I. Background of Hongda Company
Hongda Company is a joint-stock enterprise of electrical appliances established in 1988, and in March, 1994, approved by the China Securities Regulatory Commission, Hongda Company was listed. The company operates in a very wide range of businesses, including television products, air-conditioning products, electronic medical products, electrical equipment, mechanical products, digital cameras, communications and computer products. However, color TV sets are the fist product of Hongda, which has long held a leading position in the country.
Before and after 1997, HTC secured its leading position in the domestic color TV market through a strategy of drastic price cuts. In later years, profit margins became smaller and smaller as competitors raced to cut prices. In order to get the company out of this unfavorable situation, HTC was eager to explore the international market, especially the U.S. market, in order to mitigate the risks of its operations by developing in both domestic and international markets.
The Beginning and End of Accounts Receivable Crisis
The Occurrence of Accounts Receivable Crisis
Since 1996, HTC's accounts receivable had increased rapidly from 19 million yuan in 1995 to nearly 5 billion yuan in 2003, and the proportion of accounts receivable to total assets had increased from 0.3% in 1995 to 23.3% in 2003. In 2004, HTC made a provision for bad debts of $310 million, and as of the first quarter of 2005, HTC's accounts receivable stood at $2.775 billion, or 18.6 percent of total assets.
Hongda not only saw a substantial increase in accounts receivable, but also saw its accounts receivable turnover rate drop year after year, from 4.67 percent in 1999 to 1.09 percent in the first quarter of 2005, significantly lower than the accounts receivable turnover rate of the other three listed companies in the color TV industry during the same period.
The huge accounts receivable drastically reduced the net cash flow from operating activities, which fell sharply from 3 billion yuan in 1999 to -3 billion yuan in 2002. By the end of 2004, its net cash flow from operating activities was $760 million.
In late December 2004, HTC stunned investors as well as China's home appliance industry with an announcement that the company would face a major loss this year because of large bad debt provisions. Affected by patent fees and U.S. anti-dumping factors on Chinese color TVs, HTC's main customer, U.S. importer KR, has suffered big losses, and there are big difficulties in paying the company's arrears in full.KR is the biggest debtor of HTC, and the amount of accounts receivable reaches 3.838 billion yuan, which accounts for 96.4%. Accordingly, the company decided to make a bad debt provision for this receivable, and the maximum amount of bad debt provision was expected to be around $310 million at that time.
Additionally, as of December 25, 2004, the balance of HTC's entrusted treasury bond investment in Nanfang Securities amounted to RMB182.8 million. Due to the fact that Nanfang Securities is currently insolvent, the Company intends to make a full impairment provision for the balance of its entrusted treasury bond investment in accordance with the principle of prudence. HTC's net profit in 2003 was 260 million yuan, as a standard, HTC needs to carry the burden of this debt for at least 10 years. Listed for the first time in 10 years of losses, leaving debt 10 years hard to taste. Within a few days, HTC's stock price fell nearly 30 percent, with a total market value loss of more than 3 billion yuan. in the first half of 2004, HTC's net profit was only more than 60 million yuan.
It can be seen that the main culprit that led to HTC's huge loss was the U.S. distributor, KR Corp. The U.S. KR company was founded in 1997, is a joint venture established by the U.S. Sanlian, Hong Kong Dayang and the former Zhenjiang Jiangkui company, JL is the chairman of the company. Starting from July 2001, Hongda Company sent its color TVs to KR Company in a steady stream. However, the products went out, but the payment was not received. JL, the head of KR, who was honored as the world's most competitive entrepreneur in 2002 by Time magazine, always refused to pay or owed money to HTC under the pretext of quality problems or uncollected payment.
HTC's 2003 and 2004 annual reports showed that KR owed HTC nearly 4 billion yuan in accounts receivable.
HTC's 2003 annual report, published on March 23, 2004, disclosed that by the end of 2003, the company's accounts receivable was 4.985 billion yuan, of which 4.446 billion yuan was from KR.
An annual report published on March 25, 2003, disclosed that KR owed HTC 4.985 billion yuan, of which 4.446 billion yuan was from KR. On March 25, 2003, HTC published its 2002 annual report, which showed that HTC achieved revenue of RMB12.59 billion and net profit of RMB175 million, but operating cash flow was RMB2.97 billion, which was the first time since the preparation of the statement of cash flow (1998) that HTC's operating cash flow was negative. As of the end of 2002, HTC's accounts receivable still amounted to 4.22 billion yuan, of which the amount of uncollected KR's accounts receivable amounted to 3.83 billion (460 million U.S. dollars). Comparing the two, accounts receivable increased rather than decreased. Meanwhile, Hongda has more than 7 billion yuan of inventory, of which 3.12 billion yuan is inventory goods and 2.256 billion yuan is raw materials. What's confusing is that despite KR owing such huge sums, there is no special reminder of this in the annual report, either in the supervisory board report or in the financial report by the accounting firm.
The figures changed in Hongda's quarterly report for the first quarter of this year, in which the company's accounts receivable was reduced to 4.572 billion yuan, but inventory grew to 7.884 billion yuan from 7 billion yuan at the beginning of the year, and there was no crisis.
KR, in its dealings with HTC, takes the factoring process for any credit sales.After the three companies -- KR, the factoring company and HTC -- sign an agreement, the factoring company will notify retailers, such as Wal-Mart, that they may not pay KR directly for the goods, but instead hand over the money to the factoring company, which splits the money between KR and HTC at a rate of 10 percent and 90 percent, according to KR.KR said that, for goods that did not go into the supermarket chain, KR provided a check guarantee to Hongda, which was a very small quantity. In other words, there were two ways for Hongda to recover the payment for the goods: the factoring process and KR's check guarantee. In this regard, in international trade, the buyer's check guarantee has a completely different level of protection for the seller than the commonly used letter of credit. The validity of the check guarantee depends on the buyer's credit and fund account status, and the bank is not liable for payment.
In 2002, HTC's trade with KR totaled $500 million, of which $200 million was not recovered. From the statement, KR's arrears increased from $40 million at the beginning of the year to $460 million at the end of the year. From the point of view of HTC's huge accounts receivable from KR, HTC's export revenue is basically realized through KR, and HTC may be OEM for KR or KR buys out HTC's color TVs, which means that HTC's color TVs are exported to the U.S. in the credit chain for sales, and whether or not HTC can recover the payment is irrelevant to retailers such as Wal-Mart; and according to the export of 3,976,100 units of color TVs and export revenue of Based on the export of 3,976,100 units of color TVs and the export revenue of RMB 5.54 billion, it is presumed that the color TVs exported by HTC should be low-end products (less than RMB 1,400 per unit on average). In order to guard against the risk of Wal-Mart's possible closure, HTC and KR took out separate insurance policies with the insurance company, which had to pay out if the factoring company failed to collect the payment within two months. But in fact, the average recovery period of KR's payment is definitely more than two months. In 2002, HTC recovered US$0.4 billion of payment, and according to the notes to the statement, as of March 10, 2002, US$89.06 million of KR's payment had been recovered, and US$101.99 million of notes were in the process of collection. In the 2003 interim report, in response to the larger amount of accounts receivable, HTC explained, "Accounts receivable with an age of less than one year can generally be recovered in the following year based on the company's experience in previous years." However, in the 2003 annual report, Hongda disclosed that the amount owed by KR was 3.512 billion yuan for accounts with an age of less than one year and 933 million yuan for accounts with an age of one to two years. This figure leads to the question of whether the payment of 933 million yuan belongs to the payment of goods signed by the three companies, namely, Hongda, KR and Factoring Company, and if it is this kind of payment, why it is not recovered for more than 1 year. At the same time, due to problems with entrusted finance, 200 million yuan of Hongda's funds are temporarily frozen.
In fact, Hongda has KR more than 1 year accounts receivable extracted more than 90 million yuan of bad debt provision. 2003, Hongda company's main business profit of 302 million yuan, do 90 million yuan of bad debt provision undoubtedly greatly eroded the company's profitability. Total accounts receivable and inventory*** amounted to RMB 11.99 billion, accounting for 56% of the total assets and 91% of the net assets, which will affect the quality of the company's assets. As the road to export to the U.S. has been blocked, HTC's color TVs originally planned to be exported to the U.S. market may depreciate significantly. As a matter of fact, the bad debt provision on December 31, 2004 was even 26,111,550,059 yuan. Obviously, according to the profit level of HTC this year, it is unable to support this high cost.
Seeking to resolve the crisis
"Three feet of ice is not a day's cold". HTC has been burdened by KR not overnight. As early as March 5, 2003, there were media reports, KR and HTC's business dealings between the company may make HTC suffered losses. However, HTC did not put on the brakes urgently, and after the KR receivables incident, HTC's management had already determined to carry out a "dumping of the burden" on HTC, so as to start with a lighter load in 2005, and thus it would accrue 2.6 billion yuan of bad debts from KR receivables in one year, and the new management did not want this burden to affect HTC in a more lasting way. In the latter half of 2004, HTC had planned to acquire KR in a life-and-death situation to restart its internationalization strategy. The price for taking over KR was the 470 million dollars of KR's payment. For KR, 470 million dollars is first of all a solvency issue, to KR a moment to come up with so much cash is quite difficult; even if there is, KR will think of all kinds of ways to be delinquent. The path of getting KR to repay has been proven to be unworkable. Taking over KR's entry into the North American market at a cost of $470 million may be a victory or a desperate move. There are at least two benefits of taking over KR, one is that with the channel of acquiring KR, the internationalization of HTC will be a step forward; the other is to solve the problem of KR's remaining arrears, and to move forward with a lighter load.
HTC had a similar experience in Indonesia, where it began exporting to Indonesia as early as 2000, in cooperation with local Indonesian manufacturers, who produced and licensed products to HTC. At the same time, this manufacturer also sells its own brand products. After a period of cooperation, the Indonesian partner owed HTC a large sum of money. The final result was that HTC acquired the Indonesian partner and owned the Indonesian partner's sales network in Southeast Asia. With the support of the strong sales network, HTC made a big push into Indonesia with its products, including color TVs and air conditioners. By now, HTC's air conditioners and color TVs have taken over most of the Indonesian market, which is the largest in Southeast Asia, and by occupying the Indonesian market, it also occupies the commanding heights in Southeast Asia.
Although the KR incident is not exactly the same as the situation in Indonesia, the two are comparable. After taking over KR, HTC will sell KR-branded products in the U.S. with the help of KR's existing channels and resources from upstream and downstream of the industry. One background is that KR has considerable influence in the low-end market, which is the brand with the largest sales volume of home appliances in the United States. After the acquisition is completed, it will not produce the problems now occurring with KR, because HTC is facing retailers such as Wal-Mart, which even if it owes HTC payment, the nature will not be as serious as now, just like the current HTC cooperation with Suning and Gome, omitting the troublesome middle link of KR.
But it was still a vision, and for HTC, how to force KR into submission was the biggest test at the time. If it succeeded, HTC would be well on its way. The fact that HTC didn't file a lawsuit against KR in the U.S. at the time is a reflection of the fact that a lengthy cross-border lawsuit would have been a bigger risk for HTC. Because according to the agreement signed between HTC and KR, according to the territoriality principle, all lawsuits must be conducted in the United States, and the execution of the judgment must also be executed in the United States.
In October 2004, JL was criminally detained by Sichuan police in Shenzhen for "suspected bill fraud", which also meant that HTC was completely disappointed with KR. In order to try to recover the payment, reduce losses, December 14, 2004, Hongda in the United States in Los Angeles Superior Court against the KR company, in order to KR company in violation of the debt repayment agreement, the two overdue installments of the repayment obligation for the claim, the defendant KR company to repay the United States of America, 472 million U.S. dollars (about 4 billion yuan) of the purchase price (together with the interest and penalties for overdue * * * count the subject matter of 484.3 million dollars) and attorneys USD 484.3 million) and attorney's fees and litigation costs, etc., and requested the court to issue an injunction to prohibit KR from transferring assets and deleting or destroying books of accounts, and at the same time to allow HTC to ascertain the financial status of KR. KR's financial and operational status was verified through judicial proceedings to facilitate further resolution of KR's arrears. The focus of the parties centered on whether the 37 checks issued by KR for Hongda in 2003 were bad checks, which would determine whether KR was suspected of bill fraud. However, in response to the company's lawsuit, KR filed a counterclaim in the U.S. Superior Court in Los Angeles on January 14, 2005, claiming damages on the grounds that HTC's pre-loss announcements prior to the U.S. CES (Consumer Electronics Show), and media reports, had damaged HTC's business reputation. In response to the counterclaim, HTC argued that the pre-loss announcement was made by the company in accordance with Chinese law, and that the company did not make any statements to the press that damaged KR's business reputation.
Hongda, its lawyers, accountants and members of the judiciary entered KR and began inquiring about the company's financial and business conditions. After a lengthy investigation, HTC rejected the plan of "acquiring KR's shares and taking over KR's assets to collect the debt". In the course of investigation, HTC found that as a private enterprise, KR was not transparent in its financial affairs, and it was difficult to judge how big the gap was between KR's announced financial situation and its actual financial situation, and the problem was not how big the proportion of KR's assets was, but how much solvency KR still had in addition to this part of its assets. According to Dun & Bradstreet, an international credit research organization, KR's net worth figure is pitifully small compared to its sales. And from its historical record, KR is a troubled enterprise, from 2001 to the present, involved in a number of commercial disputes, including banks, suppliers, transporters and factoring agencies, including many counterparties to the KR letter, that is, to require the provision of collateral, KR has pledged a large number of its assets, individual assets and even repeated collateral. KR has pledged a large number of its assets, and individual assets are even double-pledged. Coupled with the discovery during the investigation that most of KR's partners have overdue debts, HTC is worried that after taking over KR's equity in this way, it will fall into the trap of another huge "contingent liabilities" of KR while taking over its assets, and at the same time, it will have to bear the burden of endless lawsuits for KR.
KR is known to have a staff of 100, and its products are sold in more than 20,000 retail outlets in North America, including BestBuy and CricuitCity. one sign that KR has gained a foothold in the U.S. is that it has established a solid distribution channel. On the other hand, KR already had considerable name recognition in the United States. But the reason why KR has surged in the U.S. market in recent years is that it imports large quantities of DVDs, color TVs, and other home appliances from China and then sells them to well-known U.S. supermarket chains at fairly competitive prices. And these two parts have been the last most valuable things in KR. HTC's pre-loss announcement, which expects recoverable accounts to be in the range of $150 million, is most likely based on an overall estimate of the value of KR's assets, including its brands.
HTC told the public that one of the company's main tasks now is to recover as much money as possible.
On March 27, 2005, HTC disclosed to the public that it had recovered nearly $100 million from KR.
On July 18, 2005, ZH, a Hong Kong-listed company owned by KR, announced that KR, as well as its controlling person JL, had mortgaged all of its shareholdings in ZH to serve as a guarantee for the goods receivable by HTC from KR. Hongda, which was dragged down by KR's nearly 4 billion yuan in accounts receivable, seems to have gotten a good news.
On July 18, 2005, ZH, a Hong Kong-listed company that had been suspended from trading for many days, announced that its controlling shareholders, KR and JL, had made the latest declaration of interest under the Securities and Futures Ordinance (SFO), pledging 165 million shares (51.94%) and 57.7 million shares (18.14% participation) in ZH to Wider, respectively, to serve as a guarantee for Wider's accounts receivable from KR. The main business scope of KR is in the U.S., JL is its founder, holding 52% of KR; ZH is a Hong Kong listed company of JL, and Hongda is a supplier of ZH, and currently both parties do not have any receivables or payables. zh continues to be suspended from trading. Information of Hong Kong Stock Exchange shows that ZH Company has 1.2 billion authorized shares and 318 million issued shares. The par value is HK$0.025 and the market capitalization is HK$457.92 million. But ZH's net asset value is only HK$17.882 million, and its profit is even only HK$1.3 million, or HK$0.041 per share. Based on this calculation, KR and JL have a market capitalization of about HK$238 million and HK$83 million respectively in ZH, totaling only HK$321 million. In terms of net asset value, the two mortgages are only worth HK$12.6 million. That's a far cry from the nearly 4 billion yuan in accounts receivable from Hongda.
In July 2005, the two sides reached an agreement, KR to HTC to provide three parts of the assets collateral, as part of its owed 150 million U.S. dollars in security. KR mortgage three parts of the assets, first, KR's real estate mortgage security; second, KR and its president JL held the Hong Kong GEM listed company "ZH Corp. The three assets pledged by KR are, firstly, the real estate mortgage of KR; secondly, the equity security of "ZH", a Hong Kong GEM listed company, held by KR and its president JL; and thirdly, the trademark security of KR.
In September 2005, an announcement by the board of directors of HTC showed that of the $467.5 million owed to KR, only $150 million could be recovered by HTC from KR, which meant that there was still $317.5 million (2.6 billion yuan) owed to KR that faced uncollectibility. This figure is higher than the sum of HTC's profits in the six years from 1999 to 2004. Because of HTC's large receivables that are difficult to collect, and, of HTC's past net assets of 14 billion yuan, nearly 9 billion yuan is in inventory, such a financial situation. HTC's subsequent development is worrying. in early 2005, HTC obtained a 3 billion yuan consolidated credit line through financing from banks, but HTC was still plagued by accounts receivable management failures for several years.
Three, Hongda's accounts receivable management evaluation
(A) Finance staff's thinking: accounts receivable handling strategy
Accounts receivable is one of the important indexes reflecting listed companies' operation and management ability and the real state of profitability. Investors are more concerned about the increase or decrease of the listed company's book profit, and are not concerned enough about the authenticity and reliability of the book profit. In the current listing governance in China is still relatively weak, many listed companies book earnings and actual earnings into the bag there is often a big difference, especially once the accounts receivable bad debt, prior and insufficient accruals, the actual earnings of the year will often be substantial fluctuations.
The bad debt provision ratio of accounts receivable usually increases with the increase of years. Overseas countries generally provide 100% bad debt provision for accounts receivable of more than 3 years, while the average provision ratio of listed companies in China is 68.35%, and there is no institutional mandatory provision ratio. This has caused some listed companies to adjust their profits with the increase or decrease of accounts receivable through the uncertainty of the accrual ratio, and most of them show inflated profits. Once the accrual ratio is increased or fully accrued, or bad debt actually occurs, it often leads to sudden losses or a significant drop in profits of listed companies. There are three types of listed companies that have hidden worries in accounts receivable management: firstly, listed companies that have large amount of accounts receivable and have not made full provision for bad debts beforehand; secondly, listed companies that have large amount of other receivables in 3-year period and have insufficient provision for bad debts; and thirdly, listed companies that have accounted for a high proportion of their main business income in accounts receivable. The investment risks arising from listed companies' accounts receivable often catch investors off guard.
Hongda underestimated the risk that KR's accounts receivable might affect, accordingly, the company's board of directors decided to make bad-debt provision for the accounts receivable according to the more prudent individual determination method, and carry out the corresponding accounting treatment according to the change in accounting estimate. In its December 2004 announcement, HTC indicated that it was prepared to make a bad debt provision for the KR receivable at US$310 million. However, nearly half of HTC's receivables are still at exposure risk. Finance staff should analyze the risk level of the receivables that are at exposure risk and predict the probability of default for that portion of the receivables.
Based on the prediction of the default probability of accounts receivable, the finance staff formulated a program to deal with the accounts receivable. In addition to actively collecting accounts receivable, the finance staff can consider whether to make accounts receivable factoring, that is, the enterprise will sell the accounts receivable at a certain discount to the bank, to get the corresponding financing money.
Based on the projected default probability of accounts receivable, the bank has set a discount rate for accounts receivable factoring. The higher the probability of accounts receivable default, the higher the probability of accounts receivable factoring discount, the less cash Hongda will get back from its accounts receivable and the more it will lose.
The finance staff must make a clearer prediction of the probability of default on accounts receivable in order to decide whether or not to factor accounts receivable and the most appropriate discount rate for factoring accounts receivable for the company to recover cash from the accounts receivable.
The large amount of accounts receivable has seriously affected the cash flow of Hongda. In analyzing the most appropriate discount rate on accounts receivable, the financial officer must also consider the amount of cash recovered at the established discount rate on accounts receivable, the trade-off between the discount rate on accounts receivable and the cost of raising capital in order to close the company's working capital gap, and the cost of raising capital for the company.