Tag: University of Mumbai BMS Notes

Bill discounting

Bill Discounting is a method of trading the bill of exchange to the financial institution before it gets matured, at a price that is in a smaller amount than its par value. The discount on the bill of exchange will be based on the remaining time for its maturity and also the risk concerned in it.

Bill discounting is a discount/fee which a bank takes from a seller to release funds before the credit period ends. This bill is then conferred to the seller’s client and the full amount is collected. Bill discounting is mostly applicable in scenarios when a buyer buys goods from the seller and the payment is to be made through a letter of credit. It is an arrangement whereby the seller recovers an amount of sales invoice from the financial intermediaries before it’s due. It is a business vertical for all kinds of financial intermediaries such as banks, financial institutions etc.

Bill discounting is a major trade activity. It aids the seller’s get funds earlier upon a small fee or discount. It also helps the bank earn some revenue. When the due date of the credit period comes, the borrower or (seller’s) customer can pay money then.

Bill discounting refers to a method of working capital finance for the seller of goods. It refers to a fee charged by the bank from the seller of the goods to release funds before the end of the credit period. The bill is presented to the customer and the amount is collected by the bank. It is mostly applicable in cases where letter of credit is used as a mode of payment. Bill discounting is also commonly known as invoice discounting or the purchase of bills. It is a major trading activity wherein the seller of the goods gets funds before the term of the letter of credit expires for a small amount charged by the bank as fees.

The fee paid by the seller to the bank or the financial intermediary usually depends upon the time left before maturity of letter of credit for which the bill is discounted and the risk perceived. It also depends a great deal over the credit worthiness of the seller and the past payment history of the buyer of goods.

Bill Discounting Companies in India

Bill discounting provides, as a present-day alternative to traditional working capital requirements, immediate access to funds can be provided to entrepreneurs by using their unpaid bills or goods received notes (GRN) as collateral. At present, many banks and non-banking financial companies (NBFCs) provide bill /GRN discounting services to business owners. Hence, an entrepreneur has the option to choose from a wide range of bill discounting service providers. But choosing a good provider is the key to go hassle free and save costs.

Myforexeye an online bill discounting platform where business owners get an opportunity to raise funds for their working capital needs at attractive terms by selling their unpaid invoices raised. Myforexeye aims to remove operational inefficiencies around the invoice discounting space by extensively using technology and reduction in interest rate costs.

Bill Discounting Process

The Process of Bill Discounting is as Follows;

• The seller ships the goods on credit to the buyer and sends the invoice to them
• The buyer accepts the invoice and acknowledges payment is due after credit period over.
• The seller approaches the bank to discount the bill.
• The bank transfers the fund to the seller after deducting discount fee as per the norms.
• When the payment is due, the bank or the seller collects the money from the buyer.
• The bank wants the following conditions to be fulfilled to discount the bill:.
• The bank will look into the seller’s reputation and previous payment history of the buyer.
• The buyer should have a reputed bank. This will ensure seller bank that buyer is reliable.
• The bill should be a usance bill.

Bill Purchasing

The terms ‘bills purchase’,’ bills discount’ and ‘bills negotiation’ are respectively used by the bank for financing against ‘Demand Bills’,’Usance Bills’ and LC bills. The seller of goods (exporter) gets immediate money from the bank for the goods sold by him irrespective of whether it is a purchase, discount or negotiation by the bank according to nature of bills.

For an importer, original shipping documents are required for the purpose of taking delivery of goods shipped to him by the exporter. To enable the importer to take delivery of the cargo shipped to him, the exporter after shipment of goods prepares necessary set of documents like commercial invoice, packing list, certificate of origin, quality certificate, Bill of lading/Airway bills, dock warrant, dock receipt, warehouse receipt, etc. along with order for the delivery of title to goods. The set of documents so prepared will be submitted by the exporter to his bank for onward transmission of documents to the importer’s destination, with an instruction to collect the invoice amount of goods dispatched by him under contracted terms.

Facility of Bill Purchasing

• If this Sale is a Credit Sales, then the seller will get the money from the purchaser only after the expiry of credit period.
• If the seller does not have extra money, during the period between credit sales and realization of money from debtor, he will not be able to buy more goods and sell again at a profit.
• To facilitate the business of manufacture, trade etc, banks help you by giving financial resources in the form of Bill Discounting Facility and the bank’s bill finance product helps you bridge the fund gap between the date of sale of products to the receipt of payments.
• The bank purchases the bill of exchange your company receives against a product sale, at a discount, thus doing away with the delay in realizing the receivables.
• The extent of discounting would amount to the interest calculated till the payments for the original sale are realized, and will be determined on the basis of market interest rates as well as the credit rating of the borrower.
• So, don’t keep the funds blocked during the credit period but get them discounted and increase your sales turnover.

Ancillary services are other services that banks offer to common men along with the necessary banking services. These ancillary services form a very minuscule of the services offered by the banks. Some of the ancillary services provided by the banks are:

1. Funds transfer service

Useful for sending and receiving money from all over the world.

2. Forex service

You can buy the foreign exchange for any purpose of expenditures like travel, buying merchandise, etc. and sell the same to the bank when you earn or receive from abroad.

3. Custodial Service

You can keep your valuables like jewels, documents, etc. Under this service, this is commonly known as Locker facility (Safe Deposit Vaults).

4. Gold sale

Only a few selected branches of banks or banks are allowed to provide this.

5. e–Banking

Also known as Net banking or Internet banking is  the latest and most convenient facility of the banks .You can get id and password to operate your account online : for transfer of funds to another account in the same bank or another bank. You can keep the surplus funds in fixed deposit by using this facility.

Remittance of funds

Some default funds transfer limits are given to customers based on the type of account. In case you wish to raise the limits per day), you may give a written request to your branch.

1. Beneficiary Maintenance

You can maintain a “Beneficiary” for whom you normally wish to transfer funds.   You have to give a “Payee ID” for each of the beneficiary and should attach a valid Account for each of the beneficiary maintained by you.

2. Funds Transfer between your Accounts (Real-time)

You can transfer funds to the extent of “Net available balance” (from one of your accounts – viz. Source Account) or up to the ‘Per day limit’ fixed by the Bank for you, whichever is less, to any one of your other accounts. 

3. Third Party Funds Transfer (Real-time)

You can transfer funds to the extent of “Net available balance” (from one of your accounts viz. Source account) or up to the “Per day limit” fixed by the Bank for you, whichever is less, to any one of the Beneficiary Accounts maintained by you. All the Beneficiary Accounts maintained by you will be available in the pick list and you can select any one of the accounts.

4. NEFT online Transfer

You can transfer funds to the extent of “Net available balance” (from one of your accounts viz. Source account) or upto the “Per day limit” fixed by the Bank for you, whichever is less, to an account with another Bank. The funds will be transferred using the NEFT facility provided by RBI and will be processed in the next available settlement cycle depending on the time of request. The beneficiary gets the credit on the same day or the next day depending on the time of settlement.

Term Deposit Options

Term Deposit Details: You can view the details of the selected Term Deposit account such as principal, contracted interest rate, maturity value, tenure, maturity date, lien (if any) etc.   

Loan Options

• Loan Account Details: You can view the details of the loan account selected and print these details using “print” option. You can also go to “Account Summary”, ‘Early and Final Settlement” and “Loan Repayment” options from here.
• Loan Account Activity: You can view the details of transactions for the selected account for any specified period. The details of transactions can be directly printed using ‘print’ option or can be downloaded and saved as a file using “download” option.

Standing Instruction (SI) Options

• Initiate Standing Instructions: You can create a Standing Instruction. The Standing Instructions are of 3 types viz., Account to Account, Credit to Loan Account and Banker’s Cheque (BC) Request. Wherever the BC request is selected, you have to fill up beneficiary details also. The Bank will prepare the BC and mail it to you.   For all the 3 types, the Standing Instructions will be executed on the Day Begin of the execution day. In case of insufficient balance, no further trials will be made till the next execution date.
• View SI: You can view the details of the Standing Instructions you had given either directly at the branch or through Internet Banking.

(For removing Standing instructions, you have to give a request through your branch.)

Safe custody and safe deposit                          

The facility of Safe Deposit Lockers is an ancillary service offered by the Bank. The Bank’s branches offering this facility will indicate/display this information.

Secrecy and Confidentiality

The Bank will ensure utmost secrecy of the Safe Deposit Lockers hired by the customer and will not divulge any information about hiring of lockers, mode of operation etc. to anyone, except when the disclosure is required to be made with the clear consent of the hirer(s) or in compliance of the orders of a competent authority having statutory powers.

Bank’s lockers will be available to any person, having contractual capacity i.e. capacity to enter into a contract. Thus locker can be hired by an individual singly and / or two or more individuals jointly as well as firms, limited Companies, Societies, Associations, Clubs etc.

Allotment of locker

Allotment of lockers shall be based on the duly (properly) filled in application of the prospective hirers on the printed format provided by the bank. Lockers will be allotted by the branches on first come first served basis.

Providing a copy of the agreement

Branches will give a copy of the agreement to the locker-hirer at the time of allotment of the locker, if preferred by the customer.

Recovery of rent from hirer(s)

Safe Deposit Locker  rent  will be payable in advance and in the event of locker rent remaining  unpaid, when due, the Bank will have the right to refuse access to the locker hirer(s). Locker rent will be recovered on annual basis. The lease period of one year will start from the date of hiring the locker and will continue till the preceding day of the corresponding date in the subsequent year.

Operations of Safe Deposit Vaults/Lockers

Branches will exercise due care and necessary precaution for the protection of the lockers provided to the customer. The Hirer/s can operate the Safe Deposit Locker only on the Bank’s working days and during the business hours of the Bank.

Before operating the locker, the hirer/s should sign the attendance register which shall be kept at the bank.

Death of the hirer

• Notice of knowledge of the death of a hirer or a surviving hirer will be recorded in the Locker Register with date and source of information under the initials of an officer.
• As a further precaution, a slip reading ‘hirer deceased’ will be pasted on the locker.
• Thereafter access to the locker should be allowed on production of legal representation.
• Where authority has been given to the survivor or survivors to operate the locker in writing specifically at the time of lease of the locker, in the case of joint account, the question of legal representation does not arise unless the survivor also dies.

Surrender of Locker:

• Locker can be surrendered by the hirer/s at any time during the contract period through a written application and handing over of keys to the Bank Officials.
• Bank can also request for surrender of locker with due notice.

The major aspects governing the locker services are:

• The Bank will hire locker only to properly introduced persons.
• Lockers are rented out for a minimum period of one year. Annual rent is payable in advance.
• Loss of key should be immediately informed to the branch.
• Withstanding instruction, the rent may be paid from the deposit account of the hirer.

The reported financial statements for banks are somewhat different from most companies that investors analyze. For example, there are no accounts receivables or inventory to gauge whether sales are rising or falling. On top of that, there are several unique characteristics of bank financial statements that include how the balance sheet and income statement are laid out. However, once investors have a solid understanding of how banks earn revenue and how to analyze what’s driving that revenue, bank financial statements are relatively easy to grasp.

How Banks Make Money?

Banks take in deposits from consumers and businesses and pay interest on some of the accounts. In turn, banks take the deposits and either invest those funds in securities or lend to companies and consumers. Since banks receive interest on their loans, their profits are derived from the spread between the rate they pay for the deposits and the rate they earn or receive from borrowers. Banks also earn interest income from investing their cash in short-term securities like rbi.

However, banks also earn revenue from fee income that they charge for their products and services that include wealth management advice, checking account fees, overdraft fees, ATM fees, interest and fees on credit cards. 

The primary business of a bank is managing the spread between deposits that it pays consumers and the rate it receives from their loans. In other words, when the interest that a bank earns from loans is greater than the interest it pays on deposits, it generates income from the interest rate spread. The size of this spread is a major determinant of the profit generated by a bank. Although we won’t delve into how rates are determined in the market, several factors drive rates including monetary policy set by the Reserve Bank.

A bank guarantee is a type of guarantee from a lending institution. The bank guarantee means a lending institution ensures that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan.

A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults on a loan. The guarantee lets a company buy what it otherwise could not, helping business growth and promoting entrepreneurial activity.

Features of a Valid Guarantee

• The period until which the guarantee holds is clearly specified
• The guarantee issuance is always for a specific amount
• The purpose of the guarantee is clearly stated
• The guarantee is valid for a specifically defined period
• The grace period allowed to enforce guarantee rights is also stated in the guarantee
• Guarantee clearly states the events under which it can be enforced

It is important that guarantee can be enforced based on terms of the contract (i.e. guarantee agreement) existing between the bank and the beneficiary. Generally, beneficiaries do state a clause to be included for charging penal interest in the case of delayed payment. Hence, it is essential for the bank to be cautious while finalizing the format and text of the contract (the guarantee agreement). While signing the same, the provision of penal interest and clauses attached to delays and default are to be carefully noted.

Examples of Bank Guarantees

Because of the general nature of a bank guarantee, there are many different kinds:

• A payment guarantee assures a seller the purchase price is paid on a set date.
• An advance payment guarantee acts as collateral for reimbursing advance payment from the buyer if the seller does not supply the specified goods per the contract.
• A credit security bond serves as collateral for repaying a loan.
• A rental guarantee serves as collateral for rental agreement payments.
• A confirmed payment order is an irrevocable obligation where the bank pays the beneficiary a set amount on a given date on the client’s behalf.
• A performance bond serves as collateral for the buyer’s costs incurred if services or goods are not provided as agreed in the contract.
• A warranty bond serves as collateral ensuring ordered goods are delivered as agreed.

For example, Company A is a new restaurant that wants to buy $3 million in kitchen equipment. The equipment vendor requires Company A to provide a bank guarantee to cover payments before they ship the equipment to Company A. Company A requests a guarantee from the lending institution keeping its cash accounts. The bank essentially cosigns the purchase contract with the vendor.

Types of Bank Guarantees

1. Financial Guarantee

Here, the bank guarantees that the applicant will meet the financial obligation. And in case he fails, the bank as a guarantor has to pay.

2. Performance Guarantee

Here the guarantee issued is for honoring a particular task and completion of the same in the prescribed/agreed upon manner as stated in the guarantee document.

3. Advance Payment Guarantee

This guarantee assures that they would return the advance amount in case of no fulfillment of the terms.

4. Payment Guarantee / Loan Guarantee

The guarantee is for assuring the payment/loan repayment. In case, the party fails to do so, a guarantor has to pay on behalf of the defaulting borrower.

5. Bid Bond Guarantee

As a part of the bidding process, this guarantee assures that the bidder would undertake the contract he has bid for, on the terms the bidding is done.

6. Foreign Bank Guarantee

Foreign BG is a guarantee which is issued for a foreign beneficiary.

7. Deferred Payment Guarantee

When the bank guarantees some deferred payment, the guarantee is termed as Deferred Payment Guarantee. For example, A company purchases a machine on credit basis with terms of payment being 6 equal installments. In this case, since the payment is deferred to a later period, creditor seeks deferred payment guarantee for an assurance that the payment would reach him in the given time period.

8. Shipping Guarantee

This guarantee protects the shipping company from all kinds of loss, in case the customer does not pay. This document helps the customer to take possession of goods.

Importance of Bank Guarantee

1. Adds To Creditworthiness

BGs reflect the confidence of the bank in your business and indirectly certify the soundness of your business.

2. Assessment of Business

In the case of foreign transactions or transactions with Government organizations, the foreign party or a Government Undertaking is constrained and cannot assess the soundness of each and every applicant to a project. In such cases, BGs act as a trusted instrument to assess stability and creditworthiness of companies applying for projects.

3. The Confidence of Performance

When new parties associate in the business and are skeptic about the performance of the company undertaking the project, performance guarantees help in reducing the risk of the beneficiary.

4. Risk Reduction

Advance payment guarantees act as a protection cover wherein the buyer can recover the advance amount paid to the seller if a seller fails to deliver the goods or services. This protects against any probable loss that a party can suffer from a new seller.

• A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults on a loan.
• A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults on a loan, of which there are many examples.
• Individuals often choose direct guarantees for international and cross-border transactions.
• A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan.

Asset/liability management is the process of managing the use of assets and cash flows to reduce the firm’s risk of loss from not paying a liability on time. Well-managed assets and liabilities increase business profits. The asset/liability management process is typically applied to bank loan portfolios and pension plans. It also involves the economic value of equity.

The concept of asset/liability management focuses on the timing of cash flows because company managers must plan for the payment of liabilities. The process must ensure that assets are available to pay debts as they come due and that assets or earnings can be converted into cash. The asset/liability management process applies to different categories of assets on the balance sheet.

Examples of Interest Rate Risk

Asset/liability management is also used in banking. A bank must pay interest on deposits and also charge a rate of interest on loans. To manage these two variables, bankers track the net interest margin or the difference between the interest paid on deposits and interest earned on loans.

Assume, for example, that a bank earns an average rate of 6% on three-year loans and pays a 4% rate on three-year certificates of deposit. The interest rate margin the bank generates is 6% – 4% = 2%. Since banks are subject to interest rate risk, or the risk that interest rates increase, clients demand higher interest rates on their deposits to keep assets at the bank.

Techniques of Managerial Control: Traditional and Modern Techniques

1. Traditional Techniques

Traditional techniques refer to the techniques that have been used by business organisation for longer period of time and are still in use.

Such techniques are:

• Personal Observation
• Statistical Reports
• Breakeven Analysis
• Budgetary Control

(a) Personal Observation: This is the most traditional technique of control. It helps a manager to collect first hand information about the performance of the employees. It also creates psychological pressure on the employees to improve their performance as they are aware that they are being observed personally by the manager. However, this technique is not to be effectively used in all kinds of jobs as it is very time consuming.

(b) Statistical Reports: Statistical analysis in the form of percentages, ratios, averages etc. in different areas provides useful information regarding performance of an organisation to its managers. When such information is presented in the form of tables, graphs, charts etc., it facilitates comparison of performance with the standards laid and with previous years’ performance.

(c) Breakeven Analysis: The technique used by managers to study the relationship between sales volume, costs and profit is known as Breakeven Analysis. This technique helps the managers in estimating profits at different levels of activities. The following figure shows breakeven chart of a firm.

The point at which the total revenue and total cost curves intersect is breakeven point. The figure shows that the firm will have the breakeven point at 60,000 units of output. At this point, there is neither profit nor loss. The firm starts earning profit beyond this point.

Breakeven Point= Fixed Cost/ (Selling Price per unit- Variable cost per unit).

Through breakeven analysis, a firm can keep a check on its variable cost and can also determine the level of activity at which it can earn its profit target.

(d) Budgetary Control: Under this technique, different budgets are prepared for different operations in an organization in advance. These budgets act as standards for comparing them with actual performance and taking necessary actions for attaining organizational goals.

A budget can be defined as a quantitative statement of expected result, prepared for a future period of time. The budget should be flexible so that necessary changes, if need be, can be easily made later according to the requirements of the prevailing environment.

2. Modern Techniques

Modem techniques are those techniques which are very new in management world. These techniques provide various new aspects for controlling the activities of an organisation.

These techniques are as follows:

(a) Return on Investment.

(b) Ratio Analysis.

(c) Responsibility Accounting.

(d) Management Audit.

(e) PERT and CPM.

(f) Management Information System.

(a) Return on Investment: Return on investment is very useful technique for determining whether the capital invested in the business has been effectively used or not for generating reasonable amount of return.

Return on Investment= (Net Income / Total Investment) X 100 Net Income before or after tax can be used for calculating ROI. Total investment includes investment in fixed Assets as well as working capital.

It acts as an effective control device in measuring and comparing the performance of different departments. It also helps departmental managers to find out the problems which adversely affect ROI.

(b) Ratio Analysis: Ratio Analysis is a technique of analyzing the financial statements of a business firm by computing different ratios.

(c) Responsibility Accounting: Under this system of accounting, various sections, departments or divisions of an organization are set up as ‘ Responsibility Centers’. Each centre has a head who is responsible for attaining the target of his centre.

(d) Management Audit: Management Audit is a process of judging the overall performance of the management of an organisation. It aims at reviewing the efficiency and effectiveness of management and improving its future performance. Its basic purpose is to identify the deficiencies in the performance of management functions. It also ensures updating of existing managerial policies.

(e) PERT and CPM: PERT (Programme Evaluation and Review Technique) and CPM (Critical Path Method) are two important techniques used in both planning and controlling. These techniques are used to compute the total expected time needed to complete a project & it can identify the bottleneck activities that have a critical effect on the project completion date. Such techniques are mainly used in areas like construction projects, aircraft manufacture, ship building etc.

The various steps involved in using these techniques are as follows:

(i) The project is first divided into various activities and then these activities are arranged in a logical sequence.

(ii) A network diagram is prepared showing the sequence of activities.

(iii) Time estimates are laid down for each activity. PERT prepares three time estimates-(1) Optimistic (shortest time) (2) Most likely time & (3) Pessimistic (longest time).In CPM, only one time estimate is prepared. Along with this, CPM also lays down the cost estimates for completing the project.

(iv) The most critical path in the network is the longest path. Longest path consists of those activities which are critical for completing the project on time; hence the name CPM.

(v) If required, necessary changes are made in the plan for completing the project on time.

(f) Management Information System (MIS): Management Information System (MIS) is a computer based information system which provides accurate, timely and up-to-date information to the managers for taking various managerial decisions. Thus, it is an important communication tool as well as an important control technique. It provides timely information to the managers so that they can take appropriate corrective measures in case of deviations from standards.

In business parlance, the terms strategy refers to is a unique plan designed with the aim of achieving a competitive position in the market and also to reach the organizational goals and objectives. In short, it is an interpretative plan, that guides the enterprise in realizing its goal. On the other hand, policy refers to a set of rules made by the organization for rational decision making.

Policy lays down the course of action, which is opted to guide the organization’s current and future decisions. Many people have confusion regarding the two terms, but they are not alike. Here, one should know that policies are subordinate to strategy. Here, in this article, we made an attempt to point out the significant differences between Strategy and Policy.

Strategy

The strategy is a game plan, chosen to achieve the organizational objectives, gain customer’s trust, attain competitive advantage and to acquire a market position. It is a combination of well-thought intent and actions which lead to the organization towards its desired position or destination. It is a unified and integrated plan made to achieve the basic objectives of the enterprise like:

• Effectiveness
• Handling events and problems
• Taking advantage of opportunities
• Full resource utilization
• Coping with threats

The strategy is a combination of flexibly designed corporate moves, through which an organization can compete with its rivals successfully. The following are the features of the Strategy:

• It should be formulated from top-level management. However, sub-strategies can be made by middle-level management.
• It should have a long-range perspective.
• It should be dynamic in nature.
• The main purpose is to overcome from uncertain situations.
• It should be made in such a way, to make the best possible use of scarce resources.

Policy

The policy is also regarded as a mini-mission statement, is a set of principles and rules which direct the decisions of the organization. Policies are framed by the top-level management of the organization to serve as a guideline for operational decision making. It is helpful in highlighting the rules, value and beliefs of the organization. In addition to this, it acts as a basis for guiding the actions.

Policies are designed, by taking the opinion and general view of a number of people in the organization regarding any situation. They are made from experience and basic understanding. In this way, the people who come under the range of such policy will completely agree upon its implementation.

Policies help the management of an organization to determine what is to be done, in a particular situation. These have to be consistently applied over a long period to avoid discrepancies and overlapping.

The following are the major differences between strategy and policy

1. The strategy is the best plan opted from a number of plans, in order to achieve the organizational goals and objectives. The policy is a set of common rules and regulations, which forms as a base to take the day to day decisions.
2. The strategy is a plan of action while the policy is a principle of action.

Strategies can be modified as per the situation, so they are dynamic in nature. Conversely, Policies are uniform in nature. However, relaxations can be made for unexpected situations.

3. Strategies are associated with the organizational moves and decisions for the situations and conditions which are not encountered or experienced earlier. On the contrary. Policies define the rules for routine activities, which are repetitive in nature.
4. Strategies are concentrated toward actions, whereas Policies are decision-oriented.
5. The top management always frames strategies, but sub-strategies are formulated at the middle level. In contrast to Policy, they are, in general, made by the top management.
6. Strategies deal with external environmental factors. On the other hand, Policies are made for the internal environment of business.
7. Strategies often contain methodologies used to achieve the set target. In contrast, Policies determine what is to be done and what should not be done in specific circumstances.

The difference between Strategy and Policy is, a little complicated because Policies come under the Strategies. Apart from that, the policies are made to support strategies in several ways like accomplishing organizational goals and securing an advantageous position in the market. Both of them are made by the top management as well as made after a deep analysis.

Organizational patterns are inspired in large part by the principles of the software pattern community, that in turn takes it cues from Christopher Alexander’s work on patterns of the built world. Organizational patterns also have roots in Kroeber’s classic anthropological texts on the patterns that underlie culture and society. They in turn have provided inspiration for the Agile software development movement, and for the creation of parts of Scrum and of Extreme Programming in particular.

Principles of discovery and use

Like other patterns, organizational patterns aren’t created or invented: they are discovered (or “mined”) from empirical observation. The early work on organizational patterns at Bell Laboratories focused on extracting patterns from social network analysis. That research used empirical role-playing techniques to gather information about the structure of relationships in the subject organization. These structures were analyzed for recurring patterns across organization and their contribution to achieving organizational goals. The recurring successful structures were written up in pattern form to describe their tradeoffs and detailed design decisions (forces), the context in which they apply, along with a generic description of the solution.

Patterns provide an incremental path to organizational improvement. The pattern style of building something (in this case, an organization) is:

• Find the weakest part of your organization
• Find a pattern that is likely to strengthen it
• Apply the pattern
• Measure the improvement or degradation
• If the pattern improved things, go to step 1 and find the next improvement; otherwise, undo the pattern and try an alternative.

As with Alexander-style patterns of software architecture, organizational patterns can be organized into pattern languages: collections of patterns that build on each other.

A pattern language can suggest the patterns to be applied for a known set of working patterns that are present.

Organizational designs fall into two categories, traditional and contemporary. Traditional designs include simple structure, functional structure, and divisional structure. Contemporary designs would include team structure, matrix structure, project structure, boundaryless organization, and the learning organization. I am going to define and discuss each design in order to give an understanding of the organizational design concept.

I. Traditional Designs

1. Simple Structure

A simple structure is defined as a design with low departmentalization, wide spans of control, centralized authority, and little formalization. This type of design is very common in small start up businesses. For example in a business with few employees the owner tends to be the manager and controls all of the functions of the business. Often employees work in all parts of the business and don’t just focus on one job creating little if any departmentalization. In this type of design there are usually no standardized policies and procedures. When the company begins to expand then the structure tends to become more complex and grows out of the simple structure.

2. Functional Structure

A functional structure is defined as a design that groups similar or related occupational specialties together. It is the functional approach to departmentalization applied to the entire organization.

3. Divisional Structure

A divisional structure is made up of separate, semi-autonomous units or divisions. Within one corporation there may be many different divisions and each division has its own goals to accomplish. A manager oversees their division and is completely responsible for the success or failure of the division. This gets managers to focus more on results knowing that they will be held accountable for them.

II. Contemporary Designs

1. Team Structure

A team structure is a design in which an organization is made up of teams, and each team works towards a common goal. Since the organization is made up of groups to perform the functions of the company, teams must perform well because they are held accountable for their performance. In a team structured organization there is no hierarchy or chain of command. Therefore, teams can work the way they want to, and figure out the most effective and efficient way to perform their tasks. Teams are given the power to be as innovative as they want. Some teams may have a group leader who is in charge of the group.

2. Matrix Structure

A matrix structure is one that assigns specialists from different functional departments to work on one or more projects. In an organization there may be different projects going on at once. Each specific project is assigned a project manager and he has the duty of allocating all the resources needed to accomplish the project. In a matrix structure those resources include the different functions of the company such as operations, accounting, sales, marketing, engineering, and human resources. Basically the project manager has to gather specialists from each function in order to work on a project, and complete it successfully. In this structure there are two managers, the project manager and the department or functional manager.

3. Project Structure

A project structure is an organizational structure in which employees continuously work on projects. This is like the matrix structure; however when the project ends the employees don’t go back their departments. They continuously work on projects in a team like structure. Each team has the necessary employees to successfully complete the project. Each employee brings his or her specialized skill to the team. Once the project is finished then the team moves on to the next project.

4. Autonomous Internal Units

Some large organizations have adopted this type of structure. That is, the organization is comprised of many independent decentralized business units, each with its own products, clients, competitors, and profit goals. There is no centralized control or resource allocation.

5. Boudaryless Organization

A boundaryless organization is one in which its design is not defined by, or limited to, the horizontal, vertical, or external boundaries imposed by a predefined structure. In other words it is an unstructured design. This structure is much more flexible because there is no boundaries to deal with such as chain of command, departmentalization, and organizational hierarchy. Instead of having departments, companies have used the team approach. In order to eliminate boundaries managers may use virtual, modular, or network organizational structures. In a virtual organization work is outsourced when necessary. There are a small number of permanent employees, however specialists are hired when a situation arises. Examples of this would be subcontractors or freelancers. A modular organization is one in which manufacturing is the business. This type of organization has work done outside of the company from different suppliers. Each supplier produces a specific piece of the final product. When all the pieces are done, the organization then assembles the final product. A network organization is one in which companies outsource their major business functions in order to focus more on what they are in business to do.

6. Learning Organization

A learning organization is defined as an organization that has developed the capacity to continuously learn, adapt, and change. In order to have a learning organization a company must have very knowledgeable employees who are able to share their knowledge with others and be able to apply it in a work environment. The learning organization must also have a strong organizational culture where all employees have a common goal and are willing to work together through sharing knowledge and information. A learning organization must have a team design and great leadership. Learning organizations that are innovative and knowledgeable create leverage over competitors.

Displacement of Objectives

Rules originally devised to achieve organizational goals at each level become an end in themselves independent of organizational goals. Thompson calls such bureaucratic behavior as a process of “inversion of ends and means”. When individuals holding office at lower levels pursue personal objectives or objectives of sub units, the overall objectives of the organization may be neglected. When objectives get so displaced it is often difficult for managers at higher levels or even for the other constituents of the organizations such as consumers and stock holders to seek redress.

Compartmentalization of Activities

Specialization and division of labor are encouraged in bureaucracies to improve organization effectiveness. But the resulting categorization breeds the notion of watertight compartmentalization of jobs, restricting people from performing tasks that they are capable of performing. For example, a pipe fitter can install a pump, but is prohibited from making the electrical connection. It would also encourage a tendency to preserving existing jobs even when they become redundant. The sequential flow of work may usually have an element of idle time at almost every level. The bickering over respective jurisdictions based on specialization and categorization may also often induce dysfunctional conflict in the place of coordination and cooperation among various submits of an organizations.

Bureaucracies, particularly in large complex organizations, may have unintended consequences which are often referred to as dysfunctional aspects of bureaucracy. For example, A Commercial real estate or shopping centers electric cabling plan or oceanfront luxury condos layouts require a complex planning. Over the years, there has been much disenchantment with the functioning of bureaucracies which created many antagonists of bureaucracy who prophesied about its gradual demise. The skeptics optimism however, did not fructify. None could propound workable alternatives.

As a result, bureaucracies survived notwithstanding the myriad dysfunctional aspects. It is not possible here to list all the dysfunctional functions caused by what Thompson calls as ‘bureaucratic’ behavior. There is also no agreement on whether all these are really counterproductive, because some of them at least are perceived at times as disguised blessing. The more prominent among the dysfunctional aspects include the following: 

• Rigidity
• Impersonality
• Displacement of Objectives
• Compartmentalization of Activities
• Empire building
• Red Tape

Rigidity
Critics of bureaucracy argue that rules are often and inflexible, encouraging status quoism and breeding resistance to change. Compliance with rules may provide the cover to avoid responsibility for failures. 

Impersonality
Bureaucracies emphasise mechanical way of doing things, giving primacy to organizational rules and regulations than individual’s needs and emotions. Contractual obligations receive primacy, relegating human relations to a back seat.

The foregoing discussion is based on Max Weber’s description of an ideal (normative) pattern of organization. It is difficult to distinguish precisely how the functioning of organization differs from the ideal. It can nevertheless be said that all organizations have some or all of these features and the difference between one organization and the other is one of degree alone.

Functional Aspects 

Some of the principal, prescriptive, normative functions that bureaucracies serve have positive significant to organizations. Whether and to what extent these positive features really obtain in an organization depends on actual practice which often falls short of expectations. Subject to this limitation the following can be considered as the functional aspects of an ‘ideal’ bureaucracy:

1. Specialization
2. Structure
3. Preitabiliy and Stability
4. Rationality
5. Democracy