# Presentation: 115445

## 2005 SURVEY OF CORPORATE CREDIT RISK MANAGEMENT IN CHINA

***Mark Larocca***
***Coface North America***

**Notes:**
Understand credit risk management for companies based in mainland China

## Survey Report

**Background**
**Basic Information of the Interviewed Companies**
**Credit Risk Management Practice and Analysis**
**Payment Terms Offered**
**Open Accounts vs Turnover**
**Days of Sales Outstanding**
**Payment Experience in China**
**Non Payment Experience**
**Most Effective Actions**
**Conclusions**

## Part 1 : Background

**Objective:**
**To understand the general status of the credit management in companies based in Mainland China**
**To understand the payment experience of companies based in China**
**Sample size:**
**3,000 questionnaires**
**272 valid replies from registered companies in Mainland China, 80% of respondents are ‘joint ventures’ and ‘wholly owned foreign enterprises’**
**Survey Period:**
**October – December 2005**

**Notes:**
From July to October, we did a micro survey to study the credit management practices of companies in China.

## Type of Companies : 
59% WOFE’s (161 companies)
21% JV’s  (56 companies)
13% Privately owned companies (36 companies)
7% SOE’s & Collectively owned (19 companies).

Types of Industries : 66% (180 companies) of interviewed companies are from the manufacturing industry.

Size : 66% of interviewed companies have a total number of employees between 100 to 500 and more

**59% WOFE’s (161 companies)**
**21% JV’s  (56 companies)**
**13% Privately owned companies (36 companies)**
**7% SOE’s & Collectively owned (19 companies).**
**Types of Industries : 66% (180 companies) of interviewed companies are from the manufacturing industry.**
**Size : 66% of interviewed companies have a total number of employees between 100 to 500 and more**

**Part 2 : Basic Information of the Sample Companies**

## Part 3 : Credit Risk Management Practice and Analysis

**What kind of payment tools and payment terms are used in China?**
**What are the recent trends for payments in China?**
**What are the credit management practices in China?**
**What are the impacts to their receivables?**

## Part 3 : Payment Tools

**Multiple answers**

- T/T: Telegraphic (electronic) transaction
- L/C: Letter of credit

## Part 3: Payment Terms Offered

**Multiple answers**

## O/A Payment Terms Offered Remain Stable

**Although O/A sales are the most common practice, the increase in advanced payment and cash on delivery seems to show a greater maturity of companies when doing transactions domestically**
**Companies are applying tighter payment terms than before. 50% of companies offer 60 days payment terms. The number of companies offering 90 day payment terms has dropped 18%.**
**Maximum O/A terms – 90 days is the most common payment term in that category **
**	**_**Coface experience:**_
**Companies have more diversified customer portfolios and will diversify their risks by asking advance payments or COD to some of their clients**
**We see some companies granting long term payment terms without any rational reasons, just to please their clients. **

## Medium Sized Companies are the Most Aggressive

**Most small companies do not sell on a credit basis, mainly because they are comparatively fragile financially and tend to negotiate more secure payment terms.**
**Medium sized companies are the most aggressive because they want to develop their business and market share.**
**Two extreme trends observed in large sized companies:**
**Companies who have a very cautious and conservative approach in terms of payment risks will have limited O/A sales in their portfolio (usually market leaders in less competitive markets, e.g. auto parts)**
**Companies who are very aggressive to gain more market shares and thus grant credit terms to a large number of their clients/distributors (new players or large players in very competitive markets, e.g. mobile phone industry)  **

## WOFE and JV have More Credit Sales

**Chinese companies, especially SOES, might not have a full credit culture yet. Many of them still mostly work on advanced payment / COD payment basis.  Some SOEs have also a dominant market position which enables them to decide of the payment terms to be granted to their clients **
**Foreign invested companies have a more aggressive/dynamic approach. Most of them grant significant portion of credit facilities to their clients (a 1/3 having more than 75 % of their domestic sales in China on an O/A basis). Many of these foreign invested companies want to expand and gain market shares in China. **
**Private owned companies are in between. Almost half of them keep granting very limited credit facilities to their clients (= traditional approach) but the other half looks more dynamic and is ready to take more risks to develop and gain market shares (almost 1⁄4 of them have more than 50 % of their T/O made of credit sales)**

## Part 2: Competition is the Main Driver

**Multiple answers**

## Competition Drives O/A Up, Customer Tight Liquidity Concerns

**44.5% of the companies have increased their O/A transactions in 2005.**
**Competition is again the main reason why companies grant credit facilities to their domestic clients in China. **
**But the major finding here is that 1/3 of the interviewed companies admit granting favorable payment terms to ease the financial pressure their clients might have (= tight liquidity of the client)**
**It is quite alarming since it is how ‘ triangular debt’ starts, which ultimately leads to corporate failures**

## Tight Margin Underlines Default Risk

**Several sectors are suffering tighter margins due to competitive pricing and increasing raw materials cost. Coface experience shows that such **_**rising costs have not been passed on significantly in sales prices**_** on downstream companies, subcontractors, distributors), causing the default risk to remain at a significantly high level.**
**High risk industries: mobile phone industry (overcapacity crisis with too many players now competing together on low margin products), home appliance industry (same comments)**
**Coface’s experience: default risk increasing due to fiercer competition, margins under pressure, consolidation of the market (impact on small sized companies as well as on distributors)  **

## Part 3: Average Period for Days of Sales Outstandings (DSO) for Domestic Sales in China

- DSO = (Accounts receivable/ Total credit sales) X number of days

## Part 3: Highest % of DSO Among Different Industries

- DSO = (Accounts receivable/ Total credit sales) X number of days

- Year 2005

## Part 3: Highest % of DSO among Companies of Different Nature

| Nature of companies | Highest % of DSO | Average period for delayed payments |
| --- | --- | --- |
| State Owned & Collective companies | 47.3% | Between 0 to 30 days |
| Private companies | 38.8% | Between 0 to 30 days |
| Joint ventures | 31.4% | Between 60 to 90 days |
| Wholly owned foreign companies | 35.2% | Between 30 to 60 days |

- DSO = (Accounts receivable/ Total credit sales) X number of days

- Year 2005

## Part 4 : Payment Experience in China

**What is the most risky type of company? **
**What are the reasons for non-payment? **
**Which kind of actions is effective in debt recovery?**

## Part 4: What is the Most Risky Type of Company ?

## Private Companies are the Most Risky in China

**More interviewed companies revealed private companies are still the most risky ones in terms of payment (77.1%), same as in 2004**
**Some common characteristics of private companies**
**dynamic**
**family basis with simple management system**
**recently created (less than 5 years ago = statistically the weakest companies with the highest rate of corporate failures among them)**
**small size (staff, assets)**
**limited capital**
**difficult access to bank financing**

## Lack of Credit Control is the Main Reason 

**Competition is fiercer among private companies, and many sectors are suffering from overcapacities, tight margins, and higher raw material prices**
**A large proportion of private companies are now granting credit facilities to their clients but without sufficient internal credit control capacities hence greater risks of payment defaults.  **
**SOEs are considered as a moderate risk in terms of non payments. Coface experience shows that SOEs tend to pay slowly but they eventually honor their financial commitments (usually large financial size) **
**JVs ****and WOFE’s are considered the safest types of companies since they often enjoy a strong financial position (investments from foreign parent companies), better payment practices, more sophisticated management structures and also better access to financing.**

## Financial Difficulties - Main Reason of Non-payment

**67.9% of interviewed companies think their customers fail to make payment because they are often facing financial difficulties. The market becomes increasingly competitive with a negative impact on both margins and cash liquidity.**
**Competition and lack of financial resources are the main causes of financial difficulties of debtors.**
**Commercial disputes increased by 6.9%. It is possible debtors use it as an excuse for payment default. It could be improved and get solved with a better knowledge of the trading partners as well as amicable negotiation.**
** **
**Fraud is endemic in China where still too many companies show a lack of respect for their financial commitments.    **

## China usually favors amicable solutions more than legal procedures (= notion of “face”).

Court action is something that many companies try to avoid to solve payment issues (in order not to jeopardize relationships with their partners). However, for large amount debt cases, more and more companies (including Chinese ones) take such legal actions.

According to the Contract Law in China, the status of limitation is 2 years and creditors must take legal action within 2 years or they will forfeit their rights against the debtor.

Coface remark: the impact and efficiency of legal actions should not be minimized (as long as decisions taken by courts can be enforced, which remains one the major difficulties in China)

**Court action is something that many companies try to avoid to solve payment issues (in order not to jeopardize relationships with their partners). However, for large amount debt cases, more and more companies (including Chinese ones) take such legal actions.**
**According to the Contract Law in China, the status of limitation is 2 years and creditors must take legal action within 2 years or they will forfeit their rights against the debtor.**
**Coface remark: the impact and efficiency of legal actions should not be minimized (as long as decisions taken by courts can be enforced, which remains one the major difficulties in China)**

**Part 4: Actions Taken in Case of Non-payment**

## Part 4: Evolution of Legal Environment in China during the Past 12 Months

- Year 2005

## Legal environment in China improved

**The legal environment is seen as either improving or remaining unchanged (but does not deteriorating)**
**This is to be linked to the commitments taken by China when joining WTO in December 2001. China has respected most of them and made the legal environment more transparent.**
**Of course, many companies still complain about the system (too many procedures, corruption at local or regional levels, etc). Some reforms also go slowly (new bankruptcy law for instance)**
**But overall, transparency has been improved during the last 5 years **

## Part 4 : Main Channels Used to Obtain Customer’s Credit Information

**Multiple answers**

## Part 4 : Most difficult task within the credit risk procedure in China

**Multiple answers**

## Part 4: Most effective way to avoid credit risks in China

**Multiple answers**

## More Concern on Credit Management

**Companies interviewed are more aware of credit management and now use several sources to obtain customer information.**
**Since there is no centralized system for corporate credit information in China and banks usually do not disclose information on their own clients to third parties, on-site visits and obtaining of third party information (public information, information agency) is essential.**
**As companies expand, monitoring risks become more difficult**
**Although most companies still rely on in-house expertise, an increased % of them agrees that credit information agencies, credit insurance and factoring companies can help mitigating trade risks.**
**This finding is encouraging as more and more companies are putting more resources and effort to minimize their trade risks in China. **

## 

Conclusions

_**Conclusions**_

## 4 Main Findings

**O/A sales remain stable or have increased throughout the year. The main reason is market competition, but also sometimes the necessity to help clients who face financial difficulties. It is rarely due to rising confidence in their customers. Not a very rational approach.**
**There is a very different credit risk approach between Chinese companies and foreign companies.**
**Respondents of the survey have a more mature approach to deal with local counterparts (higher awareness of the risks, actions taken to limit the credit risk).**
**Companies are looking for more diversified ways to prevent credit risks. In addition to relying on in-house expertise, credit insurance and credit information are recognized as the two most effective tools to avoid payment risks in China. **

## 4 Main Risk Signals

**Although the legal environment has improved, China becomes more risky because of fiercer competition, financial difficulties met by companies (especially private ones, with tighter margins) as well as cultural patterns (frauds)**
**The % of overdue witnessed here looks higher than globally, especially ST overdue who faced a degradation this year. LT overdue remain stable, which shows there is a structural level of overdue in domestic sales. The reasons of such overdue are not only commercial disputes (only 26 % of total cases) but also other reasons like financial difficulties, management chaos, fraud (which is pretty alarming)**
**Private companies are the most risky one in terms of non payment. They also represent an always larger proportion of total Chinese companies so it means that risk in general becomes higher YoY.**
**Production over-capacities, price war, tighter margins, cash difficulties tend to extend to a larger number of industries (mobile phone, home appliance products, car industry). **

## 
Contact:

Mark Larocca
Coface North America
(312) 382-7080
Mark_larocca@coface-usa.com

_**Contact:**_
**Mark Larocca**
**Coface North America**
**(312) 382-7080**
**Mark_larocca@coface-usa.com**

**2005 Report on Corporate Credit Risk Management of Companies in China**

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