Running out of cash can cause serious consequences to your company, such as losing business opportunities for not being able to execute contracts with clients, purchase raw materials, arrange delivery of goods within the agreed timeline, paying wages, custom duties, and taxes.
However, financing your business in China can be slower and more difficult than expected, due to a strict capital flow control imposed by the banking authorities.
Knowing a couple of key points will help to get on the right path when launching and running your business in China.
Having a proper cash flow plan
Companies have different financial needs throughout each phase of their life cycle and especially during the startup period, the cash flow can be tight as the revenues may be insufficient to cover the initial set-up and daily expenses. Therefore, financial planning is the solution to avoid cash flow predicaments, we will explain below how to define your financial needs and how to fulfil them considering various methods of capital injection in China.
Registered Capital and Total Investment Value
Peculiar to China when setting up a WFOE (Wholly Foreign-Owned Enterprise), it is required to declare to the SAFE (State Administration of Foreign Exchange) a total investment value, which refers to the total amount of funds, including capital and debt, required for the current planned business project. Besides this, companies will have to decide the registered capital, which refers to the total amount of capital to be contributed fully by the shareholders, to be used at the beginning of a company’s life cycle to pay for rent, salaries, goods, etc. until the company can generate cash reserves and auto-finance its operation.
The difference between the total investment value and the registered capital is the ‘borrowing gap’ which is strictly related to intercompany lending.
For most industries, there are no minimum requirements for the registered capital, except for specific sectors such as tourist agencies, real estate construction companies, pawnbrokers, freight forwarding, fund management, insurance companies, commercial banking, telecommunication operation companies, etc.
In most cases, it is not required to inject all the registered capital at the time of the incorporation but within the terms stated in the Articles of Association decided by the company (even 20 or 30 years). To have some special licenses, however, the company is required to fully inject the registration capital (insurance companies, fund management, pawnbroker, etc.)
The usual trading, consulting, food and beverage, import, and export activities don’t have the limit either at the registered capital or the injection limit.
Despite that, the capital is critical to sustaining the Chinese branch’s business successfully at the beginning path and it would be a mistake not to measure it according to the company’s financial needs and strategic plans. For a proper assessment of the capital, companies shall be familiar with the Chinese business practice and take into consideration all the expenses that can occur in daily operations such as rental, personnel costs (salaries, social insurance, and housing funds), customs duties, direct and indirect taxes, logistic costs, marketing costs, etc.
It is quite often that the registered capital is not sufficient to cover the cash flow needs and once the registered capital is fully paid and used up, the company would need to think about how to inject more funds into the business. As obtaining a bank loan may be difficult for a newly established business without any security, capital increase or intercompany loan may be the solution.
Financial needs may change over time for several reasons, for example, extraordinary or unforeseen costs happen, change of the company strategy, the expected growth or important income hasn’t arrived, or some decisions for additional marketing investments. On occasion, they may have to recur to a capital increase.
To complete the increase of the registered capital, the company is required to go through multiple authorizations process from different offices and may take from 6 to 8 weeks, from the moment the process of the capital increase is started to when the new capital can be injected and used in the bank account.
This timeline is quite long especially if the company has a tight cash flow and for this reason, it is advised to pay attention to cash flow and implement a reliable financial controlling procedure as increasing the capital is not an easy and quick process.
In the future, when the company does not need the additional funds due to a change of business plan or other situations that may occur, it is possible to decrease the registered capital provided that the accumulated cash reserves allow the payback without impacting the company’s cash flow or harming the creditors.
Intercompany loans can be granted from companies of the group to the Chinese subsidiary, usually for temporary financial support purposes. In China, the borrowing amount for the foreign intercompany loan is limited to the “borrowing gap” which is the difference between the total investment and the registered capital mentioned above.
Usually, the company needs to follow the indication The ratio between the registered capital and total investment, defining the maximum loan quota, is shown below:
To obtain a loan from the affiliated company, it is required to sign a loan agreement that specifies the several important conditions related to the borrowing of the loan and complete the filing at the SAFE.
The filing procedure might take around 20 working days. Once it is approved and registered correctly by SAFE the company can open an intercompany loan account at the bank and the lender company can transfer the funds.
Like in any other part of the world, in China, the bank can provide discounting services to their clients. It is a trade-related activity in which a company’s unpaid invoices which are due to be paid at a future date are sold to the bank. In bill discounting, the business discount the outstanding invoices to gain access to short-term financial assistance and maintain the working capital.
In China, due to the limit of regulations, the bank can only discount on the guaranteed bills for foreign-invested companies. The main guaranteed bills are international credit letters, domestic credit letters, and banker’s acceptance.
In conclusion, there exist also different financing solutions exist for companies in China depending on specific needs, as an alternative to other bank financing tools (commonly credit line, bank guarantee, cash pooling) that can be difficult to obtain for foreign companies.
Companies must rely on a detailed and accurate financial statement, to constantly monitor expenses, forecast cash flow movements, and plan the suitable financing structure to support the growth of the business smoothly and efficiently.
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