Ratio analysis comparability between
Chinese and Japanese firms
Chunhui (Maggie) Liu, Grace O’Farrell, Kwok-Kee Wei and Lee J. Yao
Chunhui (Maggie) Liu is
Associate Professor and
Grace O’Farrell is a faculty
member, both in the
Department of Business
and Administration,
University of Winnipeg,
Winnipeg, Canada.
Kwok-Kee Wei is Chair
Professor and Dean of the
Faculty of Business, City
University of Hong Kong,
Kowloon, Hong Kong.
Lee J. Yao was the J.A. Butt
Distinguished Professor in
Accounting, Professor, and
Marquette Faculty Fellow at
the College of Business,
Loyola University, New
Orleans, Louisiana, USA.
The authors are indebted to the
Editor-in-Chief, Dr Wing Fok,
and two anonymous reviewers
for their innumerable guidance,
enlightening comments, and
helpful suggestions.
DOI 10.1108/15587891311319468
Abstract
Purpose – Firms in different countries operate in different business environments and prepare financial
statements following, by necessity, their own countries’ accounting standards. Benchmarks for
assessing financial ratios of firms in different countries are likely to be different. In conducting financial
ratio analyses, each country’s unique cultural, business, financial, and regulatory characteristics have to
be taken into consideration, for these external factors may exert significant effects on measurements of
financial data. This study aims to investigate challenges in comparing financial ratios between Japanese
firms and Chinese firms.
Design/methodology/approach – This study compares ten major financial ratios of 75 Chinese firms
with financial ratios of 75 matched sample Japanese firms to determine if a common benchmark for each
of the financial ratios can be applied to firms in both countries.
Findings – The results show significant differences in liquidity, solvency, and activity ratios between
firms from these two countries. Further examination of differences in accounting standards, economic,
and institutional environments between these two countries suggests that these external factors have
significant effects on financial ratios and may have contributed to the observed differences.
Originality/value – This study is among the first to investigate the comparability of ratios between
Japanese firms and Chinese firms to uncover potential challenges and warn investors of such
challenges.
Keywords Ratio analysis, Japan, China, Benchmarking, Management ratios, Finance and accounting
Paper type Research paper
Introduction
Firms in different countries operate in different environments. Choi et al. (1983) demonstrate
that financial characteristics of firms in different countries differ significantly in areas such as
bad debt provisions, inventory measurement, and leases, and that differences in economic,
institutional and operating environments in different countries further reduce the
comprehensibility and comparability of financial accounting information across borders.
Since financial ratios have been found to be successful predictors of corporate bond ratings
(Horrigan, 1967) and company financial difficulties (Meyer and Pifer, 1970), they have been
used as an important tool for financial analysis (Chong et al., 2009), risk and return
assessments (Falk and Heintz, 1975). However, Decker and Brunner (1997) point out that
applying financial ratio benchmarks from one country to assess firms in another country
often resulted in inappropriate or erroneous conclusions. It follows that similar precautions
apply to analyses of financial data of firms in China by outside investors. Little or no research,
however, has been reported on ratio comparability between Chinese firms and those of firms
in other countries and, if not comparable, how they differ.
People’s Republic of China (China), the world’s fourth-largest recipient of foreign direct
investment (FDI) in 2006 as per the United Nations, has been a major recipient of Japanese
foreign direct investment (Anand and Delios, 1996). Japanese foreign direct investment in
VOL. 7 NO. 2 2013, pp. 185-199, Q Emerald Group Publishing Limited, ISSN 1558-7894 j JOURNAL OF ASIA BUSINESS STUDIES j PAGE 185
 China has increased from US$2,317 million in 1996 to US$6,169 million in 2006, a 166
percent increase as per ASEAN-Japan Statistical Pocketbook (2007). By the end of 2009,
total Japanese FDI has reached $69.48 billion, spreading over 42,401 ventures in China
(Zhang, 2010). China has replaced ASEAN-4 (Indonesia, Malaysia, the Philippines and
Thailand) to become the largest destination of Japanese FDI in Asia (Xing and Wan, 2006).
In 2005, Japanese multinational enterprises invested US$6.53 billion direct investments in
China, making Japan the third largest investor in China (Xing, 2007).

Financial statement analyses are a requisite step in investment decisions and financial ratio
analyses are an integral part of financial statement analyses. Not knowing the differences in
operating characteristics of Chinese firms and appropriate benchmarks to use in analyses,
Japanese investors may simply extend their knowledge and practices of their own country in
analyzing financial data of Chinese firms.
China and Japan share similar religions, cultures, and many other value systems because of
their close proximity and continuous cross-paths over their long history. Still, their economic,
institutional, and accounting environments are different and each operates in its unique
environment and traditions. Recent histories also led these two countries to become two very
distinct modern civilizations (Padmalingam, 2002). For example, the Japanese economic
system is a form of market capitalism introduced by the US after second world war, while
China moved from planned socialism to market socialism only in recent years. Japan’s
equity-market capitalization has 10 percent of the world’s total market capitalization as of the
end of 2006. In contrast, China’s equity markets account for only 1 percent of the global
equity markets. Japan’s GDP grew 2.4 percent in 2006 (Reuters, 2008) while China’s GDP
grew 10.7 percent in 2006 (Xu, 2007). Japan, an island nation, lacks land and manpower
resources for expansions while China, the fourth largest nation, has plenty of both. Besides
economic differences, cultural and institutional differences have all led to substantial
variations in business operations and financial reporting for firms in these two countries. As a
result, financial ratios of Chinese firms and Japanese firms likely do not reflect the same
information, even if they were identical in numbers.

In addition to direct foreign investments in China, recent years also see an increasing
number of Chinese firms issuing their equity securities in foreign markets. Several Chinese
firms have already listed on the Tokyo Stock Exchange, Inc. (TSE), e.g. Boqi Environmental
Solutions Technology (Holdings) Co. Ltd. With recent approval for the TSE to establish
representative offices in China, capital flows between Japan and China are likely to increase
both in transactions and in total (TSE news of November, 2, 2007). Underwriters consistently
report that worldwide accounting diversity increases underwriting difficulties including
pricing of new issues of equities and bonds. If investors, analysts, and underwriters indeed
are experiencing difficulties with diversity in accounting, financial markets would likely not to
be as efficient as they could be and returns to investors may be less than expected (Mueller
et al., 1984). To encourage investor confidence in China’s capital markets and financial
reporting, China has adopted International Financial Reporting Standards (IFRS) set by the
International Accounting Standards Board (IASB) since January 2007.

Despite efforts by both Chinese and Japanese toward convergence with International
Accounting Standards, however, the financial accounting information’s interpretation may
still be problematic to investors due to substantial environmental differences between these
two countries (Choi and Levich, 1990). Comparability still may not exist even if financial
statements are prepared using comparable accounting standards (Mueller et al., 1984),
because many culturally based business practices and their impact on the financial
statements (Nikkinen and Sahlström, 2004). Choi et al. (1992) and Gray (1989) call for more
research to examine the effect of international accounting and environmental differences on
reported financial results such as earnings, liquidity, and solvency. With increasing direct
investment in China, it is more urgent than ever for Japanese investors to be able to
compare, analyze, and interpret the financial accounting information prepared by Chinese
firms that operate in a totally different institutional environment. However, there is little
research comparing accounting practices in these two countries.

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PAGE 186 JOURNAL OF ASIA BUSINESS STUDIES VOL. 7 NO. 2 2013
This study examines financial ratio comparability between Japanese and Chinese firms on
four major financial factors, represented by ten financial ratios, using matched sample firms.
The results indicate that, in general, the current, quick, interest coverage, financial leverage,
inventory turnover, and asset turnover ratios for the Japanese firms are higher than those for
Chinese firms. However, Chinese firms typically have higher receivable turnover rates. The
differences in accounting systems only partially explained such differences.
Misinterpretation of ratios may also result from the lack of understanding of institutional
and environmental differences across different countries. This paper not only pinpoints
several accounting differences that can hinder the comparability of accounting information
across countries but also highlights institutional and environmental differences that
investors, security analysts, regulatory authorities, and international business researchers
need to consider. This study extends current research by revealing environmental
differences’ impact on ratio comparability between Japan and China and highlights the
major differences for investors. A better understanding of differences in accounting
practices paves the way toward international accounting harmonization (Beazley, 1968;
Alhashim and Garner, 1973).
The remainder of the paper consists of four sections. The next section is a brief review of
prior research and the research question to be investigated in this study. Section 3
discusses research methods. Section 4 presents empirical results and discusses the
findings. Section 5 concludes the paper.

Previous research
Extant research has shown significant differences in financial ratios between the US firms
and those of Chinese (Asheghian, 2012; Fuglister, 1997; Liu and O’Farrell, 2009), Japanese,
Korean (Choi et al., 1983), Latin American (Etter et al., 2006), and Italian firms (Hagigi and
Sponza, 1990). These studies attribute the finding to the differences in accounting practices
and standards, as well as cultural, economic, and institutional environments across
countries.
Choi et al. (1983) found liquidity ratios of US firms to be higher than those of Japanese or
Korean firms. They attribute the differences to preferences of short-term debt over long-term
debt by Japanese firms, and the scarcity of long-term credit in Korea. Etter et al. (2006)
found Latin American firms to have lower liquidity than those of US firms. They believe the
presence of significant short-term debt which resulted from high inflation rates in those
countries may have led to the low liquidity. Liu and O’Farrell (2009) found Chinese
companies to have lower liquidity than US companies partly due to the preference of
short-term debt over long-term debt in China (Chen, 2004).
Choi et al. (1983) as well as Hagigi and Sponza (1990) found Japanese, Korean, and Italian
firms to have lower solvency than US firms. Choi et al. (1983) argued that the lower relative
cost of debt and the historical preference of debt to equity financing in Japan and Korea
were among the possible causes for the higher debt to equity ratio. Hagigi and Sponza
(1990) attributed the higher debt to equity ratio in Italy to the lack of adequate regulations
necessary to protect investors and the desirable privacy offered by debt financing. Choi et al.
(1983) also noted lower interest coverage ratios in Japanese and Korean firms due to the
moderate perceived benefits of business earnings over those needed to cover its ‘‘captive’’
loan charges to lenders in Japan and Korea. Hagigi and Sponza (1990) attributed the lower
interest coverage ratio in Italy to the low profitability and heavy debt financing in Italian firms.
On the other hand, Etter et al. (2006), Fuglister (1997), Liu and O’Farrell (2009) found Latin
American and Chinese firms to have higher solvency than US firms. Etter et al. (2006) argued
that Latin American firms’ effort in attracting foreign equity investment, their heavy use of
retained earnings in financing expansions, and their special accounting practices such as
little to no reporting of pension/post-retirement liabilities or deferred tax liabilities and no
provision for capital lease accounting for lessees might have contributed to lower debt to
equity ratios. Fuglister (1997), and Liu and O’Farrell (2009) attributed Chinese firms’ lower
debt to equity ratios and higher interest coverage ratios to the recent shift from debt to equity
financing in China, Chinese aversion to borrowing, and the risk adverse Chinese

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VOL. 7 NO. 2 2013 JOURNAL OF ASIA BUSINESS STUDIES PAGE 187
 shareholders resulting from a culture with higher uncertainty avoidance than found in US
culture. Hughes et al. (2009) find that culture is associated with risk assessments, in that a
culture with higher power distance, uncertainty avoidance and collectivism tends to make
higher risk assessments of the same situation.
Fuglister (1997), Choi et al. (1983), Etter et al. (2006), and Hagigi and Sponza (1990) found US
firms, in general, to have higher activity ratios. Etter et al. (2006) attributed the lower inventory
turnover in Latin American firms to overstock inventory carried as a result of import restrictions,
currency restrictions, underdeveloped transportation systems, and underdeveloped
infrastructure; revaluation of inventory due to inflation; and, FIFO cost flow assumptions that
are commonly used by Latin American firms. Hagigi and Sponza (1990) noted that lower
inventory turnover in Italy resulted from high inventory levels kept to avoid underutilization of an
immobile labor force at high labor costs. Fuglister (1997), Choi et al. (1983), and Liu and
O’Farrell (2009) found the lower receivable turnover and/or higher duration of payables in
Chinese and Japanese firms are likely due to efforts to maintain stable employment.
Repayment extensions are often granted to stabilize the employment base (Choi et al., 1983).
Etter et al. (2006) argued that the lack of efficiency in collecting receivables, the emphasis on
exports, currency restrictions on both local and foreign funds, and the inclusion of finance
charges in receivable balances resulted in lower receivable turnover in Latin American firms.
Hagigi and Sponza (1990) noted lower receivable turnover in Italy relating to the longer
collection period due to lower interest charges on receivables in Italy.
Fuglister (1997), Liu and O’Farrell (2009), Choi et al. (1983), and Etter et al. (2006) attributed
the lower asset turnover in Chinese, Korean, and Latin American firms to the large
investment in fixed assets by high growth firms whose current sales have yet to reach the
expected capacity levels. Choi et al. (1983) and Etter et al. (2006) suggest revaluations of
asset values for inflation to be another contributing factor. Etter et al. (2006) also noted the
capitalization of research and development and the capitalization of leased assets to have
effects on asset turnover ratios. Hagigi and Sponza (1990) attributed lower asset turnover in
Italy to more aggressive sales practices in the US. No significant difference in asset turnover
was found between Japanese firms and US firms.
Choi et al. (1983) attribute the lower profit margin and return on asset ratios of Japanese and
Korean firms as compared to US firms to the Japanese policy of emphasizing market share
over short-run profits, Korean export policies and government controls to keep prices low
and, as a result, low profits. Liu and O’Farrell (2009) attribute the lower profit margin of
Chinese companies to China’s export policy and low pricing strategy. Hagigi and Sponza
(1990) found the return on assets ratio of Italian firms to be lower than US firms and attribute
the observation to Italian firms’ overstating assets due to capitalized financing costs incurred
for purchase and credit sales. Etter et al. (2006) ascribe the higher profit margin of Latin
American firms to higher selling price due to inflation, a protected and less competitive
market; lower labor cost due to lower employee wages, benefits, and pensions; and different
accounting practices that may have led to lower expenses such as capitalizing research and
development expenditures, not using LIFO, and little or no accounting for deferred income
tax liabilities. Table I summarizes the extant ratio comparison research findings.
Though little research has compared financial ratios between Japan and China, known
differences in accounting, cultural, institutional, and economic environments between the two
countries cast doubt on the comparability of their financial measurements. Evidence (Xiao
et al., 2004) supports the general theory that financing system of a country is the main driver of
its financial reporting system (Nobes, 2006). Since major sources of financing have been
creditors and government in Japan and China respectively, Mueller et al. (1984) found an
important concern of Japanese financial accounting was protecting the interests of creditors
while Davidson et al. (1996) noted that the government was the primary user of Chinese
financial accounting reports. Culture also matters in determining accounting attributes such as
earnings management (Ding et al., 2005; Lu, 2008; Nabar and Boonlert-U-Thai, 2007). William
and Egon (1976) pointed out that Japanese society stressed groupism while Chinese
emphasized familism. Miles (2006) identified traditional Japanese ownership structure,
‘‘keiretsu’’, as a good example of Confucian influence in Japan. Traditionally, firms in ‘‘keiretsu’’

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PAGE 188 JOURNAL OF ASIA BUSINESS STUDIES VOL. 7 NO. 2 2013
 Table I Summary of literature review
Findings for ratio
Ratio category Source category Findings for non-US ratios Causal factors Non-US situations

Liquidity Choi et al., 1983 US . Japan or Lower current and quick ratios Economical and cultural More short-term debt from
Korea preference or scarcity of long-term
debt
Etter et al., 2006 US . Latin America Lower current and quick ratios Economical More short-term debt from high
inflation
Liu and O’Farrell, 2009 US . PR China Lower current and quick ratios Cultural Preference of short-term debt to
avoid risk
Solvency Choi et al., 1983 US . Japan or Higher debt to equity ratios and Economical and cultural Debt preferred with lower relative
Korea lower interest coverage ratios cost over equity
Etter et al., 2006 US , Latin America Lower debt to equity and Economic and Emphasis on foreign equity, little
higher interest coverage accounting report of pension or deferred tax
liabilities, etc.
Fuglister, 1997; Liu and US , PR China Lower debt to equity and Economic and cultural Shift to equity and aversion to
O’Farrell, 2009 higher interest coverage borrowing
Hagigi and Sponza, 1990 US . Italy Higher debt to equity and lower Institutional and cultural Less equity due to lack of
interest coverage regulatory protection and debt
preference for privacy
Activity Choi et al., 1983 US . Japan Lower receivable turnover Institutional Effort toward stable employment
Etter et al., 2006 US . Latin America Lower inventory turnover and Institutional, economic, Import and currency restrictions,
receivable turnover and accounting export emphasis, underdeveloped
infrastructure, revaluation due to
high inflation, and common use of
FIFO cost flow assumptions
Fuglister, 1997; Liu and US . PR China Lower receivable turnover Institutional Effort toward stable employment
O’Farrell, 2009
Hagigi and Sponza, 1990 US . Italy Lower inventory turnover and Economic High labour costs and low interest

j
receivable turnover charge on receivables
Profitability Choi et al., 1983 US . Japan or Lower asset turnover, profit Economic, institutional, Growth, market share emphasis,
Korea margin and return on asset and accounting export policy, government control,
revaluation of asset for inflation
Etter et al., 2006 Mixed Lower asset turnover, higher Economic and Growth, revaluation of asset for
profit margin accounting inflation, capitalization of R&D,
etc.
Fuglister, 1997; Liu and US . PR China Lower asset turnover Economic Growth
O’Farrell, 2009
Hagigi and Sponza, 1990 US . Italy Lower asset turnover and Institutional and Less aggressive sales practice

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return on asset accounting and capitalized financing costs

VOL. 7 NO. 2 2013 JOURNAL OF ASIA BUSINESS STUDIES PAGE 189

 held shares in each other to bind themselves, ward off potential takeover bids from un-friendly
firms, boost efficiency, line up friends they can count on to stand behind them, and trade with
each other. Though Confucianism originated and is still popular in China, Chinese firms do
nottypically employ the cross-shareholding arrangements as in Keiretsu (PRS Group, Inc.,
2007). Chinese firms have less of a focus on groupism. Although younger generation decision
makers in both countries may be similarly driven more by market economy than by
Confucianism, Braun and Rodriguez (2008) found Japan to have higher level of conservatism
and uniformity but less secrecy in accounting values than China based on Hofstede’s (1980)
culture measures posited by Gray (1988). In addition, institutional environment has also been
found to affect accounting practice (Leuz et al., 2003). Lee and Kuruvilla (2001) found different
job security levels between Japanese and Chinese firms. Employment security in the form of
lifetime employment in Japan started shortly before the WWII and spread beyond large
private-sector firms in the eighties. Although recent years have seen erosion of the lifetime
employment system, it is not yet clear that it will disappear as a norm guiding a substantial
fraction of Japanese employment relationships (Lee and Kuruvilla, 2001). In contrast, China’s
ESAM, the worker-peasant system implemented in the mid-sixties, and the Contract-Labor
System (CLS) in the late eighties have been progressively replacing the lifetime employment
system commonly dubbed as the ‘‘iron rice bowl’’. The Chinese Communist Party has sent
signals that old secure employment systems would not last (Lee and Kuruvilla, 2001).
Groupism practices such as lifetime employment and keiretsu in Japan have contributed to
stronger loyalty and trust within and across firms. Wakabayashi et al. (2001) indicated that
Japanese managers depended on high employee commitment and self-motivation while
Chinese managers had to motivate employees through other means. Gable (2002) attributed
Japanese innovate ‘‘just-in-time’’ production (JIT) to Japan’s land and space constraints. With
a JIT system, firms hold no or very little inventory since their production only begins when the
product can be delivered immediately after completion. With abundant and less costly land
available, holding inventory is more likely and less costly in China. Nevertheless, increases in
inventory decrease efficiency in inventory management. These differences can have
significant impact on both the magnitude and comparability of ratios of firms operating across
different nations.
Positive accounting theory explains and predicts accounting practices based on a
contractual view of the firm. Differences in cultural, economical, institutional environments
may result in different formation of contracts in Japan and China and thus different
accounting practices. It is thus anticipated that significant differences in financial ratios will
exist between Japanese and Chinese firms. However, no research has been reported in the
literature on the existence of such differences and, if they indeed differ, how and to what
extent they differ. This study will investigate the following research questions:
Do major financial ratios of Japanese firms differ from those of Chinese firms that are comparable
size and industry? If they differ, how are they different?

Research method
Manufacturing firms account for the bulk of Japan’s direct investment in China (Xing, 2007).
As such, investors, analysts, standard-setters, regulators and other interested parties would
likely be more interested in comparability of manufacturing firms’ financial ratios than those
of non-manufacturing firms. Firms in five industries receive the most cumulative Japanese
FDI, up to 85 percent of total FDI, in the manufacturing industry and are examined in this
study: electronic and other electric equipment, transportation equipment, machinery, textile,
and metal industries (Xing, 2007).
To minimize the effects of industry and size influences on the ratio differences observed, we
used matched samples as suggested by Choi et al. (1983). We selected a random sample of
fifteen Chinese firms from each of the five manufacturing industries. We then selected a
matched Japanese firm for each of the sample Chinese firms. Firms are matched in size
(Zhu et al., 2007), measured in sales revenue, and industry per SIC code. Table II reports the
profile of sample firms. Financial statement information for 2006 is downloaded from
World’Vest Base Inc. database.

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PAGE 190 JOURNAL OF ASIA BUSINESS STUDIES VOL. 7 NO. 2 2013
Table II Profiles of firms compared
Industry SIC codes and descriptions Frequency

2281 – Yarn spinning mills 2

2284 – Thread mills 2
2299 – Textile goods, nec 26
3312 – Steel works and blast furnaces 16
3317 – Steel pipe and tubes 2
3325 – Steel foundries, nec 4
3334 – Prim production of aluminium 2
3353 – Aluminium sheet, plate and foil 2
3357 – Drawing, insulating nonfer wire 4
3531 – Construction machinery and equipment 6
3537 – Industrial trucks, tractors, trailers 2
3541 – Machine tools, metal cutting 2
3542 – Machine tools, metal forming 2
3555 – Printing trades machinery, equipment 2
3559 – Special industry machinery, nec 2
3562 – Ball and roller bearings 2
3563 – Air and gas compressors 2
3565 – Packaging machinery 2
3571 – Electronic computers 2
3577 – Computer peripheral equipment, nec 4
3585 – Air-conditioning, heating, refrig equipment 2
3612 – Power, distr, specl transformers 2
3620 – Electrical industrial apparatus 2
3663 – Radio, TV broadcast, comm eq 2
3669 – Communications equipment, nec 2
3670 – Electronic comp, accessories 4
3674 – Semiconductor, related device 4
3677 – Electr coil, transfrm, inductr 2
3679 – Electronic components, nec 2
3699 – Electrical machinery, equipment, nec 10
3711 – Motor vehicles and car bodies 8
3714 – Motor vehicle part, accessory 12
3721 – Aircraft 2
3731 – Ship building and repairing 2
3743 – Railroad equipment 2
3751 – Motorcycles, bicycles and parts 4
Total number of firms compared 150
Average number of employees in Chinese firms 3,434
Average number of employees in Japanese firms 3,167

Financial ratios are often used to measure firm performance in four major aspects:
liquidity, solvency, activity, and profitability (Groppelli and Nikbakht, 2000). With the
exception of the profitability, which has four representative ratios, we examine two most
popular ratios in each of the other three aspects. The Appendix (see Table AI) describes
the formulas used in calculating these ratios. Chinese firms are expected to have lower
liquidity ratios because significant levels of short-term debt in China due to risk averse
Chinese banks’ preference to lend short-term (Fuglister, 1997) could lead to low liquidity
as in Latin American firms (Etter et al., 2006). Japanese firms are expected to have lower
solvency ratios due to low cost of interest and high cost of equity in Japan (Barrett et al.,
1974). Chinese firms are expected have lower inventory turnover ratio as Etter et al.
(2006) point out that firms in countries with underdeveloped transportation system and
infrastructure maintain, perhaps by necessity, more inventories. Chinese firms are
expected to have higher receivable turnover ratios because unlike keiretsu in Japan, they
do not have to extend credit terms to help their customers in maintaining employment
security (Choi et al., 1983; Fuglister, 1997). Chinese firms are expected to have lower
asset turnover ratios because their current sales may not reflect expected capacity levels
recently acquired (Fuglister, 1997). Chinese firms are expected to have lower profit
margins, return on asset ratios, and return on equity ratios because of China’s export
policy and low pricing strategy (Liu and O’Farrell, 2009).

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VOL. 7 NO. 2 2013 JOURNAL OF ASIA BUSINESS STUDIES PAGE 191
 Due to the small sample size and non-normal distribution of the data, this study employs the
two-tailed Wilcoxon sign-rank test, also known as the Wilcoxon matched-pairs test, for
statistical tests. The Wilcoxon signed-rank test is a non-parametric test for the case of two
related samples when the population cannot be assumed to be normally distributed and the
data are interval-scaled. Nonparametric methods are most appropriate when the sample
sizes are small (e.g. n , ¼ 100) as in this study.

Empirical results
Table III reports the results of the comparisons. Significant differences are found between
Chinese and Japanese firms in all four major ratio categories.

Liquidity ratios
Chinese firms have lower liquidity. Both the quick ratio and the current ratio are significantly
lower than those of Japanese firms (at 0.01). One common component in both liquidity ratios
is receivables in the numerator. The result shows that Japanese firms have a higher level of
receivables, which may be a result of differences in the two practices. Japanese firms
determine bad debts reserve as per the actual average rate of bad debt losses from the
previous three years (Kojima Law Offices, 1998) whereas Chinese firms make provisions for
bad debts at a percentage prescribed by the State on a tax driven basis (Reuvid and Li,
2000). Wilcoxon Sign-Rank Test of allowance for doubtful accounts receivables reveals
significantly higher rate of bad debt provision for Chinese firms ( p , 0.001). The higher level
of receivables for Japanese firms may also be due to the lifetime employment tradition in
Japan. Often, firms grant extensions on receivables out of concern of maintaining a stable
employment base (Chan, 2002; Choi et al., 1983). This is evidenced with significantly longer
collection periods for Japanese firms. Strong bonds and reciprocal supports between firms
within a keiretsu also facilitate extensions of receivables.
Chinese firms rely heavily on short-term debt, which increases the denominator and lowers
liquidity ratios. Most of the Chinese firms’ sources of financing are banks controlled by the
government. Chinese banks prefer to lend short-term to avoid the risk of interest rate
variations (Fuglister, 1997). Wilcoxon Sign-Rank Test of current liabilities/total assets shows
significantly higher percentage of current liabilities in total financing for Chinese firms ( p ,
0.001). On average, 57 percent of total assets are financed through current liabilities for
Chinese firms while only 35 percent of total assets were financed through current liabilities
for Japanese firms. These cultural and institutional differences and differences in
business/accounting practices may have led Japanese firms to have a higher level of
receivables than Chinese firms and, as a result, higher liquidity ratios.

Table III Mean financial ratios (Wilcoxon sign-rank test, two-tailed test)
Category Ratios Mean for Chinese firms Mean for Japanese firms Z-stat

Liquidity Current ratio 1.291 2.228 23.955*

Quick ratio 0.889 1.768 24.367*
Solvency Long-term liabilities to total capitalization ratio 0.081 0.186 24.858*
Interest coverage ratio 15.864 113.448 24.245*
Activity Inventory turnover 5.614 15.206 24.203*
Receivables turnover 17.198 6.068 24.642*
Profitability Asset turnover 0.874 1.077 22.973*
Profit margin on sales 20.067 20.091 20.005
Return on assets 0.012 0.014 21.262
Return on equity 0.038 0.013 20.797

Notes: *Denotes significant difference at p , 0.01; N=75

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Solvency ratios
Chinese firms have significantly lower financial leverage ratios (long-term liabilities/total
capitalization) and significantly lower interest coverage ratios (EBIT/annual interest
expense). Such differences are a result of, at least partially, differences in cultural,
accounting, and economic environments as explained below. Japan has long been known to
have very low interest rates. For example, for 2006, the short-term interest rate was 0.25
percent per annum in Japan while the interest rate was 2.54 percent per annum in China,
according to Organization for Economic Cooperation and Development (OECD). Cost of
equity in Japan is generally high with dividend rates typically fixed at 10 to 15 percent of par
values and paid whether earned or not (Barrett et al., 1974). Close relation between borrow
companies and their bank often allows postponement of interest and principal repayments
and even refinance of loans on more liberal terms in Japan. Low interest cost, close ties with
banks, and high equity cost can contribute to heavier usage of long-term debts for financing
in Japan. Chinese aversion to borrowing (Fuglister, 1997) may also partially explain lower
financial leverage among Chinese firms. Relatively high financial leverage among Japanese
firms identified in our sample is in agreement with the findings of Choi et al. (1983). Low
interest can also lead to a high interest coverage ratio.

Activity ratios
Chinese firms have lower inventory turnover ratios, calculated as cost of goods sold/average
inventory, than those of Japanese firms. Wilcoxon Sign-Rank Test of inventory/current assets
shows that Chinese firms carry significantly higher levels of inventory ( p , 0.001). Chinese
firms value inventories at cost rather than at the lower of cost or market value (Reuvid and Li,
2000), a departure from international accounting practices. In contrast, before the issuance
of ASBJ Standard No. 9 on July 5, 2006, Japanese accounting standards allowed firms to
use either cost or lower of cost or market value methods for inventory valuation. Since then,
only the lower of cost or market value method is allowed (Kawamura, 2007a). Measuring at
cost renders a higher inventory value than if the same inventory were measured at lower of
cost or market, which increases the denominator and decreases the inventory turnover ratio.
Deflation in Japan, which averaged 2 0.2 percent in 2006 based on data provided by
Trading Economics Global Markets Research, further decreases inventory value for firms
that use the lower of cost or market for inventory valuations. Etter et al. (2006) also point out
that firms in countries with underdeveloped transportation systems and infrastructure
maintain, perhaps by necessity, more inventories. Japan, a developed country, has a
well-developed transportation system and infrastructure. Furthermore, higher relative
logistics costs encourage management to stockpile inventories (Lou, 2005). China’s
logistics costs are estimated at between 16 percent and 20 percent of China’s GDP,
compared to 12 percent for Japan. Limited land space available for inventory storage makes
warehousing costs to be astronomically high and forces firms to maintain only the minimal
inventory, which raises inventory turnover rate. This may be one reason for Japanese firms to
adopt JIT production in order to minimize inventory and to survive. Thus, the observed
differences in activity ratios between Chinese and Japanese firms may be a result of
differences in inventory measurements, business and economic environments, and
manufacturing philosophies.
Receivable turnover ratio, however, credit sale/average accounts receivable, is higher for
Chinese firms than those for Japanese firms. This may be a result of higher levels of
receivables in Japanese firms due to a lower rate of provision for bad debts and the burden
of lifetime employment traditions as explained earlier.

Profitability ratio
Of the four profitability ratios examined in this study, only one of them, asset turnover, is
statistically significant ( p , 0.05) (Wilcoxon Sign-Rank Test). The result shows Chinese firms
to have lower asset turnover rates than those of Japanese firms. Although Chinese firms also
have a lower profit margin on sales, return on assets, and return on equity, these differences
are not statistically significant.

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 Fuglister (1997) points out that firms anticipating high growth are likely to make large
investments in fixed assets, while their sales, though rising, lag behind. Japan’s GDP grew
2.4 percent in 2006 (Reuters, 2008), but China’s GDP grew 10.7 percent in 2006 (Xu, 2007).
High investment in capital equipment by Chinese firms increases the denominator of the
asset turnover ratio. The low asset turnover ratio of Chinese firms may also be a result of the
differences in accounting standards for capitalizing financial leases. The Business
Accounting Deliberation Council set forth accounting standards for leases in the early
1990 s requiring firms in Japan to distinguish finance and operating leases. However, firms
need not capitalize financial leases if pro-forma information is disclosed in the notes
(Kawamura, 2007b). ASBJ Standard No. 13 (2007) changed the requirement. In contrast,
Chinese firms capitalize finance leases as assets.

Conclusions
We investigated financial ratios in four financial factors commonly recognized as the major
categories for financial statement analyses in the literature: liquidity, solvency, activity, and
profitability to identify significant differences between Chinese and Japanese firms. In
general, Chinese firms are lower in liquidity. Both ratios for the activity factor also show
significant differences, but in opposite directions. While Chinese firms have higher
receivables turnover, they have lower inventory turnover. Of the four ratios included as
measures of profitability, only the asset turnover ratio shows significant differences. The
other three ratios failed to show significant differences. Firms in both countries are similar in
profit margin on sales, return on assets, and return on equity. Although asset turnover is
mostly deemed as a measure of profitability in the literature, it can also be considered as a
measure of ‘‘activity’’. Similar to the inventory turnover, Chinese firms have a significantly
lower asset turnover.
Wherever differences exist, we have also found differences in accounting practices or
standards, cultural, or institutional and economic environments between these two
countries. These results confirm the findings of previous research that environmental
differences among countries including business practices, accounting practices and
standards, culture, institutions, and the economy, leave significant traces on financial ratios.
The findings for Japanese and Chinese firms are no exception.
The results suggest that users of financial data cannot simply extend ratio benchmarks for
one country to another country. Nor can we use a common conclusion from several countries
and apply them directly in evaluating Chinese firms. A direct comparison of Chinese firms
with Japanese firms is, at best, inappropriate and can be misleading. One needs to consider
differences in external factors such as accounting practices and standards, business
practices, cultural, and economic environments and make proper adjustments.
Furthermore, since these external factors are likely to change over time, inappropriate, or
even erroneous, conclusions might be reached if one uses benchmarks based on historical
financial ratios of the firm or country without taking into consideration changes in accounting
standards, and more importantly, business practices, cultural, and economic environments.
Given the small sample size, limited industries investigated, the examination of a single year,
and the inclusion of only two countries, the generalizability of this study is limited. In addition,
the study only analyzes ratios in the manufacturing industry. The possibility of ratio
differences between Japanese and Chinese firms in other sectors such as transportation,
communication, and utilities, wholesale and retail trade, and services are not addressed in
this study. Besides, this study reveals general ratio differences between firms in Japan and
China but does not examine sector-wide ratio differences.
Future research is needed to analyze and compare financial information of firms in different
countries. The questions such as the stability of financial ratios over time, across industries,
and conditions that lead to changes in financial ratios of firms need to be answered.
Research is also needed to compare financial ratios by sectors to identify sector-wide
differences of economic significance. A longitudinal study on how financial ratios change to
reflect changes in management philosophy as China evolves economically over time with an

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ever strengthening equity market will be useful. Future research may also consider using
other comparison methods to test the robustness of our findings. Future research may
further investigate factors determining the differences identified in this study.
The World Investment Prospects Survey conducted by the United Nations Conference on
Trade and Development (UNCTAD) shows that the most attractive FDI destination country is
China. With the growth of financial markets and businesses in China, there are tremendous
investment opportunities for international investors. The results and subsequent discussion
in this study suggest that a successful and comprehensive analysis of Chinese financial
ratios can only be conducted with an understanding of the underlying accounting
standards, institutional and economic environments as uncovered in this study to some
extent.

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 Appendix. Financial ratios
The ratios selected for analysis should be the ones most frequently used by investors and
security analysts. The ratios used are the ratios identified to be most influential to security
analysts by Gibson, 1987.

Table AI
Category Ratio Formula used Description
Current assets
Liquidity Current Used to analyze the ability to repay short-term
Current liabilities
debt commitments
Current assets 2 inventories
Quick or acid test
Current liabilities
Solvency Used to analyze the ability to repay long-term
debt and fixed charge commitments
Earnings before interest and tax
Interest coverage or times interest
Interest expense
earned
Long 2 term liabilities
Financial leverage
Total capitalization
Sales
Activity Asset turnover Used to analyze how quickly a firm converts
Average total assets
non-cash assets to cash assets
Cost of goods sold
Inventory turnover
Average inventory
Sales
Receivable turnover
Average accounts receivable
Net income
Profitability Net profit margin Used to analyze a firm’s use of its assets and
Net sales
control of its expenses to generate an
acceptable rate of return
Net income
Return on assets
Average total assets
Net income
Return on equity
Average shareholders’ equity

About the authors

Chunhui (Maggie) Liu is Associate Professor at the University of Winnipeg. Her current
research interests include international accounting harmonization, emerging markets,
ecommerce, and computer-user interface. Dr Liu has been published in International
Journal of Human Computer Studies, Information and Management, Journal of Accounting,
Auditing and Finance, Issues in Accounting Education, and International Journal of
Accounting Information Systems.
Grace O’Farrell is a Faculty Member in the Department of Business and Administration at the
University of Winnipeg. Her current research interests include international accounting
harmonization, cost/benefit analysis of employee benefit programs, and
person-organization fit. She has published in the Ivey Business Journal, HR Professional
Magazine, International Journal of Business, Accounting, and Finance and the Journal of
Drug Issues. She has presented papers at a multitude of academic conferences including
the IABPAD conference. Chunhui (Maggie) Liu is the corresponding author and can be
contacted at: m.liu@uwinnipeg.ca
Kwok-Kee Wei is a Chair Professor and Dean of the Faculty of Business at City University of
Hong Kong. He is president of the Association for Information Systems. He has served or is
serving on the editorial boards of MIS Quarterly and Information Systems Research. His
research has been published in ACM Transactions on Computer-Human Interaction, ACM
Transactions on Information Systems, Decision Support Systems, European Journal of
Information Systems, Information Systems Research, International Journal of
Human-Computer Studies, Journal of Management Information Systems, MIS Quarterly,
and Management Science among others.

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Lee J. Yao, who passed away on 14 November, 2012, was the J.A. Butt Distinguished
Professor in Accounting, Professor, and Marquette Faculty Fellow at Loyola University New
Orleans. He was a CPA, a Chartered Accountant in Australia and in England and Wales with
great success in public accounting at a big 5 accounting firm in the past. He published
extensively in accounting and information systems resulting in three books and more than 20
articles published in major international journals, including Journal of Management
Information Systems, Journal of Accounting, Auditing and Finance, Journal of Business
Research, Review of Quantitative Finance and Accounting, International Review of
Economics and Finance, International Journal of Accounting Information Systems, Issues in
Accounting Education, and Electronic Markets, among others.

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