

outsourcing, network services, managed security operations, or overall infrastructure
management.
e) Application outsourcing may include new application development, legacy system
maintenance, testing and QA services, and packaged software implementation and
management.
f) Today, however, IT outsourcing can also include relationships with providers of
software-, infrastructure-, and platforms-as-a-service. These cloud services are
increasingly offered not only by traditional outsourcing providers but by global and niche
software vendors or even industrial companies offering technology-enabled services.

DIFFERENT FORMS OF OUTSOURCING

There are different distinguished forms of outsourcing:

• Business process outsourcing: In business process outsourcing, entire company

processes are outsourced. An example of this: you can have your employees' payroll
created by an external service provider.

• Knowledge process outsourcing: In this type of outsourcing, complex tasks are

outsourced to a third-party company. An example of this can be the preparation
of search engine optimized texts for your website. The respective company usually
has trained experts with a high degree of specialization.

• Out-tasking: In this case, only individually-defined tasks are handed over to another
company. Often it is because they are time-consuming and administrative processes,
 such as the archiving of e-mails or data backup. However, the responsibility for this
remains with the company, as the whole business area continues to be managed
independently.

• Selective outsourcing: Selective outsourcing mixes business process outsourcing and

out-tasking. Distinct sub-areas are outsourced which are more extensive than
individual tasks, but nevertheless do not correspond to a complete process.

PROS & CONS OF OUTSOURCING

Top IT outsourcing companies

According to global research firm and consultancy Everest Group’s annual rankings, the top
10 IT outsourcing services providers are:
➢ Accenture
➢ TCS
➢ CapGemini
➢ Wipro
➢ HCLTech
➢ Cognizant
➢ Infosys
➢ NTT
➢ IBM
➢ LTI/Mindtree (new entrant of merged entity)
IT OUTSOURCING MODELS AND PRICING

The appropriate model for an IT service is determined by the service provided. Most
outsourcing contracts have been billed on a time and materials or fixed price basis. But as
outsourcing services have matured to include strategic transformation and innovation
initiatives, contractual approaches have evolved to include managed services and outcome-
based arrangements.

The most common ways to structure an outsourcing engagement include:

PRICING MODEL ENGAGEMENT DETAILS

Time and materials The client pays the provider based on the time and materials
used to complete the work. Historically, this has been used in
long-term application development and maintenance contracts.
It can be appropriate when scope and specifications are
difficult to estimate or needs evolve rapidly.
Unit/on-demand pricing The vendor determines a set rate for a particular level of
service, and the client pays based on its usage of that service.
Pay-per-use pricing can deliver productivity gains from day
one and makes component cost analysis and adjustments easy.
But it requires an accurate estimate of the demand volume and
a commitment for minimum transaction volumes.
Fixed Pricing Here, price is determined at the start. This can work well when
there are stable requirements, objectives, and scope. Fixed
pricing makes costs predictable, but when market pricing goes
down over time, a fixed price stays fixed. It is also hard on the
vendor, which must meet service levels at a certain price no
matter how many resources those services require.
Variable pricing The customer pays a fixed price at the low end of a supplier’s
provided service, but this method allows for variance in pricing
based on providing higher levels of services.
Cost-Plus The client pays the supplier for its costs, plus a predetermined
percentage for profit. Such plans do not allow for flexibility as
objectives or technologies change, and it provides little
incentive for a supplier to perform effectively.
Performance-based Here, financial incentives encourage the supplier to perform
pricing optimally. This type of pricing plan also requires suppliers to
pay a penalty for unsatisfactory service levels. This model is
often used in conjunction with a traditional pricing method,
such as time-and-materials, and can be beneficial when the
customers can identify specific investments the vendor could
make in order to deliver a higher level of performance.
Gain-sharing Pricing is based on the value delivered by the vendor beyond
its typical responsibilities. For example, an automobile
manufacturer may pay a service provider based on the number
of cars it produces. With this kind of arrangement, the
customer and vendor each have skin in the game, and each
stands to gain a percentage of profits if the supplier’s
performance is optimum and meets the buyer’s objectives.
Shared risk/reward Provider and customer jointly fund the development of new
products, solutions, and services with the provider sharing in
rewards for a defined period of time. This model encourages
the provider to come up with ideas to improve the business and
spreads the financial risk between both parties. But it requires a
greater level of governance to do well.

KEYS TO A SUCCESSFUL OUTSOURCING RELATIONSHIP

• When it comes ensuring a successful IT outsourcing outcome, the customer has more
impact than you might think.
• In fact, recent research conducted by outsourcing consultancy ISG found that outsourcer
and client are equally responsible for outsourcing results — regardless of whether the
relationship succeeded or faltered.
• Clients have a huge impact on the effectiveness of the sourcing relationship at all levels.
• And the customer’s role is even more significant as companies embark on
transformation-enabling deals.
• It was estimated that 70 percent of outsourcing clients focused on transformation
efforts fail to design their outsourcing relationships for long-term satisfaction.

Following are actions an outsourcing buyer can take — from the outset of an
outsourcing engagement and throughout — that will increase the likelihood of getting the
best from their IT service providers.

a) Focus on the provider’s core competencies

“The way you manage, measure and maximize value is not by segmenting providers
based on volumes or scale, but by their role in your portfolio.
• Some are best suited to staffing augmentation. Others are legacy aggregators.
• Some are ecosystem orchestrators.
• Others are capable transformation providers.
• Don’t force a square peg into a round hole.
• Slotting the right partner for the right role is key to success,”
• Cultural fit is also critical.
• Technology is the ‘easy’ part,”.
• Aligning culture and values can supercharge an outsourcing relationship.
b) Create a service delivery framework
• Unfortunately we have seen many outsourcing partnerships do not work
because there is not an adequate understanding of the role the retained
organization needs to play.
• Establishing a service delivery framework up front and using that framework to
identify the services that are going to be outsourced versus retained helps align
both sides on the capabilities, processes and functions needed to deliver end-to-
end services.

c) Take care in setting up the contract and the relationship

“Whether it is in preparing business stakeholders for the new way that services will be
delivered, or in the careful construction of meaningful contracting components — clients
often rush to an outcome and have to face the challenges of the unresolved services and
relationship aspects after go-live,”. Thus, Focus on getting the contract right, ensuring
business stakeholders understand it, and the IT team is focused on making the relationship
work.”

d) Spell out all expectations

• Ensure that any technology transformations you are expecting (for example,
cloud enablement) are explicitly included in the contract and not assumed as a
part of the natural progression and evolution of the service delivery.
• If transformation services are not clearly articulated in the contract, then they
will not be part of the delivery.

e) Agree early on about key staff, governance, metrics and engagement

• Most enterprises get less than what they could from their sourcing
relationships,” Thinking differently about the services at the start, and the
relationship over the long term, is critical.
• Customers should make sure the right front-line staff is in place at both client
and provider, define processes to guide problem solving, create meaningful
service levels, and ensure enterprise stakeholder engagement.
• As services become more digital, and more focused on DevOps and agile, the
provider must become a trusted partner with a significantly deeper integration
into the business and services platforms.
• This drives the need for a deeper commitment to organizational change
management and governance — and emotional intelligence during the
relationship.
f) Go beyond vendor management
• Don’t handle outsourcers like just any other vendor. A transactional approach
will yield tactical results. “Nobody likes to be treated like a service provider.
• In complex services, a vendor management approach may be useful for some
details. But a significantly deeper relationship that encourages trust, openness
to ideas, incremental improvements, and innovation will make all the
difference.”
• Outsourcing customers can start by focusing on working toward a single
improvement or innovation with their outsourcing partner.
• “Get a small victory in one area, then move on to grow your expectations of
your IT team and provider.
• If you create an environment for innovation, you will realize significant benefits
— both your team and the provider’s team.”

g) Let them in
• If you want a strategic partner, you have to treat the provider as such, integrating
them into the business value chain and sharing business strategy, direction,
priorities and pain points.
• If your supplier doesn’t understand your strategy, how can you expect them to
align with that strategy.
• It’s also important for clients to be honest about the state of their environment
so that the provider can adequately accommodate those issues and mitigate
associated risks.
• Often, customers aren’t candid because they’re afraid [of] disclosing details
about how bad their systems are or how difficult the incumbent will be to work
with during the transition. “But all this does is delay the difficult conversation.”

h) Mind the what, not the how

• Don’t micromanage your provider.
• The most successful outsourcing customers focus not on how the provider
delivers the service, but on whether they are delivering outcomes and adhering
to agreed-upon processes.
• Be open to adapt to the providers’ model and best practices and recognize the
value that they can bring to the table.
• By being overly prescriptive, you lose that value.”

i) Take care of your side of the street

• In the context of transformation deals in particular “for a client to capture value,
they need to not only put mechanisms in place to manage the service providers,
but also reassess how they are structured and aligned to capture value.
• Culture and change management are critical in determining the success or
failure of transformation initiative.
 • That is 100 percent an enterprise’s own priority, and making an outsourcing
arrangement that focuses on transformation succeed needs to be the customer’s
shared responsibility.
• In any deal, governance and day-to-day management are key success factors.
• Take a look at your retained team and ensure they have the requisite skills to
manage service providers to deliver to outcomes.
• Too often we have seen that the retained team is the one that was formerly
responsible for functions that were outsourced and lack the skillsets necessary
to manage the outsourced provider.

j) Don’t squeeze your provider on price

• You will, most certainly, get what you pay for — and pay dearly for nickling
and diming a so-called strategic partner.
• The logic is simple: If a supplier isn’t making enough money, they will find
ways to make money, and that will compromise the effectiveness and quality of
the service in some shape or form.
• Savvy customers consider reinvesting some outsourcing savings back into the
relationship to incentivize the partner to engage in more value-added work.

k) Refer to the contract only as a last resort

• A good relationship is not one that does not have any issues.
• It is one where issues get resolved quickly.
• In the best cases, that will happen without having to haul in the lawyers.
• But, always have an exit strategy in your back pocket to overcome in case of
any requirements.

THE RIGHT APPROACH FOR OUTSOURCING:

Do you think that outsourcing is the best strategy for your business, but you don’t know
how best to proceed? Simply put, there is no single right approach to outsourcing a project.
Just as companies are different to one another, so too are outsourcing strategies. However,
the following best practice method has already proven itself in many situations:

1. Analyze the current state: Analyze the actual state of a task, a sub-region or a business
process. From the analysis, you can determine the best further course of action and
estimate the potential of an outsourcing strategy.
2. Prepare: Organize a kick-off meeting with all of your company's stakeholders to get
the most out of your outsourcing project. In the meeting, you can lay the foundation for
future joint work. It should highlight and discuss the benefits of the project, the content
and timing of the project, and the next steps.
3. Select a service provider: Compare potential service providers with each other. For
the selection and interaction with potential service providers you need a product
 requirement and a scope statement. In product requirement documents you record all
basic requirements as well as the rough project concept. However, in scope statements
note down the corresponding solutions and detailed requirements. On this basis, service
providers can come up with new solutions or develop existing ones. In addition, you
can avoid possible misunderstandings.
4. Stick to your implementation timeline: Once the contract has been concluded,
implementation can begin. Important: agree on a concrete timetable for implementation
in the contract. As part of the project management, regularly check to see whether
contractually agreed milestones are reached.

Mistakes to Avoid

Outsourcing is a complex process, which is why there can be mistakes in its implementation.
Even comprehensive planning cannot guarantee a smooth process. Here we look at some of the
most common mistakes so that you avoid them:

• Wrong outsourcing partner: Companies can choose between different outsourcing

partners depending on the subject: specialized manufacturers, agencies or self-
employed. However, a satisfactory result requires a careful selection of the business
partner.
• Arbitrary outsourcing: Arbitrarily outsourcing tasks may save you work, but rarely
makes sense. Not only from an economic perspective, it is best to first analyze the
different fields and activities of your own company in detail and then make a decision.
• Inaccurate agreements: Unclear arrangements will often mean you as a business are
not satisfied with the results. Therefore, it is important to specify in advance what
exactly is being outsourced and how or to what extent the specified criteria will be
monitored.
• Bad contracts: An outsourcing contract should document outsourced tasks and
mutual obligations. Unclear questions can lead to misunderstandings.

Outsourcing abroad: what is important?

Do you want to outsource part of your work processes and hire a company or service
provider abroad? Be sure to consider these three factors:
• Time difference: with the help of digitization, you can collaborate with freelancers
from around the world. But in the case of an urgent assignment or spontaneous meeting,
the time difference can be a difficulty.
• Language barriers: Fluent English is one of the most important prerequisites for
outsourcing abroad.
• Working method: Techniques and approaches are not the same in all companies. It is
likely that a company on the other side of the world might address a problem differently
to the way you are used to.
FACTORING

What is FACTORING in Finance?

Factoring in finance is a source of immediate capital. It is acquired in exchange for accounts
receivable. Hence, it is a financial arrangement between a financial institution (factor) and a small or
medium-sized firm (client). A factor purchases trade debts or receivables from a client firm at a
discounted price.

Factoring involves three parties:

i. A Factor : is the financial institution that offers finance to a client (in exchange for
receivables).
ii. A client : client is the firm that sells its goods and issues bills of receivables
iii. A Debtor : is the party who owes the trade debt and ends up paying the factor instead of
the original business.

CHARACTERISTICS OF FACTORING

1) Usually the period for factoring is 90 to 150 days. Some factoring companies allow even
more than 150 days.
2) Factoring is considered to be a costly source of finance compared to other sources of short term
borrowings.
3) Factoring receivables is an ideal financial solution for new and emerging firms. This is because
credit worthiness is evaluated based on the financial strength of the customer (debtor). Hence
these companies can leverage on the financial strength of their customers.
4) Bad debts will not be considered for factoring.
5) Credit rating is not mandatory. But the factoring companies usually does the credit risk analysis
before entering into the agreement.
6) Factoring is a method of off balance sheet financing.
7) Cost of factoring = finance cost + operating cost. Factoring cost vary according to the
transaction size, financial strength of the customer etc. The cost of factoring varies from 1.5%
to 3% per month depending upon the financial strength of the client’s customer.
8) Indian firms offer factoring for invoices as low as Rs. 1000
9) For delayed payments, beyond the approved credit period, a penal charge of around 1-2% per
month over and above the normal cost is charged (it varies between 1% for the first month and
2% afterwards).
PROCESS INVOLVED IN FACTORING / HOW DOES INVOICE FACTORING WORK?

A typical procedure of factoring an invoice looks somewhat like this:

• The seller or the supplier is in urgent need of cash and cannot wait for the said number of days
to receive payment so the company approaches the factor.
• The factor asks for some basic details. In India, all factoring companies ask for basic KYC
details to check background and company history.
• The factor checks the companies financials, number of shipments undertaken, the buyer's
purchasing history and either approves the onboarding or disapproves the application.
• Post approval, the borrowing company may be onboarded onto the factoring platform, where
the company can add the details of the buyer and factor the invoices as per his/her convenience.
• The factor will make payment an upfront payment (which is generally 80%-90% of the invoice
value to the seller).
• The remaining amount will be sent to the seller after deducting the necessary charges after the
financial institution receives the payment.

TYPES OF FACTORING IN FINANCE

Factoring is a financial tool that provides the seller of goods (client) with an advance against the
accounts receivable. It improves liquidity, leads to better working capital management, and is also easier
to obtain than traditional bank finance, especially for small and medium enterprises.
There are various types of factoring in financial services, and businesses can choose the one most
suitable for them based on the exigencies of the businesses; factors like collateral, location of the
factoring services, payment terms & the track record of the company providing the factoring services.

Factoring is a popular mode of financing for businesses. There are different types of factoring depending
on a business’s specific needs. These include:
Recourse and Non recourse Factoring
In recourse factoring, sellers remain liable to factors on the debt until buyers clear all
outstanding dues. Factors remain free of bad-debts-related risks. Under recourse factoring, the factor
does not assume the credit risk or the risk of default by the customer. Credit risk is the risk of customers
defaulting on their payment obligation. If the customer does not pay the dues on the due date, the factor
will seek recourse against the client and exercise the right to recover the amount from the client. The
factor provides sales ledger management services; however, the client bears the credit risk.

In a non-recourse arrangement, the Factor assumes the credit risk and liability of non-payment
on a factored invoice. In non-recourse factoring, the factor bears the credit risk in addition to providing
other services. Thus, even if the customer defaults on the due date, the factor cannot claim the amount
back from the client. Naturally, the fees charged for non-recourse factoring services are higher than
those for recourse factoring as they involve the cost of bearing the risk of non-payment by the customer.
The pricing in the case of non-recourse factoring tends to be on the higher side.

Domestic and Export Factoring

Quite simply, factoring transactions where both the buyer and the sellers are in the same country
is called domestic factoring. Domestic factoring involves three parties - the client (the seller), the
customer (the buyer) and the factor (the financial entity). All the parties are located in the same region.
Domestic factoring is also far easier to operate and execute since cultural, legal and trade barriers
between the trading parties are more or less similar.

An export factoring transaction can also involve a third factor in the importing country
(although not always necessary). A company specializing in export factoring needs to have a global
expertise in several industries, a strong understanding of international trade processes and the ability to
make disbursements in different currencies. The factoring solutions for export transactions requires a
much more deeper skill set, understanding of international trade processes, and a strong global presence
and network of buyers and sellers. In export factoring there may also be an additional party - the import
factor (factor located in the customer’s region) in addition to the client, the customer, and the export
factor (in the client’s region). The import factor is responsible for services like determining
creditworthiness and credit limit for the customer and collecting money from the customer on the due
date and remitting it to the export factor.

Disclosed and Undisclosed Factoring

In Disclosed factoring, the buyers also have thorough knowledge and understanding of the
factoring arrangement. Disclosed factoring is also called bulk factoring or notified factoring. Under
disclosed/bulk/notified factoring, the factor immediately discloses the fact of assignment of debt by the
client to the buyer/importer. The supplier places a notice on the buyer/importer’s invoice instructing
them to make payment directly to the factor. This is usually referred to as the Notice of Assignment.
In a non-notification or non-disclosed factoring or confidential factoring deal, the buyer is
completely unaware of the vendor’s financing arrangement with the factoring company. The factor only
provides an advance against invoices. The customer makes the payment directly to the client without
being aware of the factoring agreement. The client collects the payment from the customer and remits
the due amount to the facto. Some businesses prefer this type of factoring as it allows businesses to deal
directly with the customers and establish a better relationship. In the case of undisclosed factoring,
buyers are unaware of the factoring arrangement.
Spot versus Regular Factoring

Spot factoring is when the client and the factor enter into a factoring arrangement for one single
specific transaction. Under the factoring arrangement, the factor and the client have an ongoing
relationship.
Regular factoring usually has an approved limit. The client can draw an advance amount based
on the issued invoices up to this limit. Usually, a factor prefers regular factoring and perceives it to be
less risky than a spot factoring arrangement.

Maturity and Advance Factoring

Maturity factoring or collection factoring is a process where the factor pays the seller on or
after the invoice maturity date. Maturity Factoring is also referred to as wholesale factoring /
collection factoring ,as the supplier that avails maturity factoring typically operates in the capacity of a
wholesaler in the market. Under this type of factoring, the factor collects dues from the customer. It
passes the agreed upon share to the client usually on the maturity date of each month's sales invoices.
Sometimes the due date can be a fixed date, usually pre-decided, based on the average payment period
taken by the supplier. The factor takes care of everything related to bookkeeping, collecting, and
recording of payments over time. Maturity factoring can be with or without recourse as per the terms
and conditions of the contract.
Under Advance factoring arrangement, a factor pays 75% - 90% (as per the contractual
agreement) of factored receivables in advance to the client. This is done within a couple of working
days from the presentation of the invoice to the factor. The balance amount is paid on the guaranteed
payment date on the realization of money from the customers, as per the contract. The factor charges
an agreed rate of interest for the advance payment made to the business. This interest is called a discount.
This discount charge depends upon various factors like short-term rate, turnover, the financial standing
of the business, etc. The business may opt for advance factoring if it needs immediate liquidity.
However, if there is no immediate requirement of cash for invoices, then the business may opt for
maturity factoring. Both types of factoring can be with or without recourse. Here, the factor pays the
seller as per the pre-agreed interest rate against the yet-to-be-collected receivables.

Reverse Factoring
Reverse factoring is a financing arrangement that the buyer initiates to offer early payment to
sellers or suppliers. This is a different kind of factoring that is initiated by the buyer or the importer. It
is also called supply chain financing. The customer arranges the factor relationships such that the client
gets invoice financed upfront. Sometimes even the fees for the same are borne by the customer. Reverse
factoring is usually seen in transactions where the customer is a medium-sized or a large entity, and the
client is a small or medium enterprise. With factoring, the client gets immediate liquidity which could
be critical for business and the buyer gets more time to pay the invoice.

Full-Service Factoring

In full-service factoring (also known as full factoring), the factor performs a full range of services,
including maintaining a sales ledger, sending regular statements of accounts to the client, collection of
receivables, and credit control - gauging the creditworthiness of the customer, deciding credit limits and
credit insurance for bearing the credit risk.
Full-service factoring is also known as Old Line Factoring. Businesses prefer it as it eases pressure on
the accounting division and frees up the company's scarce resources, which can be put to optimal use.
Given the entire gamut of services, this type of factoring charges the highest rates for services. Beyond
the discount charges (interest charges), the administrative cost of factoring ranges between 0.5% to
2.5% of receivables.

Bank Participation Factoring

In most factoring solutions, not 100% of the invoice value is paid out to the supplier. The factor typically
keeps a buffer amount and advances upto 80% of the invoice value.
While this is generally acceptable to most exporters or suppliers, sometimes, suppliers need to tap into
a wider pool of resources to combat a working capital crunch.
This is where bank participation factoring plays in wherein, the bank will fund a certain % of the
unadvanced amount to the supplier.
For example: If company Y has factored 80% of its invoice or Rs 100,000 with Factor X, factor X would
have advanced only Rs 80,000, the rest will be paid out when the factor receives the payment from the
buyer. In such a case, the factor can enter into a separate agreement with a bank and avail a loan, which
is typically at a % of the unadvanced amount (Rs 20,000)

Limited Factoring
Limited factoring, also known as selective factoring, is when the factor manages selective invoices of
the client and not all. The factor discounts the selected invoices on a merit basis and remits cash
collected only against the selected invoices. The selection may be based on a set of criteria determined
by the factor, including credit risk assessment, cost considerations, processing capacity, etc. Sometimes
the factoring may be buyer based. In buyer based factoring, the factor maintains a list of the buyers
(customers) whose receivables would be factored without recourse to the seller.

Supplier Guarantee Factoring

This type of factoring is also known as ‘drop shipment factoring’ or vendor guarantee factoring or
supply chain factor. Supplier guarantee factoring is a tri-party agreement that involves one additional
party - the borrower’s supplier. The supplier could be a supplier of raw material for a huge order, or the
client could be a distributor. The factor guarantees to pay the supplier once the shipped goods are
accepted by the borrower’s buyer.
The funds generated from factoring the invoice are directly paid to the supplier. The supplier is
paid out of the client’s future receivables. When the factor receives payment from the customer on the
due date, they deduct the fees and the charges and remit the profit to the client. Thus, the factor plays a
dual role in this type of transaction - giving a guarantee for payment to the supplier and, providing the
factoring services to the business.The biggest benefit of this type of factoring is that companies can
undertake new business opportunities that were not previously achievable, due to a lack of available
credit from suppliers.

International Factoring

Other than these, Importers and Exporters engage in cross-border trade and sell their accounts
receivables to a factoring company (factor) called International Factoring. International factoring is a
practice wherein companies engaged in cross-border trade can sell their accounts receivables/or trade
receivables to a factoring company (factor) in exchange for an immediate advance on the invoice
amount. The amount is owed by the foreign company and the company availing the factoring service
can be paid in a foreign currency of their choosing.
In many ways, an international factoring solution is quite similar to basic business factoring, apart from
a few differences. Namely,
• In international factoring programs, the currency for making the payment is not as
straightforward as is in the case of domestic factoring, where the domestic currency is used.
Several factoring companies, offer borrowers the option of choosing the currency in which the
payment will be made.
• International factoring companies also need to have a strong understanding of global markets,
legal implications of payment defaults and knowledge of regularly importing companies from
a given country.
• International trade is tricky and rife with compliance processes, documentation, customs
processes and intricate logistics systems. International factoring companies need to know how
to navigate through these complexities and build these processes into their offerrings.

Why Should Companies Choose International Factoring Services?

Apart from the usual benefits of factoring, one of the main reasons why companies would want
to opt for international factoring is because :
➢ They lack the local expertise or trust when it comes to dealing with an unknown buyer and
would like to hedge the risk by opting for a non-recourse, international factoring solution.
➢ Under this arrangement, the exporter is freed from the responsibility of chasing the
customer/importer for payments. Instead, the factoring company becomes an intermediary and
is responsible for collecting payments from the importer.
➢ Depending on the recourse clause in the factoring contract, the risk of default/non-payment is
either transferred to the factoring company or retained by the exporter.
➢ Exporters prefer that the factor and its associated partners in the foreign countries deal with the
importers as the exporter himself tends to have little to no cultural understanding or methods of
verifying the authenticity of the importer and would like to transfer the risk associated with
non-payment to another third party.
➢ With a continually growing volume of international trade, international factoring allows
entrepreneurs to conduct secure trade transactions, solve their working capital woes and thereby
increase revenue significantly.
➢ In some cases, the role of an international factoring company goes beyond mere finance. Due
to a wealth of information, expertise and data, the factor can also advice the exporters on key
markets to tap, based on the industry and also connect them with importers looking to forge
newer partnerships.

How Many Parties are Involved in International Factoring?

There are two factors involved in the process of international factoring. However, single factoring
arrangements are far more common.

1.Export Factor :
The factor located in the exporter’s country is the export factor responsible for collecting the
exporter’s documents and funding their invoices, i.e., ensuring timely payments. In most cases, the
export factor is the only intermediary involved in a transaction. However, the export factor may have
local partnerships, especially in countries with a high import volume. These agencies or partners aren’t
part of any formal factoring agreement; they simply assist the factor in dealing with local customs, laws,
regulations, and collection practices.
2.Import Factor:
The factor situated in the importer’s country is called the import factor and is responsible for
assessing the buyer’s credibility and financial worthiness. The import factor thoroughly evaluates the
buyer’s payment history, chances of default, etc. Moreover, timely collection of payments/dues from
the importer is also a vital responsibility of the import factor. The import factor guarantees the payment
on behalf of the importer. Not all international factoring arrangements have an import factor.

Different Types of International Factoring

Listed below are the Three types of International Factoring:–

• Single-Factoring system
This is the most commonly used form of international factoring. Under this system, the exporter
enters into a factoring agreement with the factor, stating that only one factoring firm would perform all
the financing functions. The company undertakes due diligence and credit assessment of the exporter
and importer, but the exporter is the initiator of the transaction.
• Two-Factor system
Under this system, four parties are involved- exporter, importer, import factor in the importer’s
country, and export factor in the exporter’s country. The export factor is generally equipped to deal with
the exporter’s credit profile, export performance, and financials. The import factor undertakes checks
to ascertain the importer’s creditworthiness, track record of completed imports, financials etc.
• International Reverse factoring
International reverse factoring is popularly known as Supply Chain finance (SCF). It is a
financing arrangement where the importer/buyer initiates the factoring arrangement on behalf of the
seller. It is a method of accounts payable financing that refers to a financing arrangement between the
buyer and seller who engage regularly and it results in a lower cost of borrowing for the supplier or
exporter as he/she leverages the importer’s credit profile to secure working capital funds.

How does International Factoring Work?

The following steps reveal how an international factoring transaction works.
• The exporter receives the purchase order and sends the importer’s information to the factor for
credit approval.
• The factor evaluates the importer’s creditworthiness and agrees to finance the deal after the
exporter has shipped the goods.
• The buyer agrees to make a complete payment upon the maturity of the credit period, which is
usually over 30/60/90 days depending on the industry.
• Immediately after shipping the goods from the country, the exporter sends a copy of the invoice
and other shipping documents to the factor.
• Upon receiving the invoice, the factor verifies with the importer.
• As agreed, the factor advances up to 80-90% (varies from one factoring company to another)
of the invoice amount upfront to the exporter.
• At the end of the credit period, the factor requests payment from the buyer towards the factored
invoice.
• The buyer/importer sends the entire payment directly to the factor.
• The factor deducts the agreed-upon factoring fee from the payment received.
• The remaining amount is then transferred to the exporter.
BENEFITS OF INTERNATIONAL FACTORING

International factoring offers a wide array of benefits to the companies engaged in international
trade. Some of these key benefits are listed below.
• Consistent cash flows: International factoring helps businesses maintain smooth cash flows
and ensures that there is no interruption in capital/funds to carry out day-to-day operations.
Especially for small companies, who mostly face a working capital crunch, this process acts as
a strong safety net, enabling them to grow the business faster.
• Longer payment terms: It allows businesses to offer extended credit periods to their
customers, thereby increasing their chances of expanding to incorporate more customers.
Longer payment terms are lucrative in international trade, which allows exporting businesses
to take higher volumes of orders and further expand their sales.
• Business Expansion: Since payments are secured and guaranteed, businesses can easily take
the plunge and mark their entry into different geographies due to the mitigated risks. New
buyers in new markets can be approached with confidence, which can pave the way for business
expansion.
• Accumulation of information: The factoring company gathers adequate knowledge and
intelligence about the exporter’s current as well as prospective international customers.
Information such as their credit worthiness, financial records, market reputation, etc., is also
duly verified and collected, which helps businesses choose their trade partners more wisely.
• Less documentation: The funding process is quite simple and quick. Unlike traditional loans
and advances, there are no extensive documentation requirements or procedures, which grants
businesses easy and speedy access to funds.
• Protection against bad debts: Non-recourse international factoring offers 100% protection
against bad debts and insolvency of international buyers. Although in the case of recourse
factoring, businesses do face the risk of bad debts, recourse factoring is far less common, and
the interest rates are lucrative to balance its risk.
• Seamless collection process: Factors possess the requisite expertise in dealing with multiple
businesses in different countries across the world. As they efficiently deal with various
importers in their respective local languages, cultural differences no longer hinder the collection
process. Thus, international factoring ensures smooth transactions by eliminating the customs
and language barriers.

Key Takeaways

• The process of factoring in finance is an immediate source of money for the firms. Client firms
transfer accounts receivables to a factoring company (factor) at a lower price than the unpaid
invoice.
• The factor acquires debts and earns a margin when they encash the full value of the debt.
• But these short-term financings involve significant credit risks. Therefore, in recourse factoring,
the credit risk is borne by the client—if the debtor defaults, the client firm repays the factor.
• Most clients opt for non-recourse factoring. Here, the entire risk is borne by the factor.
ACCOUNTS RECEIVABLE MANAGEMENT

Introduction
In the world of B2B commerce, credit is the lifeblood of business operations. Many customers
routinely purchase goods or services on credit terms, creating a vital financial arrangement. Once a
supplier fulfills an order, the customer is obligated to settle the bill within a specified timeframe. This
financial process is where accounts receivable management takes center stage.
Effective management of AR is not just important; it’s vital to ensure that invoices are sent out promptly
and payments are received on time. However, its significance goes well beyond this. Accounts
receivable management has a ripple effect on your business, influencing customer relationships, cash
flow, available capital, and ultimately, your bottom line.
Let us have a look at the Accounts Receivable management process, along with challenges, best
practices, and strategies to optimize this critical financial process for your business.

What Is Accounts Receivable Management?

Accounts receivable management is the process of managing and monitoring the amounts owed
to a company by its customers for goods or services sold on credit. It includes essential functions like
invoice management, collecting payments, assessing credit risks, and resolving disputes. Effective
management of accounts receivable is an essential aspect of maintaining a positive cash flow for B2B
businesses.
It encompasses a range of tasks including :
➢ the initial onboarding of customers
➢ evaluating the creditworthiness of the customers
➢ the subsequent issuance of invoices and
➢ the collection of payments.
➢ It involves the meticulous process of reconciling received payments with
corresponding invoices
➢ Addressing any discrepancies or deductions raised by customers

. This comprehensive approach ensures a smooth and efficient management of accounts

receivable throughout the entire customer lifecycle.

Objectives of Effective Accounts Receivable (AR) Management

To effectively address the evolving complexity of your AR processes, meticulous planning and
strategic resource allocation are imperative. As your company experiences growth, the management of
accounts receivables becomes increasingly challenging.
Here are the six accounts receivable fundamental goals that need your attention in optimizing
your accounts receivable operations:
 1. Credit workflow management
Effective credit policies necessitate periodic reviews, encompassing benchmarking, escalation
procedures, and customer credit scoring, which can ultimately boost revenue.
Companies must adhere to federal and state regulations when extending credit, and it’s crucial
to provide timely training to the credit approval team to keep them updated on these evolving
requirements.
Implementing automation within this process not only reduces clerical errors but also serves as
a safeguard against fraudulent activities.

2. Cash flow management

Collecting receivables promptly is vital for every business because the pace at which you can
collect receivables from customers directly influences your cash flow. When receivables slow down, it
becomes challenging for your company to meet its ongoing business requirements.

3. Customer relations
How you handle your accounts receivables can significantly affect customer relations.
Continuously reaching out to a customer after they’ve already made a payment can lead to frustration.
Similarly, expecting payments from customers without sending invoices on time can also have a
negative impact.

4. Bank reconciliation
Bank reconciliation involves managing various remittance formats, including addressing
missing remittances. This task can be time-consuming and prone to errors if not organized properly.
Without an efficient system in place, your Accounts Receivable team can waste significant time sorting
and applying payments.

5. Improved billing & invoicing

Streamlining invoicing processes can prevent billing errors and ensure invoices reach
customers. Use tools that facilitate easy invoice sending and enable direct payments.
Providing various payment choices, like credit/debit cards, enhances customer convenience.
Online billing streamlines accounts receivable, accelerates invoice delivery, and enhances record-
keeping.

6. Resolving deductions
In case of disputes, Accounts Receivables teams should explain each item to the customer and
offer alternative solutions such as payment plans. Informing vendors about transaction terms before
invoicing allows them to raise concerns beforehand. Having a procedure to resolve disputed invoices
can lead to happier customers and more paid bills.

COMMON CHALLENGES THAT AFFECT ACCOUNTS RECEIVABLES MANAGEMENT

Inefficient management of cash flow, inadequate customer support, and excessive focus on cash
application can have a cascading impact on your team’s performance. This detrimental effect is
particularly evident in the inability to meet payment obligations to suppliers, ultimately compromising
the timely delivery of goods or services and potentially tarnishing your reputation.

So, let’s understand the common issues that affect Accounts Receivable Management.
1. Misalignment between sales and finance goals
The disparity between the goals of the sales and finance departments can lead to conflicts.
While the sales team aims to increase sales, the finance team focuses on reducing bad debt. This
misalignment becomes evident when the sales team promises credit terms to customers that the finance
department may not approve of.

2. Inefficiencies caused by Manual processes

Numerous gaps in the existing processes necessitate laborious manual efforts.
Without automated accounts receivable processes, the team is forced to dedicate significant time and
resources to manual tasks across all aspects. These inefficiencies ultimately result in poor accounts
receivable management.
3. Impeded collaboration due to data fragmentation
The absence of a unified data system and information silos creates obstacles to effective
collaboration. Without real-time access to centralized data, customer-facing teams such as sales,
collections, and others struggle to collaborate efficiently. This fragmentation of data hinders their ability
to work seamlessly towards common objectives.
4. Absence of empirical data for predicting negative outcomes
The lack of a mechanism for utilizing empirical data hinders the ability to forecast potential
adverse consequences. Failure to document historical data makes it exceedingly difficult to anticipate
when a customer’s financial situation may undergo a detrimental shift, potentially resulting in
substantial losses if they become unable to fulfil their future payment obligations.
5. Disruption in continuity stemming from internal and external Team changes
Efficient management of credit transactions requires consistent documentation, particularly in
terms of invoicing and payment flows. Inadequate streamlining of the accounts receivable processes
can lead to disruptions and gaps within the Accounts Receivable workflow, hindering the smooth
continuity of operations.

EFFECTIVE ACCOUNTS RECEIVABLE MANAGEMENT TECHNIQUES

There are many components to accounts receivable management – to manage the process
effectively it’s crucial to handle components such as credit risk evaluation, invoicing, collection,
reconciliation, and dispute resolution efficiently.
Here are seven effective accounts receivable management techniques that address these
individual components and often overlap to ensure comprehensive management.
1. Clear internal processes
Often the root cause of your collections and cash flow issues is simply a matter of poor internal
processes. One of the easiest ways to mitigate the constant issues is to make sure that each of the teams
understands the end objective of the other. Sales team should focus on getting orders and the finance
team should ensure that the customer is financially sound enough to warrant credit terms. However, it
is equally critical for each team to support the other in these processes.

2. Two-way communication
Establishing effective two-way communication is vital, both internally and externally. This may
seem like an obvious factor, but it is often ignored, especially when it comes to the finance team and
customers. Enable easy-to-use and numerous options for stakeholders—both internal and external to
interact in the way they choose to.

3. Robust post-sales setup

Many collection issues stem from customer dissatisfaction with post-sales support. This tip
applies to all customer-facing teams. As a member of the finance team, you should ensure that all sales-
related documentation reaches the customers timely. Additionally, you can streamline the invoicing
process with meticulous attention to detail.

4. Timing and tone

In invoicing, two crucial aspects must be perfected. First, ensure that invoices are sent out
promptly and in line with agreed payment terms. Establishing a consistent invoice delivery schedule
prompts customers to anticipate and prepare for on-time payments. Secondly, pay attention to the tone
of your communication when sending invoices. Maintain a clear, concise, and polite approach in both
the invoice content and accompanying email communication. Avoid clutter and ensure all necessary
details are included for a smooth payment process.

5. More payment options

When it comes to facilitating payments, providing multiple options is paramount. This approach
ensures that customers can make payments even when their authorized personnel are unavailable due
to travel or other commitments. By offering a range of payment options, you enhance convenience for
your customers, eliminating the need for them to disrupt their daily routines to fulfill payment
obligations.
6. Quality all the way
In B2B transactions, particularly those involving deferred payments, maintaining high-quality
standards is essential. Quality should encompass not only the products or services you provide but also
the quality of customer interactions at every stage of engagement. Ensure that a commitment to quality
permeates every aspect of your operations, from production and logistics to inventory management and
your finance department.

7. AR automation
Digital transformation has become increasingly valuable for businesses globally, particularly in
the realm of critical finance processes. A specific area that stands to gain significant benefits from
automation is accounts receivable. By implementing automation in this area, businesses can experience
a notable increase in efficiency, as well as a reduction in manual errors.
The advantages of accounts receivable automation extend beyond simply streamlining the
process; it also enables organizations to effectively monitor invoicing, collections, and emerging
patterns. Furthermore, this automation empowers employees to redirect their attention towards more
strategic endeavors, ultimately fostering business growth and success.

CREDIT AND COLLECTION POLICIES IN ACCOUNTS RECEIVABLE

Concept of Credit Policy

The discharge of the credit function in a company embraces a number of activities for which the policies
have to be clearly laid down. Such a step will ensure consistency in credit decisions and actions. A
credit policy thus, establishes guidelines that govern grant or reject credit to a customer, what should
be the level of credit granted to a customer etc. A credit policy can be said to have a direct effect on the
volume of investment a company desires to make in receivables.

A company falls prey of many factors pertaining to its credit policy. In addition to specific
industrial attributes like the trend of industry, pattern of demand, pace of technology changes, factors
like financial strength of a company, marketing organization, growth of its product etc. also influence
the credit policy of an enterprise.

CONSIDERATIONS WHILE FORMULATING A CREDICT POLICY

➢ Certain considerations demand greater attention while formulating the credit policy
like
➢ a product of lower price should be sold to customer bearing greater credit risk.
➢ Credit of smaller amounts results, in greater turnover of credit collection.
➢ New customers should be least favored for large credit sales.
➢ The profit margin of a company has direct relationship with the degree or risk. They
are said to be inter-woven. Since, every increase in profit margin would be
counterbalanced by increase in the element of risk.

Credit policy of every company is at large influenced by two conflicting objectives

irrespective of the native and type of company. They are liquidity and profitability.

Liquidity can be directly linked to book debts. Liquidity position of a firm can be easily
improved without affecting profitability by reducing the duration of the period for which the credit is
granted and further by collecting the realized value of receivables as soon as they falls due.
 To improve profitability one can resort to lenient credit policy as a booster of sales, but the
implications are:
• Changes of extending credit to those with week credit rating.
• Unduly long credit terms.
• Tendency to expand credit to suit customer’s needs; and
• Lack of attention to over dues accounts.

SETTING A CREDIT POLICY

To establish a credit policy, a company must establish credit terms, credit standards and a collection
policy.
1. Credit Terms
Credit terms refer to the stipulations recognized by the firms for making credit sale of the goods to
its buyers. In other words, credit terms literally mean the terms of payments of the receivables. A firm
is required to consider various aspects of credit customers, approval of credit period, acceptance of
sales discounts, provisions regarding the instruments of security for credit to be accepted are a few
considerations which need due care and attention like the selection of credit customers can be made
on the basis of firms, capacity to absorb the bad debt losses during a given period of time.
However, a firm may opt for determining the credit terms in accordance with the established
practices in the light of its needs. The amount of funds tied up in the receivables is directly related to
the limits of credit granted to customers. These limits should never be ascertained on the basis of the
subjects own requirements, they should be based upon the debt paying power of customers and his
ledger record of the orders and payments.

There are two important components of credit terms which are detailed below:

1. Credit period: The credit period lays its multi-faced effect on many aspects the volume of
investment in receivables; its indirect influence can be seen on the net worth of the company. A long
period credit term may boost sales but it‘s also increase investment in receivables and lowers the
quality of trade credit.

While determining a credit period a company is bound to take into consideration

various factors like
1) buyer’s rate of stock turnover,
2) competitors approach,
3) the nature of commodity,
4) margin of profit and
5) availability of funds etc.
6) financial position of the company
7) economic status of the customer
8) quality involved in the transactions
9) The period of credit differs from Industry to industry.

In practice, the firms of same industry grant varied credit period to different individuals. as most of
such firms decide upon the period of credit to be allowed to a customer on the basis of his financial
position in addition to the nature of commodity, quality involved in transaction, the difference in the
economic status of customer that may considerably influence the credit period.
 Net 30 : The general way of expressing credit period of a firm is to coin it in terms of net date that
is, if a firm’s credit terms are “Net 30”, it means that the customer is expected to repay his credit
obligation within 30 days.

Generally, a free credit period granted, to pay for the goods purchased on accounts tends to be
tailored in relation to the period required for the business and in turn, to resale the goods and to collect
payments for them.
A firm may tighten its credit period if it confronts fault cases too often and fears occurrence of bad
debt losses.
On the other side, it may lengthen the credit period for enhancing operating profit through sales
expansion. Anyhow, the net operating profit would increase only if the cost of extending credit period
will be less than the incremental operating profit.

But the increase in sales alone with extended credit period would increase the investment in
receivables too because of the following two reasons: (i) Incremental sales result into incremental
receivables, and (ii) The average collection period will get extended, as the customers will be granted
more time to repay credit obligation.

2. Cash Discount Terms: The cash discount is granted by the firm to its debtors, in order to induce
them to make the payment earlier than the expiry of credit period allowed to them. Granting
discount means reduction in prices entitled to the debtors so as to encourage them for early payment
before the time stipulated to the i.e. the credit period. Grant of cash discount beneficial to the debtor
is profitable to the creditor as well. A customer of the firm i.e. debtor would be realized from his
obligation to pay Soon that too at discounted prices.
On the other hand, it increases the turnover rate of working capital and enables the
creditor firm to operate a greater volume of working capital. It also prevents debtors from using
trade credit as a source of working capital.

Cash Discount
Cash discount is expressed is a percentage of sales.
A cash discount term is accompanied by
(a) the rate of cash discount,
(b) the cash discount period, and
(c) the net credit period.

For instance, a credit term may be given as “1/10 Net 30” that mean a debtor is granted 1% discount
if settles his accounts with the creditor before the tenth day starting from a day after the date of invoice.
But in case the debtor does not opt for discount he is bound to terminate his obligation within the credit
period of thirty days.

Change in cash discount can either have positive or negative implication and at times both.
➢ Any increase in cash discount would directly increase the volume of credits sale. As the
cash discount reduces the price of commodity for sale. So, the demand for the product
ultimately increase leading to more sales.
➢ On the other hand, cash discount lures the debtors for prompt payment so that they can
relish the discount facility available to them. This in turn reduces the average collection
period and bad debt expenses thereby, bringing about a decline in the level of investment
in receivables. Ultimately the profits would increase.
 ➢ Increase in discount rate can negatively affect the profit margin per unit of sale due to
reduction of prices. A situation exactly reverse of the one stated above will occur in case of
decline in cash discount.
➢ Yet, the management of business enterprises should always take note of the point that cash
discount, as a percentage of invoice prices, must not be high as to have an uneconomic
bearing on the financial position of the concern.
➢ It should be seen in this connection that terms of sales include net credit period so that cash
discount may continue to retain its significance and might be prevented from being treated
by the buyers just like quantity discount.
➢ To make cash discount an effective tool of credit control, a business enterprise should also
see that is allowed to only those customers who make payments at due date.
➢ And finally, the credit terms of an enterprise on the receipt of securities while granting
credit to its customers. Credit sales may be got secured by being furnished with instruments
such as trade acceptance, promissory notes or bank guarantees.

CREDIT STANDARDS
a) Credit standards refers to the minimum criteria adopted by a firm for the purpose of short
listing its customers for extension of credit during a period of time.
b) The nature of credit standard followed by a firm can be directly linked to changes in sales
and receivables.
c) A liberal credit standard always tends to push up the sales by luring customers into dealings.
d) The firm, as a consequence would have to expand receivables investment along with
sustaining costs of administering credit and bad-debt losses.
e) As a more liberal extension of credit may cause certain customers to the less conscientious
in paying their bills on time.
f) Contrary, to these strict credit standards would mean extending credit to financially sound
customers only.
g) This saves the firm from bad debt losses and the firm has to spend lesser by a way of
administrative credit cost.
h) But, this reduces investment in receivables besides depressing sales.
i) In this way profit sacrificed by the firm on account of losing sales amounts more than the
cost saved by the firm.
j) Prudently, a firm should opt for lowering its credit standard only up to that level where
profitability arising through expansion in sales exceeds the various costs associated with it.
k) That’s way, optimum credit standards can be determined and maintained by inducing trade-
off between incremental returns and incremental costs.

COLLECTION POLICY

a) Collection policy refers to the procedures adopted by a firm (creditor) collect the
amount of from its debtors when such amount becomes due after the expiry of credit
period.
b) The requirements of collection policy arise on account of the defaulters i.e. the
customers not making the payments of receivables on time, as a few turnouts to be slow
payers and some other non-payers.
c) A collection policy shall be formulated with a whole and sole aim of accelerating
collection from bad-debt losses by ensuring prompt and regular collections.
 d) Regular collection on one hand indicates collection efficiency through control of bad
debts and collection costs as well as by inducing velocity to working capital turnover.
e) On the other hand it keeps debtors alert in respect of prompt payments of their dues.
f) A credit policy is needed to be framed in context of various considerations like short-
term operations, determinations of level of authority, control procedures etc.
g) Credit policy of an enterprise shall be reviewed and evaluated periodically and if
necessary amendments shall be made to suit the changing requirements of the business.
h) It should be designed in such a way that its co-ordinates activities of concerns
departments to achieve the overall objective of the business enterprises.
i) Finally, poor implementation of good credit policy will not produce optimal results.

To conclude, the credit policy of a company should be developed in accordance with the
strategic, marketing, financial and organisational context of the business and be designed to contribute
to the achievement of corporate objectives.
The corporate strategy can include trade credit management not just in terms of its contribution
to collection and cash flow but as a means of generating sales and profits, and of investing in customers
by building relationships. The management of trade credit can help build stable and long term
relationships with customers, generate information about the customer and their requirements and
facilitate different customer strategies in terms of credit granting, credit terms and customer service.
The objective is to generate growing but profitable sales.

ANALYZING THE CREDIT APPLICANT

Introduction
It is no secret that achieving financial stability is a key factor in running a successful business, but do
you know a mere miscalculation in credit risk analysis can trigger a domino effect, disrupting your
financial stability.
In an environment where market conditions are susceptible to volatility, the task of accurately estimating
credit limits for customers becomes even more crucial. Why? Because bad debts are increasing. A study
by Gartner Finance, based on an analysis of 796 financial statements, unveils a stark reality: bad debts
surged by an astonishing 26% in 2020.

The escalating challenge posed by mounting bad debts underscores the necessity for conducting
comprehensive credit risk analysis for every customer seeking credit-based transactions.
So how do you estimate the correct credit limits for customers and avoid bad debts?

What Is Credit Risk Analysis?

➢ Credit risk analysis is the assessment of a borrower’s creditworthiness and their ability to repay
a loan or credit.
➢ It involves evaluating their financial history, credit score, income, and other relevant factors to
determine the level of risk associated with lending to them.
➢ Cash flow is the most crucial KPI for any business. Disruptions to cash flow can significantly
affect both daily operations and investment opportunities.
How Does Credit Risk Analysis Help to Improve Your Cash Flow?

Credit risk assessment plays a vital role in safeguarding a positive cash flow by:

1. Minimizing Bad Debts

Invoices might turn into bad debts if adequate measures are not taken to collect the payments. Credit
risk analysis enables you to extend credit to reliable customers who are more likely to repay on time,
helping you avoid the risk of bad debt.

2. Reducing Days Sales Outstanding (DSO)

Whenever there is a trend of increasing DSO within your business, you must take additional steps,
including spending more resources and time to collect the payments. Credit risk analysis helps reduce
the hidden operational costs of late payments by lowering the DSO. It also contributes to maintaining a
positive working capital that can fund the current operations and future growth initiatives of the
company.

3. Mitigating Financial Risks

Credit risk analysis provides greater visibility into accounts receivable forecasting. It helps your
business identify high-risk customer accounts and plan strategically to tackle them. Reducing default
risks can improve the financial health of your business.

4. Improving customer experience

Customer satisfaction is vital for a company’s long-term growth. Credit risk analysis enables you
to onboard low-risk customers quickly and improve their overall experience. Loyal customers who pay
on time also help you utilize your resources to expand your services.
HOW TO DO CREDIT RISK ANALYSIS FOR YOUR ACCOUNTS RECEIVABLE?

ANALYSING THE CREDIT APPLICANT

1.Assessment of unpaid invoices

➢ The first step toward conducting an in-depth credit risk analysis is to review your customers’
past few years’ invoices.
➢ It is beneficial to understand the reasons for delayed payments.
➢ You can use the record of unpaid invoices to determine which customer is more prone to default
risks or who requires additional payment guarantees.
➢ After analyzing the invoices and identifying the default risks, you can categorize the late
payment trends and group customers accordingly for dunning purposes.
➢ Dunning : it is the process of business owners communicating with customers in an effort to
collect money owed for goods or services provided.

2. Grouping of customers
The more segmented your customer base is, the easier it is to identify and analyze high-risk profiles and
focus accordingly.
Thus, it is essential to group your customers based on factors such as:
• Industry
• Geography
• Size of business
• Payment guarantees
• Percentage of your receivables the customer represents

Let’s take a scenario in which a few customers exhibit poor payment practices. After grouping
customers based on their payment trends, you notice that most defaulters belong to the same industry.
It makes you realize that this particular industry might be risky to do business with. You can accordingly
reduce your exposure to clients from that industry or take additional precautions when dealing with
them.
3. Calculation of Days sales outstanding (DSO)
➢ Days sales outstanding measures the average number of days a company takes to collect
payment for a sale.
➢ You can segregate customers using this metric and analyze which segments make their
payments on time and whose DSOs are higher and more prone to risks.

Calculating DSO in regular intervals helps you to:

• Keep a check on your cash flow
• Measure the effectiveness of your receivables
• Keep track of how the ratio has changed over time
• Compare the ratio with the industry average to determine whether your payment terms are
more/less risky than your competitors

The formula for calculating DSO is:

For instance, consider the scenario of Company A. In January month, the company achieved a total of
$500,000 in credit sales, resulting in accounts receivable amounting to $350,000. Given the month's
duration of 31 days, the calculation for Days Sales Outstanding (DSO) for January unfolds as follows:
Accounts Receivable (AR) = $350,000 Credit Sales = $500,000 Number of Days = 31
DSO = ($350,000 / $500,000) * 31 = 0.7 * 31 = 21.7 days
Hence, the DSO for January equals 21.7 days.

4. Review of receivables aging report

➢ Accounts receivable aging report lists the unpaid invoices and their outstanding duration.
➢ Let’s assume a company has $250,000 in its accounts receivable. $50,000 falls under the 0-30
days aging bucket, $150,000 in the 31-60 days aging bucket, and the remaining $50,000 in the
61-90 days bucket.
➢ An aging report gives you a more detailed breakdown of the open invoices.
➢ It reflects how long your invoices remain open as well as gives an idea of how many customers
delay their payments.
➢ It also helps determine whether the current credit limits are suitable or not.
➢ If your report shows any deviation from the standard payment patterns, there might be a need
to investigate the issue.

5. Periodic credit review of your customer

➢ Periodic credit reviews assist you in evaluating your customers' credit profiles at regular
intervals.
➢ They contribute to refining credit scores and assessing customers' creditworthiness for
determining appropriate credit limits.
➢ A higher credit score serves as a positive indicator of creditworthiness.
➢ By updating credit scores through periodic reviews, you gain a more profound comprehension
of your customers' financial health, especially within volatile market conditions.

6. Managing Deteriorating payment trends

➢ Your accounts receivable policy should include what actions you’ll likely initiate against
customers who default or pay late.
➢ Your customer must be made aware of the implications of poor payment behavior; else, they
might become accustomed to paying late.
Some of the potential steps you might consider to manage deteriorating payment trends are:
• Sending dunning emails regularly
• Employing escalation notices
• Conducting in-person visits
• Adjusting the credit facility as needed
• Applying penalties for late payments
• Exploring potential legal actions

7.Check your accounts receivable concentration ratio

The accounts receivable concentration ratio is a metric to determine the risks associated with your
accounts receivable.

It helps to evaluate:
• The number of customers who owe money
• The amount of money owed to your business
• Relative share of each customer in the total receivables and
• how that compares to an ideal situation
• If the ratio of unpaid receivables to total receivables is high and closer to one, it indicates that
even if one customer fails to pay, it will significantly impact your business, and there is a need
to reduce it.

Example:
Consider a total accounts receivable balance of $250,000, broken down as follows:
• Company 1: $50,000
• Company 2: $150,000
• Company 3: $50,000

Step 1: Compute the percentage each customer contributes relative to the total accounts receivable
balance:
• Company 1: $50,000 / $250,000 = 20%
• Company 2: $150,000 / $250,000 = 60%
• Company 3: $50,000 / $250,000 = 20%

Step 2: Square the obtained percentages and convert them into decimals:
• Company 1: 20% * 20% = 0.04
• Company 2: 60% * 60% = 0.36
• Company 3: 20% * 20% = 0.04
Step 3: Sum up the squared values to derive the accounts receivable concentration ratio:
• 0.04 + 0.36 + 0.04 = 0.44
Here, the accounts receivable concentration ratio is 0.44.
This ratio is significantly more than 0.1 (ideal result). Hence, the accounts receivable is more
concentrated and therefore risky.

8. Understanding customer industry

It is necessary to understand your customer’s industry well to carry out thorough credit risk analysis.
Some of the factors that you should consider are:
 • Financial stability
• Competitiveness of the industry
• Government policies relating to the industry
• Future growth potential
• Current trends affecting the industry
• Potential factors that might affect the industry in future
Once you have a thorough grasp of your customer’s industry, you may tailor your services to fit their
specific requirements. It also establishes a trustworthy relationship between the customer and the
company.

9. Future planning
➢ Predictive analytics tools help you accurately forecast future events and risks associated with
your actions (e.g., credit sales).
➢ This helps you better prepare your business to mitigate credit risks.
➢ Identifying doubtful accounts would help you predict bad debts and help you put in extra
payment collection measures when dealing with such clients.
➢ To get a sense of your customer’s future financial health, you should also analyze their growth
strategies and upcoming projects.

10. Use of technology tools

➢ Technology solutions help optimize processes and improve efficiency.
➢ Credit risk analysis can also be streamlined with the right technology.
➢ Automation solutions help standardize the process, enable real-time monitoring, and increase
the efficiency of detecting potential risks.

Advantages over traditional process :

• Track changes in customers’ payment behavior with real-time credit risk monitoring
• Automate periodic credit reviews and stay updated
• Gain 360-degree process visibility with advanced reporting and analytics
• Save time and increase productivity of the credit department by reducing manual work with
automation

How to Improve the Credit Risk Analysis Process?

Conducting a comprehensive credit risk analysis can enhance cash flow and mitigate the impact of bad
debt. For optimal outcomes, prioritize periodic assessments over annual ones.
Moreover, you can elevate your credit processes through the prowess of automation. By
implementing Credit Risk Management Software to automate the process, you can consistently monitor
the health of your receivables and achieve unprecedented reduction in bad debts.
SELECTING OPTIMUM CREDIT PERIOD

What is Account Receivable Collection Period?

➢ The account receivable collection period is the number of days it takes the business to convert
its account receivable balances to cash.
➢ In simpler terms, it denotes the time it takes for a business to recover its account receivables
balances. It is also known as the days sales outstanding.
➢ It gives a result in number of days.
➢ This can also easily be calculated in number of weeks or months if the credit periods are longer.
➢ Ideally, it should be lower or, at the very least, equal to the number of days that the
business allows its customers to pay for credit sales. For businesses that rely heavily on
cash sales rather than credit sales, this may even be zero or close to zero. (optimum credit
period)
➢ However, lower account receivable collection periods may also indicate aggressive credit
control behaviors.
➢ For example, the credit control of the business calls their customers every day and threaten with
legal action in case of failure to repay their balance within time.
➢ Businesses should ensure that it is kept at an optimal level while ensuring the satisfaction of
the customers.
➢ In addition, if the account receivable collection period of a business is significantly lower than
its credit periods, it must consider whether loosening its credit control policies may result in
higher sales for the company.

PURPOSE OF CALCULATING ACCOUNT RECEIVABLE COLLECTION PERIOD

➢ The account receivable collection period of a business allows the business to evaluate its credit
limits and policies.
➢ By calculating the receivable collection period, a business can determine how much time it
takes for the business to recover its receivable balances.
➢ If the collection period is above the expected period, then the business will have to take steps
to rectify it and ensure the chances of bad debts are reduced to a minimum.
➢ It can also be used for decision-making purposes.
➢ Businesses base their credit limits and credit periods on their historical data such as the account
receivable collection period.
➢ For example, if the business has a very high account receivable collection period, it may reduce
its credit limits or periods to reduce it.
➢ Furthermore, decisions regarding whether customers should be offered early settlement
discounts can be made by considering the account receivable collection period of the business.
➢ Account receivable collection period is also an indicator of the performance of the credit control
department of a business.
➢ It is the duty of the credit control department of a business to ensure the collection period of
the balances is lesser or at least the same as the agreed credit period.
➢ It can also be used to make decisions about factoring account receivables or outsourcing the
credit control department.
➢ Moreover, the account receivable collection period is used in working capital management of
a business. For example, the account receivable collection period of a business can be used in
the calculation of its cash operating cycle.
➢ Businesses can use this information to determine the length of time it takes them from the initial
purchase of raw materials to final receipt of cash from the sales of their finished goods.
➢ Additionally, It can be used as part of the analytical procedure which is part of the audit
procedures of accounts receivable to assess how the company manage its receivable.