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E-commerce is big, its operational finance issues are bigger

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E commerce industry with  such breakneck growth rates needs to give importance to processes and guidance in place to sustain fast growth without committing fatal mistakes and heartburns for employees and customers. It’s imperative to also look at the issues faced by the companies in finance and related sectors.

E-commerce’s growth story in India has been phenomenal. The e-commerce market was worth $14 billion in 2012. It is expected to grow at a pace of 57% annually till 2016, the fastest in the Asia-Pacific region, according to Forrester, a leading market research firm specializing in technology. More importantly, a large ecosystem of specialized service providers have sprung up to support the growth of e-commerce companies: this is an ecosystem that is beginning to sustain itself.

With such breakneck growth rates, it is important to have systems, processes and guidance in place to sustain fast growth without committing fatal mistakes and heartburns for employees and customers. It’s imperative to also look at the issues faced by the companies in finance and related sectors.

The most critical issue faced by the ecommerce companies, as is typical of most Indian firms, is compliance and sound financial advice. In the absence of these factors, companies can grow but after some time start facing issues which not only stall their growth but can also lead to much bigger threats. In most cases, ecommerce entails pan-India operations, which throw up unique problems. For example, tax- and labour-related laws vary from state to state. Under labour laws, Labour Welfare Fund registration is required in Maharashtra but not in Haryana. Professional Tax is applicable in Maharashtra but not in Haryana.  So, these companies have to either resort to tailor-made solutions as per state laws, effectively meaning employing more effort and human resource or they tend to adopt the strictest compliance practice, the lowest common denominator, to be compliant with all states. Adding to the complexities, the big firms typically sell across multiple categories: again, it means having specific tax treatment and compliance for each category.

This kind of complicated tax structure makes right advice indispensible for long-term growth of business and reduced litigation costs. The right advice at the right stage is required to ensure that companies do not pay hefty fines and get it right the first time.

Another major problem area is financial controls. The product based e-commerce is a transaction-heavy business, compared to other industries. The return volume of sold products is quite high across this industry, going as high as 40 per cent in certain cases. There are two main reasons behind this:  (i) liberal return terms – for example, cash on delivery, returning the product in 10 days from the date of purchase – set by companies to gain the trust of end-customers, a lot of whom are shopping for the first time; and,

(ii) a lack of physical touch by end-customers, which quite often leads to a mismatch between the client’s expectation and the product.
These kinds of unique terms and conditions increase the probability of mistakes in finance and accounting. So, companies require robust financial controls to ensure that daily transactions are being accounted properly.

Another major problem encountered by e-commerce companies is the complicated delivery/transaction model. Typically, a product is shipped from a manufacturer/wholesaler to the company’s warehouse (for big firms) and is shipped out to a third-party e-commerce logistics company, which handles the last-mile delivery. Depending on the transaction model, the product can be billed directly to the company or the vendor. In most cases, it involves multiple transactions: a purchase order being issued by the company, inwards/goods received by the company, quality control rejections, shipping to the Logistics Company, sales returns, and commission paid to payment gateways, etc.

This makes systems and financial controls the need of the hour. It requires multiple and independent verifications to be done to ensure that chances of fraud are minimized. Time-to-time reconciliations with vendors is a must to ensure the accounting books are closed on time and disputes do not arise between vendors and the company months after a transaction is completed, which is a common malaise in all big companies, e-commerce or otherwise. Inventory audit, an oft-ignored area by small companies, should be done for complete reconciliation between physical and accounting reality. Also, daily cash reconciliation for cash on delivery payments, a customer payment model unique to developing companies, is a must, because (i) the chances of fraud are the highest in cash dealings and (ii) it will make way for the minimal blockage of working capital.

One mistake most companies make is not taking care of the financial work flow in their ERP systems. E-commerce is a relatively new sector and its business models are evolving. Already available ERP solutions are still under development and there is no standardized ERP solution available for the e-commerce industry which can handle all of its concerns. Hence, companies need to customize their ERP solutions at the commencement of their operations. In the beginning of operations, companies require sound financial advice to customize the ERP solution which can suit the requirement of the finance function. The problem is further compounded by the fact that most companies focus on core operations, and finance being a support function is typically neglected. Also, companies need to upgrade their ERP systems as the number of transactions increase, at which point sound financial advice is required again.

E-commerce is a reasonably capital-intensive business. Since most firms are new, vendors are unwilling to commit credit, epically to smaller firms, and many demand advance payment terms. Due to the high number of SKUs and higher margins in long-tail items, the working capital is blocked significantly. As most firms are burning cash, an eagle’s eye needs to be maintained on minimizing the working capital. A strong MIS system is required to undertake any analysis to improve business profitability, for which a real-time bookkeeping system needs to be maintained as a backbone. This fact is often ignored by smaller firms.

Due to high operating burn rates and sporadic funding, a lot of companies have partially or fully adopted or are in the process of adopting a marketplace and light-inventory model, where a vendor ships the item directly to the end-customer or a third-party logistics warehouse, bypassing the company’s warehouse. However, from a financial perspective it increases complexity, as (i) the number of vendors increases multiple folds and (ii) there is a lack of control on the item’s quality, as the item bypasses the company’s warehouse (although some large firms adopt the practice of having back-to-back shipping from the vendor to the company’s warehouse for QC check and then to the third party logistics provider).
The mantra is simple: do not ignore critical support functions; get right advice at the right time; avoid silly mistakes which lead to large penalties and delays; and, set up the system right the first time.

About the author: Deepak Dhamija is co-founder, Aristotle Consultancy. The company is a provider of end-to-end financial and legal services to startups and SMEs.

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