19.1 INTERNATIONAL CASH MANAGEMENT

Organization

When compared with a system of autonomous operating units, a fully centralized international cash management program offers a number of advantages:

l The corporation is able to operate with a smaller amount of cash, pools of excess

liquidity are absorbed and eliminated, and each operation will maintain transactions balances only and not hold speculative or precautionary ones.

l By reducing total assets, profitability is enhanced and financing costs are reduced. l The headquarters staff, with its purview of all corporate activity, can recognize problems

and opportunities that an individual unit might not perceive. l All decisions can be made using the overall corporate benefit as the criterion. l By increasing the volume of foreign exchange and other transactions done through

headquarters, firms encourage banks to provide better foreign exchange quotes and

better service. l Greater expertise in cash and portfolio management exists if one group is responsible

for these activities. l Less can be lost in the event of an expropriation or currency controls restricting the

transfer of funds because the corporation’s total assets at risk in a foreign country can

be reduced.

Many experienced multinational firms have long understood these benefits. Today, the

combination of volatile currency and interest rate fluctuations, questions of capital availability, increasingly complex organizations and operating arrangements, and a growing emphasis on profitability virtually mandates a highly centralized international cash management system. There is also a trend to place much greater responsibility in corporate headquarters.

Centralization does not necessarily mean that corporate headquarters has control of all facets of cash management. Instead, a 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 optimize the firm’s position.

Collection and Disbursement of Funds

Accelerating collections both within a foreign country and across borders is a key element of international cash management. Material potential benefits exist because long delays often are encountered in collecting receivables, particularly on export sales, and in transferring funds among affiliates and corporate headquarters. Allowing for mail time and bank processing, delays of eight to 10 business days are common from the moment an importer pays an invoice to the time when the exporter is credited with good funds—that is, when the funds are available for use. Given high interest rates, wide fluctuations in the foreign exchange markets, and the periodic imposition of credit restrictions that have characterized financial markets in some years, cash in transit has become more expensive and more exposed to risk.

With increasing frequency, corporate management is participating in the establishment

of an affiliate’s credit policy and the monitoring of collection performance. The principal goals of this intervention are to minimize float—that is, the transit time of payments—to reduce the investment in accounts receivable and to lower banking fees and other transaction costs. By converting receivables into cash as rapidly as possible, a company can increase its portfolio or reduce its borrowing and thereby earn a higher investment return or save interest expense.

Considering either national or international collections, accelerating the receipt of funds usually involves (1) defining and analyzing the different available payment channels; (2) selecting the most efficient method, which can vary by country and by customer; and (3) giving specific instructions regarding procedures to the firm’s customers and banks.

In addressing the first two points, the full costs of using the various methods must be determined, and the inherent delay of each must be calculated. Two main sources of delay in the collections process are (1) the time between the dates of payment and of receipt and (2) the time for the payment to clear through the banking system. Inasmuch as banks will be as ‘‘inefficient’’ as possible to increase their float, understanding the subtleties of domestic and international money transfers is requisite if a firm is to reduce the time that funds are held and extract the maximum value from its banking relationships. Exhibit 19.1 lists the different methods multinationals use to expedite their collection of receivables.

Payments Netting in International Cash Management

Many multinational corporations are now in the process of rationalizing their production on a global basis. This process involves a highly coordinated international interchange of materials, parts, subassemblies, and finished products among the various units of the MNC, with many affiliates both buying from and selling to each other.

Bilateral and Multilateral Netting The idea behind a payments netting system is simple: Payments among affiliates go back and forth, whereas only a netted amount need be transferred. Suppose, for example, the German subsidiary of an MNC sells goods worth $1 million to its Italian affiliate that in turn sells goods worth $2 million to the German unit. The combined flows total $3 million. On a net basis, however, the German unit need remit only $1 million to the Italian unit. This type of bilateral netting is valuable, however, only if subsidiaries sell back and forth to each other.

Bilateral netting would be of less use when there is a more complex structure of internal sales, such as in the situation depicted in Exhibit 19.3A, which presents the payment flows (converted first into a common currency, assumed here to be the dollar) that take place among four European affiliates, located in France, Belgium, Sweden, and the Netherlands. On a multilateral basis, however, there is greater scope for reducing cross-border fund transfers by netting out each affiliate’s inflows against its outflows

Information Requirements. Essential to any netting scheme is a centralized control point that can collect and record detailed information on the intracorporate accounts of each participating affiliate at specified time intervals. The control point, called a netting center, is a subsidiary company set up in a location with minimal exchange controls for trade transactions.

Analysis. The higher the volume of intercompany transactions and the more back-and-forth selling that takes place, the more worthwhile netting is likely to be. A useful approach to evaluating a netting system would be to establish the direct cost savings of the netting system and then use this figure as a benchmark against which to measure the costs of implementation and operation.

An additional benefit from running a netting system is the tighter control that management can exert over corporate fund flows. The same information required to operate a netting system also will enable an MNC to shift funds in response to expectations of currency movements, changing interest differentials, and tax differentials.

Optimal Worldwide Cash Levels

Centralized cash management typically involves the transfer of an affiliate’s cash in excess of minimal operating requirements into a centrally managed account, or cash pool. Some firms have established a special corporate entity that collects and disburses funds through a single bank account.

With cash pooling, each affiliate need hold locally only the minimum cash balance required for transactions purposes. All precautionary balances are held by the parent or in the pool. As long as the demands for cash by the various units are reasonably independent of one another, centralized cash management can provide an equivalent degree of protection with a lower level of cash reserves.

Evaluation and Control. Taking over control of an affiliate’s cash reserves can create motivational problems for local managers unless some adjustments are made to the way in which these managers are evaluated. One possible approach is to relieve local managers of profit responsibility for their excess funds. The problem with this solution is that it provides no incentive for local managers to take advantage of specific opportunities of which only they may be aware. An alternative approach is to present local managers with interest rates for borrowing or lending funds to the pool that reflect the opportunity cost of money to the parent corporation. In setting these internal interest rates (IIRs), the corporate treasurer, in effect, is acting as a bank, offering to borrow or lend currencies at given rates. By examining these IIRs, local treasurers will be more aware of the opportunity cost of their idle cash balances, as well as having an added incentive to act on this information. In many instances, they will prefer to transfer at least part of their cash balances (where permitted) to a central pool in order to earn a greater return. To make pooling work, managers must have access to the central pool whenever they require money.

Multinational Cash Mobilization. A multinational cash mobilization system is designed to optimize the use of funds by tracking current and near-term cash positions. The information gathered can be used to aid a multilateral netting system, to increase the operational efficiency of a centralized cash pool, and to determine more effective short-term borrowing and investment policies.

The operation of a multinational cash mobilization system is illustrated here with a simple example centered on a firm’s four European affiliates. Assume that the European headquarters maintains a regional cash pool in London for its operating units located in England, France, Germany, and Italy. Each day, at the close of banking hours, every affiliate reports to London its current cash balances in cleared funds—that is, its cash accounts net of all receipts and disbursements that have cleared during the day. All balances are reported in a common currency, which is assumed here to be the U.S. dollar, with local currencies translated at rates designated by the manager of the central pool.

Bank Relations

Good bank relations are central to a company’s international cash management effort. Although some companies may be quite pleased with their banks’ services, others may not even realize that they are being poorly served by their banks. Poor cash management services mean lost interest revenues, overpriced services, and inappropriate or redundant services. Here are some common problems in bank relations:

l Too many relations: Many firms that have conducted a bank relations audit find that they

are dealing with too many banks. Using too many banks can be expensive. It also invariably generates idle balances, higher compensating balances, more check-clearing float, suboptimal rates on foreign exchange and loans, a heavier administrative workload, and diminished control over every aspect of banking relations.

l High banking costs: To keep a lid on bank expenses, treasury management must carefully track not only the direct costs of banking services—including rates, spreads, and commissions—but also the indirect costs rising from check float, value-dating—that is, when value is given for funds—and compensating balances. This monitoring is especially important in the developing countries of Latin America and Asia. In these countries, compensating balance requirements—the fraction of an outstanding loan balance required to be held on deposit in a non-interest-bearing account—may range as high as 30% to 35%, and check-clearing times may drag on for days or even weeks. It also pays off in European countries such as Italy, where banks enjoy value-dating periods of as long as 20 to 25 days.

l Inadequate reporting: Banks often do not provide immediate information on collections and account balances. This delay can cause excessive amounts of idle cash and prolonged float. To avoid such problems, firms should instruct their banks to provide daily balance information and to distinguish clearly between ledger and collected balances—that is, posted totals versus immediately available funds.

l Excessive clearing delays: In many countries, bank float can rob firms of funds availability. In nations such as Mexico, Spain, Italy, and Indonesia, checks drawn on banks located in remote areas can take weeks to clear to headquarters accounts in the capital city. Fortunately, firms that negotiate for better float times often meet with success. Whatever method is used to reduce clearing time, it is crucial that companies constantly check up on their banks to ensure that funds are credited to accounts as expected.

Negotiating better service is easier if the company is a valued customer. Demonstrating that it is a valuable customer requires the firm to have ongoing discussions with its bankers to determine the precise value of each type of banking activity and the value of the business it generates for each bank. Armed with this information, the firm should make up a monthly report that details the value of its banking business. By compiling this report, the company knows precisely how much business it is giving to each bank it uses. With such information in hand, the firm can negotiate better terms and better service from its banks.