WHEN SEEING IS BELIEVING
The ultimate enemy of companies in China battling bad debts is their own credit culture.
By Abe De Ramos

Nanjing road at the heart of shanghai is a shopping district with a buzz that has been compared with Times Square in New York. But if one sound is missing inside its maze of identical shops, it's the soft swish of plastic money cutting through a magnetic card reader. Outside of the main tourist areas in China, even a shiny Platinum Visa becomes less valuable than Monopoly money.

After more than two decades of liberalization, China remains a cash-based society. Little wonder, then, that when credit is involved, risk assessment is often poorly executed. The World Trade Organization, however, is about to change the way finance departments look at their customers. Because credit is an indispensable part of domestic and foreign trade, its use is about to get more prevalent. "Companies all over Asia are now competing in offering better terms, including open account, which leads to the need for careful credit risk assessment," says Richard Burton, Hong Kong-based managing director of Coface, a French credit information and export insurance company. To stay afloat, companies need to make sure they grant credit only to deserving customers - and this is where the problem begins. Given the absence of an official credit information bureau, companies are pretty much on their own in terms of risk assessment.

"China has a do-it-yourself culture when it comes to credit. They don't want to check (financial accounts); they want to see the person and shake hands on the deal," says Ming Shen, China country manager for Coface in Shanghai.

Trust Nobody

As such, credit terms are granted on the strength of relationships. The result: poor quality of accounts receivable. In China, it is not uncommon to treat a two-year-old debt as receivable without the benefit of provisioning, despite accounting rules. In a survey of credit management practices in China two years ago, US-based credit information firm D&B found that the average Chinese company has a days sales outstanding (DSO) of 63.5 days.

But Lawrence Yee, managing director of the firm's regional office in Hong Kong, is skeptical of the result. After all, only 55 percent of companies surveyed - among them the largest state-owned enterprises, foreign joint ventures and private companies - said they have "some form" of risk control systems. "Some Chinese companies grant credit based on friendship, and they call it a system," says Yee. "Now it's getting out of hand. When we asked about potential losses from bad debt, at least 80 percent are from existing customers, not new customers," he says.

The problem is compounded by a simple desire to generate revenues. "If there are conflicts between sales people and credit control people, the decision is always to go for business first, and worry about accounts receivables later," says Yee. Well and good for the sales people, who, more often than not, get their full commission on signing of the contract. But finance departments in China often have a lack of clear accountability, says Chantal Free, partner at human resources firm Watson Wyatt in Hong Kong. When the due date comes, credit collection can fall on anyone's lap, oftentimes to sales people who have no incentive to do so since they have already obtained their commissions. "It's very typical of Chinese organizational structure," says Free. "There's a lot of duplication between departments, no clear definition of roles, and the people who are holding positions aren't necessarily functional experts," she says.

Many Chinese companies acknowledge the problem and are eager to change. Some have even adopted a credit scoring or credit rating system offered by some local private credit information companies, and foreign firms such as D&B and Coface.

Nanfou Batteries in Fujian province, for example, has a list of factors to assess the credit risk of potential and existing customers, and assigns a score for each, with ten being the highest. They are then weighted on a scale of 100 percent. "If last year's sales were above 10 million renminbi (US$1.2 million), the company gets ten marks, or eight marks for sales between 5 million and 10 million renminbi," says Huang Gongwei, head of the credit department. "New clients are rated similar to old clients, but we eliminate certain considerations such as record of cancelled payments, and instead adjust the weighting on each factor," he says. Clients are then categorized as good, normal, restricted and "clean-up" for delinquents that are making good.

Norin Optech, a two-year-old, Guangzhou-based manufacturer of optical equipment, uses software provided by D&B, called Risk Assessment Manager (RAM). "We assess the creditworthiness of our clients through internal and outsourced collection of information, setting up proper client files, and frequently updating them," says Chen Jingjing of the operations management department. This includes financial information, as well as transaction history and payment records, among others. The end result is a credit score - a departure from its earlier "overly subjective decision-making habits" - which then guides Norin on setting the length of credit to grant. Norin has also sought the help of external consultants to help it on handling bad debts.

Neither Nanfou nor Norin has perfected the art of credit risk assessment, however. In Norin, for example, the credit management department is an entity that acts as a bridge between finance and operations. However, credit managers ultimately report to the operations department. As such, the operational management director and assistant manager for operations have the final say on granting credit. This is the opposite of what Intel, the US chipmaker, does in Hong Kong. To ensure neutrality, the credit department has the last word, according to its CFO Francis Lo.

Nanfou, on the other hand, still uses "subjective factors" in its credit rating system. "Subjective factors occupy 20 percent of our credit consideration, including the opinion of our frontline sales staff regarding the clients, whether they are very good, good, ordinary, bad or very bad," says Huang.

Tip of the Iceberg

But who's to blame them? In the first place, credit information is a scarce commodity in China. D&B, for example, has a database of 500,000 companies in China - or just 2 percent of the 10 million registered companies. Yee acknowledges that even the sources it uses to gather basic information are not entirely reliable. Registered companies are required to submit financial information annually to China's Administration of Industry and Commerce, but it's up to D&B and its domestic partners to countercheck them. Shen of Coface agrees. "Like in other countries, there are different sets of books, but China is at the extreme end," he says. As such, both Coface and D&B find it necessary to interview management and check court records to research cases of delinquencies. Because this is a labor-intensive process, both companies do it more often on companies whom a supplier has already asked to check.

Voluntary requests for credit checks are very rare. More unfortunate, voluntary reporting of payment records and history - perhaps the most important factor in credit risk assessment - has a long way to go. While companies would benefit from sharing information on each other's clients through a credit bureau, it does not happen in China, because of the culture of secrecy, says Shen. Even in the most developed city of Shanghai, says Yee, there are no commercial credit bureaus. This contrasts with other countries in Asia. The Philippines, for example, has long established the Credit Information Bureau, which has gained enough clout that it has become the local partner of Standard & Poor's. In Taiwan companies have been so robust in reporting payment information to D&B, that D&B has established a service called Paydex, in which members submit their clients' payment data on a monthly basis.

To be sure, China is going in that direction. The State Economic and Trade Commission has been mandated to work with nine other state agencies, including the People's Bank of China, the Taxation and Statistics Bureaus, and the Administration for Commerce and Industry - to build a database of credit information. The initiative is still in the planning stage. As such, for now, the ultimate enemy of traditional companies in China battling payment delinquencies is their own credit culture.

Abe De Ramos is a senior writer at CFO Asia based in Hong Kong.