Superpower 6: The importance of creating and executing system processes and operational guidelines
Many foreign professionals, excited with the ample opportunities offered by the Chinese market, rush to launch their companies and later find themselves spending more time and money fixing administrative functions rather than focusing on the growth of their business.
Superpower 6 is about the importance of creating and executing system processes and operational guidelines to avoid fraud and costly mistakes, as well as to build your business on solid ground.
For many small to medium size companies in China it is difficult to implement an efficient internal control system to eliminate the possibility of corruption or fraud. But when executed correctly, these measures can improve the internal control environment and help reduce opportunistic behavior by employees and managers.
During the past few years, the Chinese government has tightened up their regulations on corporate corruption and has implemented new legislation to reduce fraudulent practices that might have been common in the past.
It may be tempting for some companies to try to avoid the heavy load of paperwork involved in processing employee expense claims as long as the amounts seem reasonable, but a strong internal control procedure and documentation leave managers in difficult positions to engage in corruption activities.
For firms with weak internal controls, it is hard to detect corruption risk and implement the necessary measures to avoid it. Generally, reimbursements are paid, though the process is not properly supervised. A lack of expense claim controls creates several risks including additional tax liabilities for the business, opportunities for employee fraud and uncontrolled budget spending.
Some companies are willing to take these business risks because it can be time consuming and costly to implement the correct internal control system. Nevertheless, there are simple but effective ways a firm can adopt to improve their expense claim process.
A better internal control environment has the potential to limit corruption activities, such as insider trading, fake fapiao submission or misappropriation of company’s assets. Internal controls can be integrated into daily operations and into the corporate culture. This type of corporate environment could reduce managers’ incentive to engage in misconduct. That is, a high-quality control environment establishes the importance of internal control throughout the firm.
A control system requires companies to develop policies and procedures related to their various business activities. For example, better internal controls will pre-assess the main risks in addition to related party transactions and will implement a documentation procedure along the transaction chain; this will facilitate future double-checks.
Those procedures increase the possibility of detecting the misbehaviors of managers or employees. In addition, better internal controls make business transactions more transparent. Information transparency facilitates the monitoring of staff and the reduction of misconduct.
In China, some of the most common business risks can arise when expense claims fail to produce all the required documents to be deducted from a company’s revenue for Corporate Income Tax (CIT) purposes. This may result in the firm paying unnecessary taxes.
Foreign companies face mandatory annual tax adjustments by an external auditor, who will ensure that all supporting documents for employee expense claims are submitted. If any expense claims are found to be missing documents or unqualified, the business will not be able to deduct those expenses from its CIT. If expenses are staff’s personal expenditures, the company will need to pay individual income tax in addition to any fine for the tax shortage.
Another case of internal fraud or corruption is when an employee is given the authorization to make purchases on behalf of the company but uses this purchasing ability for his or her personal benefit. Generally, empowering managers gives the company the opportunity to run more efficiently. However, this requires employees to act with integrity and exercise their best judgement.
The implementation of expense claim controls requires a company to execute steps in the process to evaluate employee’s activities systematically while still allowing them the autonomy to do their job.
It is essential to define staff member’s budgets and issue company policies regarding allowances for travel and other activities in advance and communicate them clearly. The organizational structure for authorizing expenses is meant to ensure that expense claim controls work.
Expense claim software can be used by managers to set soft limits for expense claims submitted by employees. This creates an alert if the staff exceeds their daily allowance or travel budget and requires special approval. In addition, employees should be required to submit supporting documents for business expenses. Generally, this is an official fapiao with the company’s correct tax information but could include contracts and other papers.
In order to control cash flow and manage budget spending, managers and accountants should monitor the booking of expenses against the internal budgets set by management.
Exceeding deductible limits causes all expenses to incur additional 25% CIT. For this reason, accountants should be monitoring tax deduction limits for expense claims. Identifying this early allows businesses to control their spending and maximize their deductible amounts for a given period.
There are software tools that help businesses implement the correct internal control system and facilitate the process of collecting documents and verifying their authenticity. This allows managers and employees to do their job properly, without additional and complicated paperwork.
Another efficient way of implementing operational guidelines is through an Enterprise Resource Planning (ERP) system.
When implemented correctly, an ERP system facilitates better planning by management, improves management control, and increases organizational ability to control day-to-day operations. This enables the company to directly reduce operating costs and lower inventory stock while strengthening relations with suppliers and customers.
China has a very particular business culture and different workplace habits than other Western countries and expecting the same results from an ERP system developed with another cultural perspective in mind is not realistic. When executed in the wrong way, the system can have a negative impact in the operation of your business and its working efficiency.
The way ERP systems are perceived, treated, and integrated within the business plays a critical role in the success or failure of the implementation. The internal culture of a company is a reflection of society’s culture, and in China this is especially true due to the nationalistic nature of business.
Implementing an ERP system is a major cultural change for any organization. When national or cultural borders are crossed, implementation in a global environment takes on a new dimension.
Numerous foreign companies assume that their business models and management philosophy will transfer smoothly into their China operation, with minimal adaptation issues. But this can cause significant problems within the business structure. When your ERP system fails, it may not always be clear that the system is not to blame, and it is just a sign for other underlying issues.
Information technology is a powerful tool for organizations that seek to gain a competitive edge in a global business environment. ERP systems are examples of the most strategic tools a business can employ to integrate its operations. It facilitates the sharing of large amounts of information effectively and efficiently, as well as creating a central database for sales and marketing, production and materials management, accounting and finance, and human resources.
There are five main reasons companies implement ERP systems: integrate financial information, integrate customer order information, standardize and speed up manufacturing processes, reduce inventory, and regulate human resource information.
In China, markets move and change quickly, and your company’s adaptation will be crucial for its survival. Unlike in Western countries, that have long-time established rules and relatively predictable supply chain behaviors, to maintain competitiveness in today’s Chinese marketplace businesses must be serving clients with incredible speed, extreme flexibility, in-depth local knowledge, and extensive connections.
It is vital to understand that there is no perfect ERP system that will solve all your business problems. Before implementing an ERP system, companies should evaluate their organizational strategy, structure, culture, and operations.
Superpower 6 will help your company evaluate and identify corruption or fraud risks, as well as reduce opportunistic behavior by employees and managers. It will also ensure that your operations remain efficient and competitive.
To learn more about Superpower 6 and how we can help you, complete our online inquiry form here below.
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.