International Finance

International FinanceFIN456

Michael Dimond

Michael DimondSchool of Business Administration

Working Capital Management

• Management of cash, accounts receivable and inventory, and the financing of these current assets, is crucial to a MNC.

• The operating cycle of a business generates funding needs, cash inflows and outflows

• Remember how o compute the operating cycle & the cash cycle?


Days Working Capital for Selected U.S. and European Technology Hardware and Equipment Firms, 2001


International Cash Management

• International cash management is the set of activities determining the levels of cash balances held throughout the MNC, cash management, and the facilitation of its movement cross border, settlements and processing– This takes a significant amount of time from treasurers of MNCs– Most large banks have services for international money management,

including a variety of money market products and servicing of payables & receivables

• Cash levels are determined independently of working capital management decisions– Cash balances, including marketable securities, are held partly for

day-to-day transactions and to protect against unanticipated variations from budgeted cash flows

– These two motives are called the transaction motive and the precautionary motive


International Cash Management

• Cash disbursed for operations is replenished from two sources– Internal working capital turnover– External sourcing, traditionally short-term borrowing

• All firms engage in some sort form of the following steps– Planning – a financial manager anticipates cash flows over future days,

weeks, or months– Collection – controlled through time lags between the the shipment

date and the payment date

– Disbursement – steps included are avoiding unnecessary early payment, maximizing float and selecting a disbursement bank

– Covering cash shortages – anticipated cash shortages can be managed by borrowing locally

– Investing surplus cash – if a subsidiary of an MNC generates surplus cash, the MNC must decide whether to handle its own short-term liquidity or whether surplus funds should be controlled centrally


International Cash Settlements & Processing• Four techniques for simplifying and lowering the cost of

settling cash flows between related and unrelated firms– Wire transfers– Cash pooling– Payment netting– Electronic fund transfers


International Cash Settlements & Processing• Wire Transfers

– Variety of methods but two most popular for cash settlements are CHIPS and SWIFT

• CHIPS is the Clearing House Interbank Payment System owned and operated by its member 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


International Cash Settlements & Processing• Cash Pooling and Centralized Depositories

– Businesses with widely dispersed operating subsidiaries can gain operational benefits by centralizing cash management

– Subsidiaries hold minimum cash for their own transactions and no cash for precautionary purposes

– All excess funds are remitted to a central cash depository– 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


Decentralized vs Centralized Cash Depositories


International Cash Settlements & Processing

• Multilateral Netting– Defined as the process that cancels via offset all, or part, of the

debt owed by one entity to another related entity– Netting of payments is useful primarily when a large number of

separate foreign exchange transactions occur between subsidiaries

– Example: Quad Belge owes Deutscheland Quad $5,000,000 and Deutscheland Quad simultaneously owes Quad Belge $3,000,000

– Bilateral settlement calls for $2,000,000 payment from Belgium to Germany and cancellation of remainder

– Multilateral system is expanded version• Assume that payments are due between Quad’s European

operations each month.

• Without netting Quad Belge would make 3 separate transactions each way


Multilateral Matrix Before Netting (US$ 000s)


Multilateral Matrix Before Netting (US$ 000s)


Repositioning Decisions• Multinational firms often unbundle their transfers of funds into

separate flows for specific purposes• The conduits, or means of moving funds, are separable into those

which are before-tax and after-tax in the host country• These are various conduits available for repositioning funds:


Repositioning Decisions

• While fund flows between units of a domestic business are generally unimpeded, a firm operating globally faces a variety of considerations which limit its ability to move funds easily and without cost from one country or currency to another;– Political constraints– Tax constraints– Transaction costs– Liquidity needs


• As foreign operations expand, a MNC will increase its inventories and accounts payable as well as accounts receivables

• These components make up net working capital

• Note that short-term debt is not a part of net working capital although it is a part of gross working capital

(A/P) - Inventory) (A/R C)capital(NW gNet workin

Working Capital Funding


NWC management in broader financial strategy• If forward contracts exist, the only strategic objective of

borrowing is to minimize covered after‑tax interest costs.• If forward contracts do not exist, MNCs can establish some

trade‑off between reducing expected costs and reducing the degree of cash flow exposure• Offset operating cash inflows in a currency with financing cash outflows in that

same currency.

• Borrowing decisions should be integrated with hedging decisions.

• MNCs will attempt to minimize expected costs


Working Capital Funding

• Timing of AP payments is a key policy decision• The alternative financing for NWC is short-term debt

– Example: Paraña Electronics is a Brazilian supplier; their credit terms state 5/10 net 60 on a R$180,000 shipment

– 5/10 net 60 means that the entire amount is due in 60 days but if the buyer pays within 10 days they will receive a 5% discount

– R$180,000 x (1-.05) = R$171,000 – Managers must decide which is the lower cost method for financing

the NWC– Short-term debt in Brazil costs 24% p.a. so we must compare this cost

to the cost of financing offered by Paraña’s credit terms– The buyer is effectively paid 5% for giving up 50 days of financing– Assuming a 365 day count for interest

30.7days 50

days 365


p.a. 42.%or ,428.1)05.01( 30.7

Working Capital Financing

– To calculate the effective annual interest cost of the supplier financing, the 5% discount for 50 days 7.30 times, yields a cost of carry of

– Paraña is effectively charging 42.8% p.a. for financing as opposed to short-term financing offered at 24% p.a.

– Some argue this figure should not be compounded, in which case the rate is 5% x 7.30 = 36.50% p.a.



• Days working capital is a common method used to calculate the NWC of a firm– This method is based on using a “days sales” basis– If the value of A/R, inventories and A/P are divided by the annual daily

sales– The firm’s NWC can be summarized in the number of days sales of

NWC– These results vary among industries and countries so the averages

and levels will vary


Working Capital Financing• Intra-Firm working capital

– Within an MNC, the various subsidiaries’ operations create differing levels of payables, inventories and receivables at inter and intra-firm levels

– This can create severe mismatches



• Managing Receivables– A firm’s operating cash inflow is derived primarily from the collection

of receivables– There are several factors that go into the management of receivables

• Independent customers – requires decisions about currency of denomination and payments terms

• Payment terms

• Self-liquidating bills – secured by physical inventory that has been sold and the funds are lent based on the securitization

• Other terms


18-22


• Inventory Management– Anticipating devaluation – management must decide whether to build

inventory of items that carry foreign exchange exposure– Anticipating price freezes– Free trade zones and free industrial zones – free trade zones

combines the idea of duty-free ports with legislation that reduces customs duties to retailers or manufacturers who structure their operations to benefit from the technique


Financing Working Capital

• All firms need to finance working capital and most of the short-term financing needs is done through the use of bank credit lines

• Banking sources available to MNCs are– In-house Banks– Commercial Banking Offices

• In-house Bank is not a separate corporation. Rather it is a set of functions performed by the existing treasury department– The purpose of the In-house Bank is to provide banking services to

the various units of the firm– It can provide lower credit spreads because it does not have to meet

any capital requirements imposed on commercial banks– The In-house Bank can also better handle currency related risks


Financing Working Capital

• Commercial Banking can support MNC’s needs through various offices– Correspondent Banks with local banks in important cities across the

world– Representative Offices are established in a foreign country to help

parent bank clients– Branch Banks are foreign branches that are a legal and operational

part of the parent bank– Affiliates are locally incorporated banks owned in part by a foreign

parent– Edge Act Corporations are subsidiaries of US banks to engage in

international banking and financing operations

Documents

International Finance