working capital management for international companies

8/2/2019 Working Capital Management for International Companies

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Working Capital Managementfor the MultinationalCorporation

International Financial ManagementMr. Jyoti Prakash BeheraRavenshaw University


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Learning Objectives

How does multinational working capitalmanagement differ from domestic workingcapital management?What are the objectives of international cashmanagement?What techniques are used by MNCs for makingcross-border payments?What key factors are associated with a firmsfunding strategy?What short-term financing options are

available?


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Multinational Working CapitalManagement

Funds AvailabilityAdditional Risks

Movement of CapitalDecisionsTaxes


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International Cash Management

A set of activities, which consists of: Cash management - the levels of cash balances

held throughout the MNC - Cash settlements and processing - the

facilitation of its movement across borders


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Cash Management

Cash levels are determined independently of working capital management decisions Cash balances, including marketable securities,

are held partly for day-to-day transactions andto protect against unanticipated variations frombudgeted cash flows

These two motives are called the transactionmotive and the precautionary motive .


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International Cash Management

Goal: Minimize cash balances without reducingoperations or increasing risk.Steps: Cash Planning - anticipating cash flows over future days,

weeks, or months. Cash Collection getting cash into the firm as soon as

possible. Cash Mobilization moving cash within the firm to the

location where needed. Cash Disbursements planning procedures for distributing

cash. Covering Cash Shortages managing anticipated cash

shortages by borrowing locally. Investing Surplus Cash managing anticipated cash surpluses

by investing locally or controlling them centrally.


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Cash Positioning Decision

Currency of location

Type of liquid asset held

Maturities, yields, and liquiditycharacteristics


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Objectives of an Effective CashManagement System

Minimizing overall cash requirementsMinimizing currency exposure risk

Minimizing political risk Minimizing transactions costsTaking full advantage of economies of scale


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Complexities of the InternationalCash Positioning Decision

Conflicting nature of cash managementobjectivesGovernment restrictionsMultiple taxation systemsMultiple currencies


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International Cash Settlementsand Processing

Four techniques for simplifying andlowering the cost of settling cash flowsbetween related and unrelated firms Wire transfers Cash pooling Payment netting Electronic fund transfers


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Wire Transfers

Variety of methods but two most popularfor cash settlements are CHIPS and SWIFT CHIPS is the Clearing House Interbank

Payment System owned and operated by itsmember banks SWIFT is the Society for Worldwide Interbank

Financial Telecommunications which also

facilitates the wire transfer settlement process Whereas CHIPS actually clears transactions,

SWIFT is purely a communications system


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Cash Pooling and Centralized

DepositoriesKey: Centralizing the cash positioning function to gain operationalbenefits. Subsidiaries hold minimum cash for their own transactions and no

cash for precautionary purposes

All excess funds are remitted to a central cash depositoryCentralized depositories provide the following advantages: Information advantage is attained by central depository on currency

movements and interest rate risk Precautionary balance advantages as MNC can reduce pool without

any loss in level of protection Interest rate advantages as funds can be borrowed at a lower cost and

invested at a more advantageous rate. Location can provide tax benefits, access to international

communications, clearly defined legal procedures.


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Payments NettingExample: A Belgian affiliate owes an Italianaffiliate $5,000,000, while the Italian affiliatesimultaneously owes the Belgian affiliate$3,000,000. Bilateral settlement calls for $2,000,000 payment from

Belgium to Italy and cancellation of the remainder viaoffset.

Multilateral netting is an extension of bilateral netting. Assume that payments are due between Apexs European

operations each month. Without netting Apex de France would make three

separate transactions each way.


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Financing Working Capital

Financing working capital requirements of aMNCs foreign affiliates poses a complexdecision problem.Financing options for a subsidiary include: Intercompany loans from the parent or a sister

affiliate.

Local currency financing.


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Key Factors Underlying the FundingStrategy

Interest Rate Without forward contracts With forward contracts

Exchange Risk Degree of Risk Aversion

TaxesPolitical Risk


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Financing Objectives

Minimize covered after-tax interest costsMinimize expects costs

Trade-off between expected cost andreducing the degree of cash flow exposure


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Intercompany Loans

The cost of an intercompany loan isdetermined by the following factors: Opportunity cost of funds Interest rate Tax rates and regulations Currency of denomination Expected exchange rate change


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Local Currency Financing

Bank Loans Term Loans Line of Credit Overdraft Revolving Credit Agreement Discounting

Commercial Paper


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Effective Interest Rate on Bank Loans

Simple interest loanDiscount loan

Loan with compensating balancerequirement Simple interest loan Discount loan


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Effective Annual Percentage CostIllustration

The Olivera Corporation, a manufacturer of olive oilproducts, needs to acquire 1 million in funds today toexpand a pimiento-stuffing facility. Banca di Roma hasoffered them a choice of an 11% loan payable at maturityor a 10% loan on a discount basis. Which loan shouldOlivera choose?


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Calculating the Dollar Costs of Alternative Financing Options

In deciding on a particular financing option,a firm needs to estimate and then comparethe effective after-tax dollar costs of local

currency financing and dollar financing. In reality, the value of the currency borrowed

will most likely change with respect to the borrowers local currency over time.

Breakeven analysis can be used to determinethe least expensive financing source for eachfuture exchange rate.


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Effective Financing Rate:No Taxes

Suppose that Ford has an affiliate in Mexico,which can borrow pesos at 80% or dollars at 12%for one year. If the peso is expected to devalue from MP$ 7.50/$ at

the beginning of the year to MP$ 10.23/$ at the end of the year, what is the expected before-tax dollar cost of the peso loan?

What is the cost of the dollar loan to Ford?

What is the breakeven rate of currency change at whichthe dollar cost of borrowing pesos is just equal to thecost of dollar financing?


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Effective Financing Rate:No Taxes

Dollar cost of local currency (LC) loan rH (LC) = r L (1 + c) + c

Cost of dollar loan (HC) rH (HC) = r H

Breakeven rate of currency change rL (1 + c) + c = rH


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Effective Financing Rate:With Taxes

Suppose the Mexican corporate tax rate is53%. What is the expected after-tax dollar cost of

borrowing pesos? What is the expected after-tax cost of the dollar

loan? What is the breakeven rate of currency change

at which the after-tax dollar cost of localcurrency financing is just equal to the after-taxcost of dollar financing?


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Effective Financing Rate:With Taxes

After-tax dollar cost of borrowing localcurrency rH (LC) = r L (1 - T a)(1 + c) + c

After-tax cost of dollar loan rH (HC) = r H (1 - T a) + cTa

Breakeven rate of currency change rL(1 - T a)(1 + c) + c = rH(1 - T a) + cTa

working capital management for international companies

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