Unit II International Financial Management - PowerPoint Presentation

1. Unit IIInternational Financial Management

2.

3.

4. Managing Assets and LiabilitiesThe management of working capital in a multinational firm is similar to a domestic firm. Both are essentially concerned with selecting that combination of current assets- cash, marketable securities, accounts receivable and inventory that will maximize the value of the firm. The basic difference between domestic and international working capital management is the impact of currency fluctuations, different rate of inflation, exchange control, diversity of banking and commercial practices, wider range of short-term financing and investment options available.

5. Managing Assets and LiabilitiesA multinational firm owns a number of enterprises across the globe, it also examines the tax and other consequences of these affiliates. Mainly concerned with the management of cash, marketable securities, accounts receivable and inventory.

6. Cash ManagementCash management is an important aspect of working capital management and principles of domestic and international cash management are the same. The basic difference between the two is, international cash management is wider in scope and is more complicated because it has to consider the principles and practices of other countries. The cash management is mainly concerned with the cash balances, including marketable securities, are held partly to allow normal day-to-day cash disbursements and partly to protect against unanticipated variations from budgeted cash flows. These two motives are called the transaction motive and precautionary motive. Cash disbursement for operations is replenished from two sources: Internal working capital turnover Short-term borrowings.

7. Cash ManagementThe efficient cash management is mainly concerned with to reduce cash tied up unnecessarily in the system, without diminishing profit or increasing risk so as to increase the rate of return on capital employed. The main objectives of cash management are: (i) How to manage and control the cash resources of the company as quickly and efficiently as possible. (ii) To achieve the optimum and conservation of cash.

8. Cash ManagementThe first objective of international cash management can be achieved by improving the cash collections and disbursements with the help of accurate and timely forecast of the cash flow. The second objective of international cash management can be achieved by minimizing the required level of cash balances and increasing the risk adjusted return on capital employed.

9. International Cash Management The international cash management requires achieving the two basic objectives: Bridging the company's cash resources within control as quickly and efficiently Accomplishing this objectives requires establishing accurate, timely forecasting and reporting system, improving cash collection and disbursement and decreasing the cost of moving funds among affiliates.2) Achieving the optimum conservation and utilization of these funds Second objective is achieved by minimizing the required level of cash balances, making money available when and where it is needed and increasing the risk adjusted return on those find that can be invested

10. Optimizing Cash Flows

11. International Cash ManagementThe section is divided into 4 key areas of international cash management: Central Cash management System Collection and disbursement of fundNetting of inter affiliate paymentsInvestment of excess funds

12. 1. CENTRALISATION OF CASH MANAGEMENT SYSTEMCentralized cash management system will benefit the multinational firm in the following ways:

13. CENTRALISATION OF CASH MANAGEMENT SYSTEMThe corporation is able to operate with a smaller amount of cash, pools of excess liquidity are absorbed and eliminated and each operation will maintain transaction balance only and not wood speculative or precautionary ones.The headquarters staff, with its purview of all corporate activity, can recognise problems and opportunities than an individual unit might not perceive.

14. CENTRALISATION OF CASH MANAGEMENT SYSTEMAll decisions can be made using the overall corporate benefits as the criterion.By increasing the volume of foreign exchange and other transactions done through headquarters firms in encourage banks to provide better foreign exchange quotes in better serviceGreater expertise in cash and portfolio management exist if one group is responsible for these activities

15. CENTRALISATION OF CASH MANAGEMENT SYSTEMToday, the combination of volatile currency and interest rate fluctuations, questions of capital availability, increasingly Complex organisations and a growing emphasis on profitability mandates a highly centralised International cash management system.There is also a trend to place much greater responsibility in corporate headquarters

16. CENTRALISATION OF CASH MANAGEMENT SYSTEMCentralisation does not necessarily mean that corporate headquarters has control of all facets of cash management. Instead Concentration of decision-making at a sufficiently High level within the corporation is required so that all pertinent information is readily available and can be used to optimise the forms position

17. 2. Accelerating cash inflows Accelerating cash inflow is one of the main objectives of international cash management. Early recovery of cash assures that cash is available with the firm for making payments or investment. To accelerate the cash inflows, the companies also establishes lock boxes around the world which are numbered by post office department and customers are instructed to put cheques of payment in these boxes. This system helps in reducing the time involved in receiving the payment.

18. Accelerating cash inflows In this context, the society for world-wide Inter-bank Financial Telecommunications (SWIFT) has brought into its fold around 1000 banks among which funds are transferred electronically with case. There are some multinational banks that provide ‘same-day-value’ facilities. In this facility, the amount deposited in any branch of the bank in any country is credited to the firm’s account on the same day. Delaying cash outflows means postponing the cash disbursements without effecting the goodwill of the firm.

19. 3. NettingNetting is a technique of optimising cash flow movements with the joint efforts of subsidiaries. Netting is, in fact, the elimination of counter payments. This means that only net amount is paid. For example, if the parent company is to receive US $ 6.0 million from its subsidiary and if the same subsidiary is to get US $ 2.0 million from the parent company, these two transactions can be netted to one transaction where the subsidiary will transfer US $ 4.00 million to the parent company.

20. NettingIf the amount of these two payments is equal, there will be no movements of funds, and transaction cost will reduce to zero. The process involves the reduction of administration and transaction costs that result from currency conversion. Netting is of two types: (i) Bilateral netting system; and (ii) Multinational netting system.

21. Bilateral netting system A bilateral netting system involves transactions between the parent and a subsidiary or between two subsidiaries. For example, US parent and the German affiliate have to receive net $ 40,000 and $ 30,000 from one another. Thus, under a bilateral netting system, only one payment will be made the German affiliate pays the US parent an amount equal to $ 10,000

22.

23. Multinational Netting system A multinational netting system involves a move complex interchange among the parent and its several affiliates but it results in a considerable saving in exchange and transfer costs. Under this system, each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, depending on whether it is a net receiver or a payer. To make a multinational netting system effective, it needs the services of a centralized communication system and discipline on the part of subsidiaries involved.

24. Multinational Netting system Many companies find they can eliminate 50% or more of their intercompany transactions through multilateral netting with annual savings in foreign exchange transaction cost and bank transfer fees charged that average between point 5% to 1.5 % per dollar netted.

25. Payments Flows Before Multilateral Netting

26. Intercompany payment Matrix (US $ Millions)

27. NettingEssential to any netting scheme is a centralized control point that can collect and record detail information on the intra corporate accounts of each participating affiliate at specified time intervals the control point called as a netting Centre is a subsidiary company setup in location with minimal exchange controls for trade transactions

28. Nettingwithout netting, the total payments in the system would equal to $ 44 million and the number of separate payments made would be 11. Multilateral netting will pair this transfer to $12 million, a net reduction of 73% and the number of payments can be reduced to 3, a net reduction of 73% as well. Assuming foreign exchange and bank transfer charges of 0.75% that company will save $2,40,000 through netting. (0.0075 X $32 million.)

29. Netting

30. NettingNetting has become increasingly popular because it offers several key benefits. First, it reduces the number of cross-border transactions between subsidiaries, thereby reducing the overall administrative cost of such cash transfers. Second, because transactions occur less frequently, there is less need for foreign exchange conversion, so the transaction costs associated with such conversions are reduced.

31. NettingThird, the netting process imposes tight control over information on transactions between subsidiaries. Thus all subsidiaries engage in a more coordinated effort to accurately report and settle their various accounts. Finally, cash flow forecasting is easier because only net cash transfers are made at the end of each period, rather than individual cash transfers throughout the period. Improved cash flow forecasting can enhance financing and investment decisions.

32. Managing Blocked FundsCash flows can also be affected by a host government’s blockage of funds, which might occur if the government requires all funds to remain within the country in order to create jobs and reduce unemployment. To deal with funds blockage, the MNC may implement the same strategies used when a host country government imposes high taxes. To make efficient use of these funds, the MNC may instruct the subsidiary to set up a research and development division, which incurs costs and possibly generates revenues for other subsidiaries.

33. Managing Blocked FundsAnother strategy is to use transfer pricing in a manner that will increase the expenses incurred by the subsidiary. A host country government is likely to be more lenient on funds sent to cover expenses than on earnings remitted to the parent.

34. Managing Blocked FundsWhen subsidiaries are restricted from transferring funds to the parent, the parent may instruct the subsidiary to obtain financing from a local bank rather than from the parent. By borrowing through a local intermediary, the subsidiary is assured that its earnings can be distributed to pay off previous financing. Overall, most methods of managing blocked funds are intended to make efficient use of the funds by using them to cover expenses that are transferred to that country.

35. Guidelines for globally managing the marketable securities portfolio

36. GuidelinesDiversify the instruments in the portfolio to maximize the yield for a given level of risk, don't invest in only in government securities, another instrument may be nearly as safeReview the portfolio daily to decide which security should be liquidated and which new investment should be madeTailor the maturity of the investment to the firm's projected cash need or be sure a secondary market for the investment with high liquidity exist

37. GuidelinesIn devising the portfolio make sure that the incremental interest earned more than compensated for added causes clerical work the income lost between investment fixed charge such as the foreign exchange spread and Commission on the sale and purchase of securitiesIf Rapid conversion to cash is an important consideration then carefully evaluate the security is marketability ready market exist for some securities but not for others

38. ACCOUNTS RECEIVABLE MANAGEMENT Firms grant trade credit to customers both domestically and internationally, because firms expect that credit sales to be profitable, either by increasing sales or by retaining sales that otherwise would be lost to competitors. In same cases, it may happen that companies also earn profits on the financing charges that impose on the credit sales.

39. ACCOUNTS RECEIVABLE MANAGEMENT The need to scrutinize the credit terms is particularly important in countries experiencing rapid rates of inflation. Credit Standards abroad are often more relaxed than standards in the home market. To remain competitive, MNCs may feel compelled to loosen their own credit standards. Finally, the compensation system in many companies tends to reward higher sales more than it penalizes an increased investment in accounts receivable. Local managers frequently have an incentive to expand sales even if the MNC overall does not benefit.

40. ACCOUNTS RECEIVABLE MANAGEMENT The effort to better manage receivables overseas will not get far if finance and marketing do not coordinate their efforts. In many companies, finance and marketing work at cross purposes. Marketing thinks about selling, and finance thinks about speeding up cash flows. One way to ease the tensions between finance and marketing is to educate the sales force on how credit and collection affect company profits. Another way is to tie bonuses for salespeople to collected sales or to adjust sales bonuses for the interest cost of credit sales.

41. Short Term Financing

42. Short Term Financing (Financing the working capital requirements of a multinational corporation's foreign affiliates poses a complex decision problem. This complexity stems from the large number of financing options available to the subsidiary of an MNC. Subsidiaries have access to funds from sister affiliates and the parent, as well as from external sources. This section is concerned with the following four aspects of developing a short-term overseas financing strategy: (1) identifying the key factors, (2) formulating and evaluating objectives, (3) describing available short-term borrowing options, and (4) developing a methodology for calculating and comparing the effective dollar costs of these alternatives.

43. Key Factors in Short-Term Financing Strategy1. If forward contracts are unavailable, the crucial issue is whether differences in nominal interest rates among currencies are matched by anticipated changes in the exchange rate. For example, is the difference between an 8% dollar interest rate and a 3% Swiss franc interest rate due solely to expectations that the dollar will devalue by5% relative to the franc? The key issue here, in other words, is whether there are deviations from the international Fisher effect. If deviations do exist, then expected dollar borrowing costs will vary by currency, leading to a decision problem. Trade-offs must be made between the expected borrowing costs and the exchange risks associated with each financing option.

44. Key Factors in Short-Term Financing Strategy2. The element of exchange risk is the second key factor. Many firms borrow locally to provide an offsetting liability for their exposed local currency assets. On the other hand, borrowing a foreign currency in which the firm has no exposure will increase its exchange risk. That is, the risks associated with borrowing in a specific currency are related to the firm's degree of exposure in that currency.

45. Key Factors in Short-Term Financing Strategy3. The third essential element is the firm's degree of risk aversion. The more risk averse the firm (or its management) is, the higher the price it should be willing to pay to reduce its currency exposure. Risk aversion affects the company's risk-cost trade-off and consequently, in the absence of forward contracts, influences the selection of currencies it will use to finance its foreign operations.

46. Key Factors in Short-Term Financing Strategy4. A final factor that may enter into the borrowing decision is political risk. Even if local financing is not the minimum cost option, multinationals often will still try to maximize their local borrowings if they believe that expropriation or exchange controls are serious possibilities. If either event occurs, an MNC has fewer assets at risk if it has used local, rather than external, financing.

47. Short-Term Financing

48. Sources of Foreign FinancingMultinational corporations may sometimes experience a temporary shortage of funds, so they rely on short-term financing until they receive sufficient cash inflows to cover the shortage. They may first attempt internal short-term financing, but if internal funds are not available, they access funds externally.

49. Internal Short-Term FinancingBefore an MNC or subsidiary in need of funds searches for outside funding, it should check other subsidiaries’ cash flow positions to determine whether any internal funds are available.

50. Internal Short-Term FinancingMultinational corporations can also attempt to obtain financing from their subsidiaries by increasing the markups on supplies that they send to them. In this case, the funds the subsidiary gives to the parent will never be returned. This method of supporting the parent can sometimes be more feasible than obtaining loans from the subsidiary because it may circumvent restrictions or taxes imposed by national governments. In some cases, though, this method itself may be restricted or limited by the host governments where the subsidiaries are located.

51. Internal Control over FundsAn MNC should have an internal system that constantly monitors the amount of short-term financing by all of its subsidiaries. This may allow it to recognize which subsidiaries have cash available in the same currency that another subsidiary needs to borrow. Furthermore, the monitoring system can govern the extent of short-term financing by each subsidiary. Without such controls, one subsidiary may borrow excessively, which may ultimately affect the amount that other subsidiaries can borrow if all subsidiary borrowing from banks is backed by the parent’s guarantee. Thus the MNC can use internal controls both to monitor the short-term financing at its subsidiaries and to impose a maximum short-term debt level at each subsidiary.

52. External Short-Term FinancingIf MNCs and their subsidiaries cannot access short-term funds internally, they can consider the following external sources of short-term funds to satisfy their liquidity needs.

53. Short-Term NotesOne method increasingly used in recent years is the issuing of short-term notes, or unsecured debt securities. In Europe, the securities are referred to as Euronotes. The interest rates on these notes are based on LIBOR, the interest rate charged on interbank loans among European and other countries. Short-term notes typically have maturities of one, three, or six months. Some MNCs continually roll them over as a form of intermediate-term financing. Commercial banks underwrite the notes for MNCs, and some commercial banks purchase them for their own investment portfolios.

54. Commercial paperCommercial paper, also called CP, is a short-term debt instrument issued by companies to raise funds generally for a time period up to one year. It is an unsecured money market instrument issued in the form of a promissory note and was introduced in India for the first time in 1990.

55. Commercial paperCompanies that enjoy high ratings from rating agencies often use CPs to diversify their sources of short-term borrowings. This gives investors an additional instrument. They are typically issued by large banks or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project.CPS have a minimum maturity of seven days and a maximum of up to one year from the date of issue. However, the maturity date of the instrument should typically not go beyond the date up to which the credit rating of the issuer is valid. They can be issued in denominations of Rs 5 lakh or multiples thereof.

56. Commercial paperSince such instruments are not backed by collateral, only firms with high ratings from a recognised credit rating agency can sell such commercial papers at a reasonable price. CPs are usually sold at a discount to their face value, and carry higher interest rates than bonds.

57. Commercial PaperIn addition to short-term notes, MNCs also issue commercial paper. In Europe, this is sometimes referred to as Euro–commercial paper. Dealers issue commercial paper for MNCs without the backing of an underwriting syndicate, so the issuer is not guaranteed a selling price. Maturities can be tailored to the issuer’s preferences. Dealers may make a secondary market by offering to repurchase commercial paper before maturity.

58. Bank LoansDirect loans from banks, which are often used to maintain bank relationships, are another popular source of short-term funds for MNCs. If alternative sources of short-term funds become unavailable, MNCs rely more heavily on direct loans from banks. Most MNCs maintain credit arrangements with various banks around the world; some have credit arrangements with more than 100 foreign and domestic banks.