International Financial Management in MNC
International Financial Management in MNC
International Financial Management in MNC
Introduction
The essence of short term financial management can be stated as
Minimize the working capital needs consistent with other policies Raise short term funds at the minimum possible cost and deploy short term cash surpluses at the maximum possible rate of return consistent with the firm's risk preferences and liquidity needs
In a multinational context, the added dimensions are the multiplicity of currencies and a much wider array of markets and instruments for raising and deploying funds Focus on cash management since it is complex because of possibility of raising and deploying cash in many currencies, many locations, and profit opportunities presented by imperfections in international money and foreign exchange markets Other aspects of short-term financial management such as inventories, receivables/payables management etc. not too different in a multinational context as opposed to a purely domestic firm.
Even a purely domestic firm or a firm with imports and exports but no cross-border manufacturing facilities can "internationalize" its cash management if the government of the country permits free capital inflows and outflows In India as of now, the capital account has not been fully opened up; short-term borrowings are generally discouraged and there are restrictions on parking surplus funds abroad. Also, restrictions on leading-lagging, netting etc.
Indian firms have been permitted access to foreign money markets (through domestic banks) for pre-shipment credits for exports and settlement of import payments The Exchange Earners Foreign Currency (EEFC) account facility is available to all exporters (50% of FC earnings) with special facilities for software firms 100% EOUs (100%). Cannot access foreign markets for day-to-day cash management Banks arbitrage between domestic and foreign money markets so that forward margins closely related to interest rate differentials.
The passive approach confines itself to minimizing cash needs and currency exposure as well as optimal deployment of cash balances arising out of the firm's operating requirements The active approach deliberately creates cash positions to profit from perceived market imperfections or the firm's supposedly superior forecasting ability Again a matter of risk-reward tradeoff.
i.e.
The
i.e.
The
This assumes perfect capital mobility, risk neutrality e (B/A) : Expected depreciation of currency A vis--vis B.
F(A/B) is the relevant forward rate and Se(A/B) is the expected future spot rate
If excess funds on hand exceed S*, money should be borrowed to invest in the money market instrument; otherwise the excess funds should be left in a bank deposit A similar problem is minimum tenor problem Financing Short-Term Deficits Careful handling of short-term deficits can lead to significant savings Minimize the overall borrowing requirement consistent with the firm's liquidity needs and to fund these at the minimum possible all-in cost
One of the cheapest ways of covering shortterm deficits is internal funds A centralized cash management system with cash pooling described below can efficiently allocate internal surpluses External sources of short-term funding consist of overdraft facilities, fixed term bank loans and advances and instruments like commercial paper, trade and bankers' acceptances
$15 $10
$55
Central depository
$15
$40
Consider the case of an American multinational with subsidiaries in France, Switzerland and the UK. The parent operates a cash management center. By a specific date each month - say the 15th - all units, the subsidiaries as well as the parent report their receivables and payables among themselves to the CMC. The CMC uses the current spot rates to convert all cash flows into a common denominator viz.US dollars. Figure below shows the positions reported by the various units. The spot rates are assumed to be USD/CHF = 1.5000, GBP/USD = 1.6000 and EUR/USD = 1.2000
SWITZERLAND
CHF 1.5m (USD 1m) EUR 5m (USD 6m) GBP 1m CHF 9m (USD 1.6m) (USD 6m)
FRANCE
EUR 2.5m (USD 3m) USD 2m USD 1m
UK
USA (PARENT)
The CMC nets out the receivables against payables of each unit and informs the net payers to pay designated amounts to the net receivers. The actual settlements take place at a specified date - say the 25th of the month - for which the net payers acquire the necessary currencies at the spot rate ruling at that time. Any exchange gains or losses are attributed to the individual units. The net positions of the various units, in millions of dollars, are as follows (+ sign indicates inflow and a - sign an outflow):
FRANCE
UK
1.0m
0.45m 1.35m 2m
Netting need not be confined to intra-corporate transactions. Transactions with third parties can also be incorporated.
More flexibility can be achieved in cash management if netting can be combined with leading and lagging Payments to cash surplus units can be lagged (with appropriate compensation at the ruling rates of interest) and those to cash deficit units can be accelerated to manage overall cash needs and minimise the use of bank credit lines.
Cash Pooling
The CMC can act not only as a netting center but also the repository of all surplus funds. The CMC can in fact function as a finance company which accepts loans from individual surplus units, makes loans to deficit units and also undertakes market borrowing and investment.
By denominating the intra-corporate loans in the units' currencies, the responsibility for exposure management is entirely transferred to the finance company and the operating subsidiaries can concentrate on their main business viz. production and selling of goods and services.
Cash pooling will also reduce overall cash needs since cash requirements of individual units will not be synchronous.
The concept of CMC can be combined with that of a reinvoicing center. Under this system, notionally all subsidiaries sell their output to the reinvoicing center which is located in a low-tax country. The sales are invoiced in the selling company's currency. The reinvoicing center takes title to the goods and in turn sells to third party customers as well as other members of the corporate family which may be production and/or sales subsidiaries. The actual deliveries are made from the selling units to the buying units.
For intra-corporate sales, the buying units are invoiced in their respective currencies. Thus the entire currency exposure is transferred to the reinvoicing center which can use matching and pairing to minimise recourse to forward markets or other hedging devices.
Cash Transmission
Minimizing the unnecessary costs in the process of collecting cash from debtors and making payments to creditors; the costs arising from the so called "float" The treasurer must try and minimize the float in the cash collection cycle and take advantage of the float in the cash payment cycle
Cash Transmission
The banking systems in various countries have evolved clearing mechanisms which aim at reducing the delays between a payment instruction being received and the payee actually being able to apply the funds. The CHIPS in the US, CHAPS in the UK are examples of such systems. SWIFT is an electronic network for cross-border funds transfers. A treasurer operating in a multinational framework needs a good working knowledge of these systems. Similarly banks around the world offer various facilities to their clients to speed up funds transfers. Direct debits, lock-box facilities and other such devices can help in cutting down these delays often enabling realization of value the same day.
An LP Formulation of Netting
____________________________________________________
Unit Total Receivables Total Payables Net
____________________________________________________
CANADA
UK GERMANY
20.80
14.75 30.00
28.05
21.80 9.90
-7.25
-7.05 +20.10
HOLLAND
S.KOREA US
15.40
10.90 28.60
13.50
25.80 21.40
+1.90
-14.90 +7.20
_____________________________________________________
Minimise: (0.001X1 + 0.001X2 + 0.0012X3 + 0.0015X4 + 0.0015X5 + 0.001X6 + 0.0018X7 + 0.0018X8 + 0.0016X9) ..
Minimise total cost of funds transfer Subject to the constraints : X1 + X2 + X3 = 7.05 Total payments from UK X4 + X5 + X6 = 7.25 Total payments from Canada X7 + X8 + X9 = 14.90 Total payments from S.Korea X1 + X4 + X7 = 20.10 Total payments to Germany X2 + X5 + X8 = 1.90 Total payments to Holland
Blocked Funds
A form of political risk is the risk that the foreign government may impose exchange restrictions on its own currency. Several methods exist for moving blocked funds:
Transfer pricing
Blocked Funds
Additional strategies for unblocking funds:
For example, use the National Airlines of the host country for travel of executives of the MNC, and pay for the tickets with the blocked funds.
Transfer local expatriates from home payroll to the local subsidiaries payroll.
Summary
Within the constraints imposed by the exchange control and other regulations, a MNC has access to a much wider menu of funding avenues and investment vehicles for short-term funds management Apart from funding and investment avenues, the mechanics of efficient cash transmission and configuration of bank accounts is an important aspect of cash management in a MNC The decision to centralize cash management in a separate cash management center needs to be carefully evaluated