How to create a budget for your China business - Part 2
Once you recognized the importance of having a budget, the next
step is to create one for your China business. Taking into
consideration the different variables, you should evaluate your
projected cash flow and decide how much money you will need as
According to the regulations in China, you don’t have to transfer your registered capital all at once; it can be done in installments. Many foreign business professionals are hesitant about having a large sum of money in Chinese bank accounts and they prefer to bring it step by step. There are also companies that may need these funds for other things.
An initial budget can be calculated by projecting your cash flow month to month. There are certain items that are stable, such as rent and salaries. At least for the first year, you will be able to understand how much money you need and how much you will have left over.
Generally, there are three types of costs and expenses: fixed costs, variable costs and one-off capital costs. A one-off is, for example, purchasing computer equipment, furniture, printers, etc. You may save some of your capital costs by using a business center, where you have a furnished space and can use technical equipment, such as printers.
If you decide to rent an office, it would be wise to research the market and negotiate a contract with a fixed rent price for a certain period of time. Talking to suppliers to compare rates is also beneficial, particularly if you can get reduced prices by becoming a long-term client. Make sure you review contracts carefully. This is how you will be able to determinate your budget every year.
When it comes to start-up companies in China, it is difficult to estimate revenue. In this case, it is a good idea to do a market research study with a focus group, especially if you're selling products and you want to know how popular your brand would be in China.
In general, firms in the service sector go into China already having potential clients on hand, while other companies do business through distributors or agents. They have a better idea of what their sales figures would look like or may have a sales history.
Forecasting revenue without a sales history can be challenging, especially within your first year of operation. The best thing you can do is to be conservative with your figures and not too optimistic. Once you’ve been through your first year and you have a pipeline, you can evaluate how the negotiations are moving forward with potential clients and customers, which will allow you to predict the budget for your second year much better. But it is that first year when people truly get stuck and disappointed.
In order to survive the first year and not encounter discouraging obstacles, you should keep your budget updated and evaluate quarterly your fixed costs, overhead, the direct cost of sales, the costs of materials as well as the costs of third-party providers, and any other costs related to your industry or sector. If your plan is to stay in China for the long term, these are the questions your company should be asking on a regular basis.
Having the ability to compare year-to-year the changes in your budget will give you a better perspective and will help you understand the rights and wrongs. For this purpose, the budget should be as detailed as possible. For example, the first item could be the cost of premises -rent-. Then there is tax, management fees and service charges. You may want to divide that into three different line items.
Even when your rent price is fixed for five years, the tax rates or management fees could increase. But if you lump sum everything into just rent, you're going to see an increase but won’t know the reason because it’s not broken down.
The same concept applies to soft costs. You might want to break it down into salary, social insurance, allowances, bonuses, and commissions to see over time what has increased. Obviously, salaries might go up according to inflation year-on-year. If social insurance regulations change, these items could also rise.
Similarly, you can break down utilities (electricity, telephone, cellular); vehicles and equipment costs, marketing, advertising and promotions, as well as travel expenses and costs (meals). In this last item, you may want to pre-approve travel before it happens to have more control over expenditures.
Another important cost to consider is legal, professional and consulting. You may be using the services of a trademark lawyer, an insurance company, a PR and marketing company, an accounting firm or recruitment firm. There are many different professional costs than can arise and again, you may want to break this down so that you can see clearly where your expenses are and how things are changing.
In a similar way, revenue should be itemized as well. If you have one product that can be adapted in ten different ways, you should add under your revenue line items the ten different ways so that you can review which types are more successful versus the others.
Once a budget is created, the key element is to pair it to a financial action plan, to make sure that things are linked together. For example, revenue should be linked to the cost of goods or services. Everything should match together.
The third step is to check that your actual numbers match your budget. In China, if you are a general VAT taxpayer, you need to pay on monthly basis, which means that you must evaluate your finances once a month. But even if you are a small-scale taxpayer, it is a smart idea to review your finances monthly. One common mistake that many companies do is not to look at their numbers until the end of the year.
In China, the profits tax is declared on a quarterly basis. For this reason, it is critical to go over the company’s finances on a monthly basis to be able to adjust and implement the necessary changes, before you have to face auditors and their questions. This will also help you with your cash flow.
It is critical to revise your profit and loss statements, your balance sheet, and cash flow. When you know where you are standing at the end of each month, you will be able to make immediate decisions and proceed forward with your business plan.
During their first year, more than 90% of companies end up overspending because they don't look at their month-to-month financials and they only have a vague idea of the numbers. The cash flow can be affected when the exact figures are not considered.
A company that overspends their registered capital amount, based on their budget, won’t have any cash available. When this happens, they must wait at least two months for the register capital to be remitted and go through an application procedure to register it. Therefore, they may find themselves in a situation where they cannot pay rent or salaries.
Once you leave the difficulties of the first year behind and your company starts to grow, your budget will become even more vital for your success. As you add more departments to your operation, such as sales, customer service or human resources, maintaining open and fluid communication channels will ensure that everyone works together as a team and participates in the creation of the budget.
Regular discussions on how to create and amend the budget based on revenue will make all departments feel included in the growth of the company.
Trying to predict how certain economic situations, such as the trade war between China and the United States or the political volatility in Hong Kong, or the COVID-19 crisis will affect your business can be tough. However, you can create specific scenarios where you may encounter obstacles in the next few years. The more detailed your budget is in terms of breakdowns and line items, the better you will be able to account for everything, especially as a start-up business owner.
An important piece of advice is don’t put your budget and business plan in a drawer and never look at them again. These are adaptable documents designed to support and help your business. If reviewing them on a monthly basis is too much and your attention is needed somewhere else, carve one or two hours of your schedule to organize a conference call or meeting to talk about the budget.
In most cases, this can be done periodically, and the time spent will decrease over a few meetings because you will be better prepared.
It is possible to design a budget that gives you enough freedom and flexibility to embrace the opportunities that come along. In China, your company may come across numerous interesting prospects, but not all of them will be correct for your business. You should always calculate the return on investment before jumping into a new venture.
Knowledge is power. The more you know about your finances, the better prepared you will be to make important decisions. Reviewing your numbers month-to-month, or quarterly, will give you the ability to guide and watch your investment. It may take some practice and patience, but at the end of the day it will make you a better business professional.
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DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.