Credit risk is an inevitable part of doing business, but it looms particularly large in the China market. Outstanding debt has grown steadily, and long overdue accounts and payment failure are familiar problems afflicting foreign-invested enterprises (FIEs) and state-owned enterprises (SOEs) alike. Defaults on payment to suppliers, whatever their cause, inevitably create a chain reaction of cash-flow problems.
Better collection practices
Several factors contribute to the high levels of risk in China. One is an under-developed business infrastructure. SOEs, once the sole players in the Chinese economy, are under-going extensive reform but continue to lose money. Many of their funds – in some cases up to 20 percent – are tied up in large inventories of goods that cannot be sold. These obsolete inventories are estimated to account for one percent of total GDP. Most SOEs are propped up by government subsidies and by large, often unrecoverable loans from the commercial banking sector.
All this means that companies offering goods to SOEs on credit are faced with a high risk of default. The fast growing privatesector allows more competition but also involves greater risk. Business in China has suffered in recent years from impacts as diverse as the Asian financial crisis and the summer floods of 1998.
Over the past year, businesses have improved the systematisation of credit and collection practices, as reflected in indicators such as DSO (days sales outstanding). This is a measure of how long on average it takes for a company to be paid and is calculated by dividing accounts receivable by total sales and then multiplying by 365 days. A 1999 survey by Dun & Bradstreet China showed that DSO for FIEs fell from an average of 100.7 days in 1998 to 73.9 days in 1999. Open sales terms, after rising rapidly from 60 percent to 80 percent of total sales between 1997 and 1998, contracted to 71 percent of the total in 1999, most likely due to increased credit risk.
DSO for the state enterprises surveyed was 84 days, surprisingly perhaps not very different from that of FIEs. It was highest for other, mainly listed companies, at III days. By sector, respondents who classified themselves as engaged in energy/materials, fast moving consumer goods, textiles and chemicals fared relatively well, with DSO ratings of 46, 46, 48 and 53 days respectively. The problem was greatest in the pharmaceuticals and automotive sectors, with DSO ratings of 139 and 130 days respectively, while building/construction respondents recorded DSO levels of 113 days and those engaged in the production of cosmetics 103 days.
Several factors significantly reduce DSO, bad debt and levels of accounts receivable. No single one will solve a company's payment problems; rather a coordinated approach is recommended. Of the companies surveyed, those with the best track record had standardised, formal and rigorously applied processes for credit review and for the tracking and collection of accounts receivable.
The single most effective measure proved to be a standardised credit review procedure, although only 41 percent of respondents had such a system in place. Those who did aver-aged a DSO of 67 days, while those without averaged 91. Three factors appeared crucial: the existence of a credit manager or department, the review of existing customers against previous payments, and the use of a third-party credit information provider.
Another measure effective in reducing DSO was to retain sales staff on a commission basis and to tie their commissions to customer payment. Companies offering sales commissions averaged a DSO of 77 days, while those which did not averaged 85 days. Companies operating a system of commissions based on full payment had greatly reduced DSOs – on average 65 days. These figures indicate the importance of giving sales staff a degree of responsibility in collecting payments.
Other factors of positive benefit included computerisation of the tracking system, a general manager who pays attention to the collection process, and coordination and communication between different company departments in granting credit and tracking accounts receivable. Perhaps unsurprisingly, good relations and regular contact with customers also proved to be important factors.
The third annual Dun & Bradstreet Accounts Receivable Survey was based on the responses of 127 companies. Of the respondents in 1999, 64 percent were engaged in manufacturing activities, 25 percent in trading and 11 percent in services. Shanghai was the base for 45 percent of respondents and Beijing 17 percent, while the rest were distributed across China.