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International Finance

International Finance. Chapter 18: Multinational Cash Management. Cash Management for a Global Firm. A global firm’s cash management is actually part of the larger issue of working capital management. Working capital = current assets – current liabilities. Current assets:

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International Finance

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  1. International Finance Chapter 18: Multinational Cash Management

  2. Cash Management for a Global Firm • A global firm’s cash management is actually part of the larger issue of working capital management. • Working capital = current assets – current liabilities. • Current assets: • Cash, accounts receivable, inventories, short term investments. • Current liabilities: • Accounts payable, bank loans and notes payable, current taxes payable.

  3. Working Capital Management • Broader issue than cash. • Global firm needs to manage the: • Individual components in its working capital structure. • Ensure that funds are available when needed to meet current liabilities as they come due. • If internal funds are not available, need to enter short term money markets to cover.

  4. Focus on Cash Management • Issues for Global Firms: • Size of cash balances • Currency denominations of cash balances • Where cash balances are located among the global firm’s foreign affiliates. • Goal of Global Firms: • Minimize the size of cash balances. • Non-interest earning assets! • Reduce foreign exchange transaction expenses and exposure.

  5. Additional Objectives of Cash Management • When sourcing short term funds to cover cash flow needs: • Do so at the lowest possible borrowing cost. • When investing short term (“excess” cash) funds: • Do so where the greatest returns can be earned. • Both objectives need to consider: • Risk • Foreign exchange expsoure

  6. Operational Consideration • Global firm must decide whether its cash management shall be done: • Centrally (e.g., at headquarters), or • Centralized organizational structure. • Locally (e.g., at the affiliate level). • Decentralized organizational structure.

  7. Cash Management Techniques • The following are the two major techniques which are used by global firms in managing their cash positions: • Netting Systems • Bilateral and Multilateral • Netting the cash positions of the various affiliates. Transferring the net amounts (not the gross amounts). • Transfer Pricing • Establishing prices among affiliates for the intra-global firm selling of produces and services. • Means of moving (repositioning) cash within the global firm.

  8. Netting Systems • Begins with an analysis of the global firm’s internal cash flows (i.e., among affiliates and the parent). • What are the amount of the payments that each entity expects to pay and expects to receive. • Netting the above amounts is a way of reducing the amount of cash flow (and its associated cost) within the organization. • Netting is an efficient and cost-effective mechanism for settling interaffiliate foreign exchange transactions. • However, not all countries allow MNCs to net payments • If this is the case, larger foreign exchange transactions flow through the local (host country) banking system.

  9. Exposure Netting: an Example Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions: $20 $30 $40 $10 $35 $10 $30 $40 $25 $60 $20 $30

  10. Bilateral Netting: an Example Bilateral Netting would reduce the number of foreign exchange transactions as follows; Examine U.S and Canadian affiliate $20 $30 $40 $10 $35 $10 $30 $40 $25 $60 $20 $30

  11. Bilateral Netting: an Example Bilateral Netting: U.S. and Canada net out at $10 $10 $40 $10 $35 $10 $30 $40 $25 $60 $20 $30

  12. Bilateral Netting: an Example Bilateral Netting: Canadian and U.K. affiliates. $10 $40 $10 $35 $10 $30 $40 $25 $60 $20 $30

  13. Bilateral Netting: an Example Bilateral Netting: Canadian and U.K. affiliates net out at $10 $10 $40 $10 $35 $10 $10 $25 $60 $20 $30

  14. Bilateral Netting: an Example Bilateral Netting: U.K. and German affiliates. $10 $40 $10 $35 $10 $10 $25 $60 $20 $30

  15. Bilateral Netting: an Example Bilateral Netting: U.K. and German affiliates net out at $10 $10 $40 $10 $35 $10 $10 $25 $60 $10

  16. Bilateral Netting: an Example Bilateral Netting: U.S. and German affiliate. $10 $40 $10 $35 $10 $10 $25 $60 $10

  17. Bilateral Netting: an Example Bilateral Netting: U.S. and German affiliate net out at $25. $10 $40 $10 $25 $10 $25 $60 $10

  18. Bilateral Netting: an Example Bilateral Netting: U.S. and U.K. affiliate. $10 $40 $10 $25 $10 $25 $60 $10

  19. Bilateral Netting: an Example Bilateral Netting: U.S. and U.K. affiliate net out at $20. $10 $20 $10 $25 $10 $25 $10

  20. Bilateral Netting: an Example Bilateral Netting: German and Canadian affiliates. $10 $20 $10 $25 $10 $25 $10

  21. Bilateral Netting: an Example Bilateral Netting: German and Canadian affiliates net out at $15 $10 $20 $15 $25 $10 $10

  22. Bilateral Netting • Before bilateral netting: • Total funds (gross) to be moved: $350 • With bilateral netting: • Total funds (net( to be moved: $90 • This is a reduction of $260 in foreign exchange transactions.

  23. Multilateral Netting: an Example Consider simplifying the bilateral netting with multilateral netting: Start with the bilateral amounts. $10 $20 $15 $25 $10 $10

  24. Multilateral Netting: an Example U.K. affiliate owes the German affiliate $10; the German affiliate owes U.S. $10. $10 $20 $15 $15 $10 $10 $10

  25. Multilateral Netting: an Example Thus, the U.K. affiliate nets its payment to the U.S. of $10. $10 $20 $15 $15 $10 $10

  26. Multilateral Netting: an Example U.K. net payment of $10 to U.S. is combined with the $20 it owes. $10 $20 $15 $15 $10 $10

  27. Multilateral Netting: an Example U.K. affiliates owes $30 to U.S. $10 $30 $15 $15 $10

  28. Multilateral Netting: an Example Consider Canadian and German affiliates. $10 $30 $15 $15 $10

  29. Multilateral Netting: an Example Canadian affiliate owes German affiliate $15 and the German affiliate owes the U.S. $15. $10 $30 $15 $15 $10

  30. Multilateral Netting: an Example Canadian affiliate nets its payment to the U.S. of $15; total Canadian affiliate payment to U.S. $25. $10 $15 $30 $10

  31. Multilateral Netting: an Example Consider Canadian and U.K. affiliate $10 $15 $30 $10

  32. Multilateral Netting: an Example U.K. affiliate owes Canadian affiliate $10; Canadian affiliate owes U.S. $10. $10 $15 $30 $10

  33. Multilateral Netting: an Example U.K. affiliate nets its payment to the U.S. of $10. $15 $30 $10

  34. Multilateral Netting: an Example Combine this $10 with the $30 the U.K. affiliate owes the U.S. $15 $30 $10

  35. Multilateral Netting: an Example U.K. affiliate owes the U.S. $40. $15 $40

  36. Multilateral Netting: an Example Total funds to be moved under multilateral netting is $55. $15 $40

  37. Summary of Netting Compare this (before netting). $20 $30 $40 $10 $35 $10 $30 $40 $25 $60 $20 $30

  38. Bilateral Netting To this. Bilateral Netting: Total funds moved = $90 $10 $20 $15 $25 $10 $10

  39. Multilateral Netting With this. Multilateral netting: Total funds moved = $55 $15 $40

  40. Government Policies and Netting • As noted, not all governments permit global firms to net their account: • Who does without request: • United States, U.K., Canada, Germany, Switzerland, Hong Kong. • Who does upon request and approval: • Italy, the Netherlands, Belgium. • Who doesn’t: • Spain. Austria, the Philippines. • Why: Want transactions to flow through local banking system (generate fees for local banks).

  41. Benefits of Netting • Studies have shown the following: • Decrease in the expenses associated with moving funds internationally. • Decrease in the number of foreign exchange transactions (also reduces costs). • Reduction in intra-company float (wire transfers can take up to 5 days). • Savings in administrative time.

  42. Transfer Pricing • Refers to the prices being assigned to goods and/or services transferred among the affiliates (including the parent) within a global organization. • The transfer price will reposition funds (cash) within the organization. • High transfer price transfers to selling entity!

  43. Reasons for Transfer Pricing • Reposition funds. • Out of high risk areas • Concerns about exchange rate changes, host government policy changes affecting funds transfers, political risk… • Move funds (profits) into low tax rate countries. • Minimize the consolidated tax liability of the global firm.

  44. Government Involvement in Transfer Pricing • Most governments monitor the use of transfer pricing by firms within their political boundaries. • Concerned with companies attempting to escape their “appropriate” tax liabilities. • Most governments insist that the transfer price be: • An “arm’s-length” price, or what the selling affiliate would charge an unrelated customer.

  45. Calculating the “Arm’s-Length” Price • United States (IRS) government uses the following procedures for calculating an “arm’s-length” price: • Comparable uncontrolled price. • Between affiliate and unrelated parties • Third party price • Similar goods/services sold in the market place. • Cost-plus price • Appropriate profit added to the cost of production

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