Superpower 8: The importance of analyzing your China business
At this point you have invested in a sophisticated accounting system for your China business and developed a mechanism to keep organized. But do you really know what those numbers mean and how can they affect your business moving forward?
In China, markets move fast, regulations change unannounced and business opportunities come and go quickly. For this reason, the better you understand your numbers and what they mean to your business, the better you will be equipped to make fast, smart decisions.
Superpower 8 will enable you to do that through financial, management and sales data analysis. This aspect is critical to help you focus on your strategy and ultimately grow your business.
In order to achieve this superpower, it is important to know how to effectively analyze the financial statements of your firm. This requires an understanding of three key areas: the structure of the financial statements, the economic characteristics of the industry in which the firm operates and the strategies the firm pursues to differentiate itself from its competitors.
An effective analysis of financial statements includes the evaluation of industry economic characteristics, such as the chain of activities involved in the creation, manufacture and distribution of the firm’s products and/or services, and the nature of those products, including their uniqueness, level of profit margins, creation of brand loyalty and control of costs.
Additionally, factors such as supply chain integration, geographic diversification and industry diversification should be considered.
Financial statements should be reviewed within the context of the relevant accounting standards. In examining balance sheet accounts, issues such as recognition, valuation and classification are keys to proper evaluation. The main question should be whether this balance sheet is a complete representation of the firm’s economic position.
When evaluating the income statement, the main point is to properly assess the quality of earnings as a complete representation of the firm’s economic performance. Evaluation of the statement of cash flows helps in understanding the impact of the firm’s liquidity position from its operations, investments and financial activities over the period—in essence, where funds came from, where they went, and how the overall liquidity of the firm was affected.
It is important to analyze all aspects of your business, including profitability and risk. The most common analysis tools are key financial statement ratios relating to liquidity, asset management, profitability, debt management/coverage and risk/market valuation.
With respect to profitability, there are two questions to be asked: how profitable the operations of the firm are relative to its assets—independent of how the firm finances those assets—and how profitable is the firm from the perspective of the equity shareholders.
It is also important to learn how to disaggregate return measures into primary impact factors. It is critical to analyze any financial statement ratios in a comparative manner, looking at the current ratios in relation to those from earlier periods or relative to other firms or industry averages.
Cultural differences and a unique business culture make analyzing management reports in China an area in which both experience and specific knowledge are vital. The importance of understanding Chinese financial reporting and financial management revolves around due diligence, verifiable accounting, and risk reduction.
While Chinese accounting standards (CAS) and International Reporting Standards (IFRS) share some key similarities, it is prudent that foreign companies take note of the differences because they can easily get them into conflict with the law.
Investors in China should be aware of relevant risks and obtain professional advice when assessing Chinese financial statements.
In general, accounting books are prepared by Chinese nationals. While the level of education is improving amongst Chinese accounting staff, in many businesses, Chinese laws in regard to the proper maintenance of accounts are either misunderstood, or willfully neglected in order to present a better situation than reality, to cover up fraud (such as missing inventory) or, in a more negative situation, to avoid tax.
The legally liable person in China is responsible for evaluating and authorizing accounts as prepared by local staff. Severe penalties and other serious consequences with the customs and tax bureau can arise when the reports submitted are incorrect or have missing information. In some cases, attempted tax fraud can lead to prison.
When companies move to China, they face major challenges, especially on the interpretation of the Chinese accounts. Also, they may find it an uphill task when trying to consolidate their Chinese companies’ accounts with the firms in their countries of origin.
Several issues can be identified by examining first, the balance sheet and second, the income statement.
Within the balance sheet, the areas to consider are mainly Accounts Receivable; Other Accounts Receivable; Fixed Assets; Construction in Process; Accounts Payable; Other Payable; and Payroll Payable, while in the income statement, it is important to evaluate Sales Income; Cost of Goods Sold; Expenses; and Income Tax.
Doing business in a foreign country is never simple, and the same goes for China. Since Chinese accounting standards and financial reports differ to those in Western nations, and accounting must almost completely be done in Chinese, many foreign companies will need assistance.
When you decide to incorporate a company in China, it is important to understand that the Chinese government takes financial and tax-related matters with a lot of strictness. Therefore, you should ensure that your staff respects and follows the Chinese accounting standards correctly.
Hiring a local accountant could be a solution, but you need to be extremely vigilant and make sure that they are not, inadvertently or otherwise, cutting corners which could cause you to fail your annual audit and run into trouble with the Chinese authorities.
The most important thing is that your company is well informed and prepared, and that you do not go into things blind. Even having an overview of the way things are supposed to be in China, will allow you to protect your investment and make better business decisions moving forward.
Mastering Superpower 8 will allow you to make reasonable assumptions about the future of the firm (and its industry) and determine how these assumptions will impact both the cash flows and the funding.
Once the analysis of the firm and its financial statements are completed, there are further questions that must be answered. One of the most critical is: “Can you really trust the numbers that are being provided?”
There are many reported instances of accounting irregularities. Superpower 8 will assist you in understanding how these types of manipulations can be perpetrated and more importantly, how to detect them.
To learn more about Superpower 8 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.