EBITDA Income Statement: What Financial Metrics Investors Should Look For in Chinese Statements ( Part 2)russonxiao
In the previous article, we shared the concept and role of EBIT and EBITDA, two crucial financial data. Content can be reviewed on our webiste: www.serviceonnewgrounds.com. In this article, we will further explain the various components of EBIT and EBITDA so that investors can clearly understand why they should obtain them and what they mean.
- Analysis of the components
- Net profit
Net profit is the amount of the company’s total profit for the period minus income tax, i.e., the company’s profit after tax. Net Profit is the final result of a company’s operations and is usually presented at the bottom of the P&L Statement after EBIT, indicating the effectiveness of the company’s operations during a given accounting period.
Interest is generally defined as interest expense incurred based on financing, other borrowing, discounting, etc., with special attention being paid to the fact that the interest does not include the interest income. There is a difference between this and the Financial Expenses in the P&L Statement. Financial Expenses in the P&L Statement include:
- interest income and expenses (interest expense minus (-) interest income);
- exchange profit or loss (exchange losses minus (-) exchange profits);
- bank charges;
- cash discounts, etc.
When we calculate the EBIT & EBITDA metrics, only the interest expense component is extracted. The deduction of interest expense is calculated because the same industry generates different interest rates due to different financing costs in different regions.
For example, some prefecture-level cities will sign betting agreements with large companies to provide large interest-free loans to companies as start-up capital, and the correspondingly, company needs to fulfill the tax target in the future years, which can be seen in the company’s financing costs are low, and the interest expense is almost zero. In some areas where financing is difficult, the interest rate is relatively high, and the interest expense is also high. These fluctuating factors, which affect the net profit of the companies, are not affected in the EBIT & EBITDA indicator.
- Income tax
Income tax, generally referred to as Corporate Income Tax (CIT), is an income tax levied on the production & operations income and other income of 1) companies and 2) other organizations that derive incomes.
CIT is levied in all countries and regions, but the time, method, and rate of levy vary. For example,
- in China, quarterly prepayment of CIT is required, and the CIT rate is 25%. Certainly, if the company is recognized as a small micro-company, and the annual profit is less than CNY 3 million, it can enjoy a preferential tax rate of 5% (in accordance with the latest policy in 2023).
- in the United States, state tax laws vary, but usually, income tax returns must be completed by April 15 each year (U.S. time), and the basic income tax rate is 21%, but of course, there are appropriate relief measures.
The factor of income tax, which varies from country to country in terms of when it is levied and at what rate, affects the net profit of a company but is not affected by the EBIT & EBITDA metrics.
Depreciation is the systematic apportionment of accrued depreciation over the useful life of a fixed asset in accordance with a defined method.
Different types of fixed assets are subject to different statutory minimum depreciation periods, and the method of depreciation allocation and the recognition of residual value varies according to the business needs of the company.
Fixed assets are generally large in subject matter and have long useful lives. They are usually acquired initially or in the short term, resulting in an instantaneous net cash drain to the company. For example, for aircraft engines, usually purchased at a cost of 12 million U.S. dollars (equivalent to 86.4 million yuan), the depreciation period of fixed assets can be up to 20 years, and the annual depreciation of fixed assets of the company will affect the net profit, but in up to 20 years, only the previous period (or a shorter period of time) when the payment is made, it will affect the company’s net cash flow.
Investors are most interested in the net cash flow of the tranche rather than the cost of fixed assets paid in past years, however, the depreciation itself is an indirect measure of past capital expenditures. Therefore, in the EBITDA metric, the company’s true net cash flow for the current period can be presented, and investors can more easily focus on the estimation of future capital expenditures rather than the sunk costs of the past.
Amortization generally refers to long-term amortized expenses: economic management activities that amortize expenses that have been incurred by the company but have an amortization period of more than one year (excluding one year).
Long-term amortized expenses mainly include:
- fixed asset repair expenditure,
- expenditures for leasehold improvements of fixed assets, and
- other amortized expenses with an amortization period of more than 1 year.
This element, as described in point 4), due to the large initial cost of acquiring long-term amortizes, a short period of time results in a net loss of cash and amortization of long-term amortization expense in subsequent years.
Amortization itself is an indirect measure of past capital expenditures. However, in the EBITDA metric, the company’s true net cash flow for the current period can be presented, and investors can more easily focus on the estimation of future capital expenditures rather than the sunk costs of the past.
Some investors would believe that annual net profit is also an important indicator of how well a company is operating. This is something that we will explain further in our next article, about some of the differences between Net Profit and EBIT & EBITDA indices, and introduce case studies to further analyze.
If you have any questions, please feel free to contact us.
(Continued from the previous article)
- Provision on bona fide acquisition of false special invoices
«Circular of the State Administration of Taxation on the Settlement for the Taxpayers Obtaining the False Special Invoice of Value-added Tax without Acknowledgement» defines what is “bona fide”.
It is stated in the Circular that the purchaser shall be deemed to have obtained the false special invoice in good faith if all the following conditions are met:
- a genuine transaction between the purchaser and the seller;
- the sale is made using the special invoices of the province (autonomous region, municipality directly under the Central Government, and cities listed in the plan) in which the purchaser is located;
- all the contents of the special invoices match with the actual ones, such as the name of the seller, the seal, the number of goods, the amount, and the tax amount; and
- no evidence that the purchaser knows that the special invoices provided by the seller were obtained by illegal means.
On the other hand, tax authorities of the purchaser’s location shall grant credit for input tax or export tax refund in accordance with the law, if:
- the purchaser is able to obtain again from the seller a legal and valid special invoice issued by the anti-counterfeit tax-control system; and
- the purchaser has obtained the certificate that the tax authorities in the place where the seller is located have conducted or are conducting an investigation and punishment on the seller’s false special invoices accordingly.
However, if the above conditions cannot be met, the input tax deducted or the export tax refund obtained by the purchasing party shall be recovered accordingly.
In addition, if the taxpayer has obtained in good faith a false special invoice that has been recovered and deducted in accordance with the law, then the taxpayer does not need to consider the provisions of Article 32 of the «Tax Collection Administration Law of the People’s Republic of China»: – If the taxpayer fails to pay the tax in accordance with the prescribed period, and the withholding agent fails to settle the tax in accordance with the prescribed period, the tax authorities shall, in addition to ordering the payment within the prescribed period, impose a late payment fee of five percent of the tax due on a daily basis. If the taxpayer fails to pay the tax in accordance with the prescribed period, the taxation authority shall, in addition to ordering the payment within the prescribed period, impose a late payment fee of five ten thousandths of the late payment of tax on a daily basis from the date of the late payment of tax. In other words, tax authorities will not add the late payment fee arising from the recovery of past taxes.
- Necessary documentation in case the tax inspection happens
Through the above layer-by-layer analysis, accountants of enterprises need to prepare the necessary financial documents to respond to tax inspection, while supporting themselves if they are bona fide purchasers, including but not limited to: –
- the original special invoice was identified as a false invoice
- purchase and sale contracts/business contracts or other contracts involving the invoice
- the goods involved in the incoming order, outgoing order, transfer orders, or transport documents
- relevant accounting documents
- bank payment voucher
- VAT declaration report for the month in which VAT is deducted, and CIT annual return
- statement of the entire business transaction and tax declaration
To sum up, enterprises do not need to be too panicky after receiving the Notice of Tax Inspection. Prepare the above list of supporting materials first and conduct self-inspection after communicating with the relevant tax officer to understand the situation. Companies that have evidence to prove they are bona fide invoice purchasers should actively respond to the tax authorities’ inspection and cooperate with the follow-up investigation. The enterprise will usually pass the tax inspection successfully if they respect all the conditions mentioned previously.
If you have any questions, please feel free to contact us.
«Circular of the State Administration of Taxation on the Settlement for the Taxpayers Obtaining the False Special Invoice of Value-added Tax without Acknowledgement»
China is now fully open! In order to better coordinate the epidemic prevention and control as well as the needs of economic and social development, and to facilitate the people-to-people exchange between China and foreign countries, the National Immigration Administration of PRC has decided to adjust the visa and entry policy starting as of Beijing time at 00:00 on March 15, 2023.
- Valid visas issued before 28 March 2020 by the Chinese visa authorities abroad will resume functioning.
- Foreigners may apply for all types of visas, including tourism and medical treatment.
- Port visas shall resume being issued in line with the relevant laws and regulations.
- The visa-exemption policy for Hainan, visa-exemption cruise policy for Shanghai, visa-exemption policy for foreigners to visit Guangdong from Hong Kong and Macao, and visa-exemption policy for ASEAN tour groups to Guilin, Guangxi shall resume operation.
In recent times, the immigration policies of many countries are updated in real-time. In addition to the reopening policy, other restrictions are listed below for your consideration.
Chinese embassies in many countries notice: From 15 March, antigen testing instead of nucleic acid testing.
According to the latest requirements of the Chinese government regarding the optimization of pre-trip testing measures for people traveling to China, starting from 15 March 2023, passengers flying directly from specific countries to China are allowed to replace nucleic acid testing with antigen testing (including self-testing with kits). In order to facilitate the pre-trip preparation of travelers, the embassies concerned have issued guidelines on epidemic prevention and control.
- Distal testing: Nucleic acid testing within 48 hours before boarding or self-testing with antigen kits, negative results before going to China, positive results please go to China after turning negative.
- Customs declaration: After obtaining a negative test result, fill out the “Health Declaration Card of the People’s Republic of China” through the WeChat app “Customs Passenger Service” (“海关旅客指尖服务”), the Customs APP or the web version to make declaration.
- Airlines are not required to check pre-boarding nucleic acid test certificates and antigen test results.
- In-flight epidemic prevention: Please insist on wearing a mask during the flight and do your personal protection to reduce the risk of infection.
- Entry quarantine: Upon arrival at the port, complete the necessary customs clearance procedures with the customs health declaration code. Customs will test a sample of people with abnormal health declarations or fever and other symptoms in accordance with a certain percentage.
- passengers with positive test results, in accordance with the requirements of the notification letter, go home/living place for isolation, or medical treatment;
- passengers with negative test results, by the Customs and Excise Department in accordance with the “Frontier Health and Quarantine Law of PRC” and other laws and regulations to implement routine quarantine;
- passengers with normal health declarations and tests can pass the entrance.
- Territorial epidemic prevention and control: Passengers should strictly comply with the requirements of territorial epidemic prevention and control after entering the country.
Policies vary from country to country, so it is recommended that you pay attention to the latest Chinese embassy and consulate notices in real-time before making travel arrangements, read them carefully, and follow them to avoid affecting your trip.
Should you have any further questions, please feel free to contact us.
Further Adjustment of Visa and Entry Policy for Foreigners to China
Authority: National Immigration Administration
Notice on Further Adjustment of Visa and Entry Policy for Foreigners to China
Authority: Embassy of the People’s Republic of China in the United States of America
 Currently, the following countries have issued this notice: France, Italy, Denmark, Spain, Georgia, Tanzania, Nepal, Mongolia, Vietnam, Iran, Greece, Brunei, Thailand, New Zealand, Malaysia, etc.