When trying to get your new business off the ground in China, your initial focus might be on rapid growth. Internal controls could easily be neglected in the hustle and bustle of this competitive market.
This lapse, however, can potentially put you at risk of compliance issues, especially in China where changes in regulations can be frequent and non-compliance can result in serious consequences.
In essence, internal controls are processes within the business to help it comply with laws and regulations. They also help to improve operational efficiency. Adopting a long-term view, it is crucial for companies to have effective internal compliance measures, and to conduct regular “health checks” on them.
In this article, we will guide you through establishing effective internal controls for your business. We will focus on three core areas: financial management, tax and HR.
Key financial management internal control checkpoints
If financial records are inaccurate or non-existent, your business will lack accurate data to reflect your financial performance. This can result in making misguided decisions based on flawed numbers or gut feeling and can be challenged by local authorities, such as the tax bureau and the statistics bureau.
For example, you might overestimate your cash flow which could lead to overspending or underestimate it and miss investment opportunities.
In both cases, the financial stability of your business may be compromised. Here are three questions to ask when you are doing a health check on financial management.
Q1. Is your accounting software comprehensive and compliant?
For starters, ensure that your company has established a comprehensive accounting system which can help maintain accurate financial records and support compliance with Chinese accounting standards. The majority of businesses today rely on accounting software, with additional processes to ensure accurate data entry. In China, widely used ones include Kingdee and UFIDA (Yonyou).
However, it is not enough to just have a system in place; your staff needs to be familiar with, and adhere to, the required accounting standards to reduce the risk of errors.
This includes understanding the Chinese Accounting Standards (CAS), which may differ from International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP) used in other jurisdictions.
As part of your standard operating procedure (SOP), it is also important to regularly check the accuracy of your accounting records, including bookkeeping and financial statement compilation.
Q2. Is your cash journal accurate and up-to-date?
When managing non-cash transactions, your company should maintain a complete and accurate cash journal. For this, you must have a funds management procedure which includes regularly reconciling bookkeeping records with monetary fund balances. This ensures the accuracy of your financial records, allowing you to promptly identify any discrepancies early on.
For incoming payments, all transaction funds should be deposited into the company’s designated accounts. These should be verified with the relevant business personnel to ensure the collections match the corresponding invoices. You may also consider including credit management in your accounts receivable process to monitor payments better.
On the outgoing side, you will need a clear payment procedure that not only safeguards funds but also ensures they are used efficiently. Each outgoing fund expenditure should be supported by a corresponding payment application process. This means that having appropriate approval and supporting documentation, such as receipts or invoices, to provide a clear audit trail. This approach helps protect the company’s financial health and optimise the use of available funds. You can then be confident that your company’s funds management is thorough, reliable, and on par with the good practices.
Q3. Are you effectively managing and protecting your company assets?
Without internal control, company assets may be misused, lost or misappropriated. Having proper asset management will ensure that your assets are accounted for and protected from loss or theft.
One key aspect of effective asset management is verifying that the acquisition, transfer and disposal of assets have gone through the appropriate approval procedures. If they are reviewed by the relevant personnel, you can better avoid unauthorised transactions and ensure that all asset movements are in line with your company's strategic objectives.
Regular asset inventory checks are also crucial for effective asset management. This can help ascertain any discrepancies or misappropriations early on, ensuring reliable asset records. Assets should also be properly recorded with supporting documents, such as invoices and purchase agreements.
Essential tax internal control checkpoints
Running a business overseas, especially in China, requires early implementation of internal controls on tax compliance due to the varying requirements across different jurisdictions. Tax compliance can be an issue if you fail to adhere to the regulations in China.
Q1. Are you accurately calculating your business's tax liabilities?
With that in mind, you must first ensure that your company pays all applicable taxes, including corporate income tax, value-added tax (VAT) and other local taxes in China. This includes accurately calculating tax liabilities, timely filing of tax returns and making the required tax payments to avoid penalties.
Additionally, you should verify that there is no tax evasion or misuse of tax incentives. Tax evasion, which involves deliberately underreporting income, inflating deductions or fabricating conditions that qualify for tax incentives, is illegal and can result in severe consequences.
You will also want to check that all tax incentives and deductions claimed are legitimate. To substantiate your claims, be sure to understand the specific requirements and conditions for each tax incentive in China and maintain proper documentation. By adhering to these practices, your company can optimise your tax position in a lawful manner, enhancing your credibility with tax authorities and other stakeholders.
Q2. Is your tax planning strategy fully compliant with current laws?
On a regular basis, evaluate your company’s tax planning strategies to ensure you are effectively reducing your tax burden while adhering to the relevant tax laws and regulations. This will involve assessing the methods used to minimise taxes, such as deductions and credits, to confirm they are appropriate and lawful.
It can also make a difference if your company has robust tax risk prevention mechanisms in your SOPs. This includes having processes that identify, assess and manage potential tax risks, such as changes in tax laws or unforeseen tax liabilities.
Your company should be prepared for tax audits at any time. Your staff must maintain accurate and comprehensive records, have clear procedures for responding to tax authority inquiries and regularly review and update tax compliance practices.
This proactive approach helps safeguard your company against potential tax issues and ensures readiness to handle tax audits.
Q3. Are you checking the tax compliance of major business transactions?
In managing your business' tax obligations, it is essential to keep an eye on any major transactions. This means reviewing the tax implications of financial activities such as acquisitions, disposals, mergers and other major domestic and cross-border transactions to ensure they are correctly reported and compliant with the law.
Prior to making any major transaction, you can also be better positioned by first assessing the potential tax risks to identify any areas where your company might face unexpected liabilities and reporting obligations. At the same time, look for tax optimisation opportunities that may arise from these transactions, such as eligible deductions and credits to legally minimise your tax burden as you grow.
Crucial HR internal control checkpoints
Inconsistent or poorly defined HR practices can lead to numerous compliance issues for a company. These can become more distinct when you are hiring for your foreign business in China.
Q1. Are you compliant with China’s labour laws?
With the complexity of differing labour laws in China, you should be vigilant and proactive in managing your HR operations. Given this, you should ensure your HR operations comply with China’s complex labour laws to mitigate risks and maintain operational efficiency.
For example, there are three types of work hour systems in China. The standard work hour system mandates that employees work no more than eight hours per day and 40 hours per week, with at least one day off each week. There are also flexible and comprehensive work hour systems that can be applied to certain positions or industries.
To stay compliant, regularly review and update your HR practices to align with the latest legal requirements. This continuous monitoring and adjustment will help mitigate risks and ensure that your HR operations run smoothly within China's regulatory framework.
Q2. How comprehensive are your HR internal policies?
For guidance, your HR department should be equipped with detailed internal policies. These should cover all aspects of HR management — recruitment, onboarding, compensation and benefits, performance appraisal and termination — and must be strictly enforced to maintain consistency.
By having well-defined and consistently applied HR policies, your business can better motivate employees while ensuring legal compliance. This approach can also strengthen your ability to attract and retain top talent, which will be essential for the growth and success of your foreign business in China.
Q3. How secure is your employee data?
While you focus on hiring staff and building your business, it is equally important to protect your employee information. To manage this, you will need to evaluate whether your HR department has adequate data protection measures. This involves ensuring that all employee data is securely stored and handled according to Chinese privacy regulations and best practices. Key steps include implementing robust security protocols, regularly updating security systems to protect against emerging threats and allowing access to authorised personnel only.
To check for risks of unauthorised access or leakage of employee information, frequently evaluate your current security protocols. Make it a point to conduct regular audits and penetration testing to uncover potential weaknesses in the system. With strong data protection measures in place, your HR department can support your company better.
Start taking control
This article has covered the essentials areas of your business that require internal controls, but there are others. Not having strong internal controls procedures may eventually result in legal penalties, fines and damage to your company’s reputation in China.
As a trusted provider of corporate services, our team at Hawksford can support you in accounting, tax and HR in China. By partnering with us, you can leverage our expertise to strengthen your SOPs and improve your business operations. Our customised solutions are designed to address the specific needs of your business, so no critical area goes overlooked. For further information, don’t hesitate to contact our team.
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