School of Management Studies Nagaland University (A Central University Established by an Act of Parliament 1989)

DC Court Junction Dimapur-797112 Nagaland Topic: MNC Working Capital Management Submitted to : Sir, D. Bordoloi By DilipSah(NU/MN 06/11) Sokhrl Phesao (NU/MN 26/11)

MGT 301 International Financial Management

Introduction
Working capital management in a Multinational enterprise requires managing the repositioning of cash flows, as well as managing current assets and liabilities, when faced with political, foreign exchange, tax and liquidity constraints. The overall goal is to reduce funds tied up in working capital while simultaneously providing sufficient funding and liquidity for the conduct of global business. This should enhance return on assets and return on equity. It also should improve efficiency ratios and other evaluation of performance parameters. The objectives of effective working capital management in an international environment are: 1) To allocate short term investments and cash balance holdings between currencies and countries to maximize overall corporate returns, and 2) To borrow in different money market to achieve the minimum cost. 3) These objectives are to be pursued under the conditions of maintaining required liquidity and minimizing any risks that might be incurred. The problem of having numerous currency and country choices for investing and borrowing, which is the extra dimension of international finance, is shared by companies with local markets and companies with international markets for their products. 4) For example, a company that produces and sells only within the U.S. will still have an incentive to earn the highest yield or borrow at the lowest cost, even if that means venturing to foreign money markets. There are additional problems faced by companies that have a multinational orientation of production and sales. These include the questions of local versus head office management of working capital and how to minimize foreign exchange cost/political risks and taxes.
Fund flows between units of a domestic business are generally unconstrained, but that is not the case in a multinational business. A firm operating globally faces a variety of political, tax, foreign exchange, and liquidity considerations which limit its ability to move funds easily and without cost from one country or currency to another. These constraints are why multinational financial managers must plan ahead for repositioning funds within the MNE. Some of the constraints for MNE are discussed below: Political constraints: Political constraints can block the transfer of funds either overtly or covertly. Overt blockage occurs when a currency becomes inconvertible or is subject to government exchange controls that

prevent its transfer at reasonable exchange rates. Covert blockage occurs when dividends or other forms of fund remittances are severely limited, heavily taxed, or excessively delayed by the need for bureaucratic approval. Tax constraints: Tax constraints arise because of the complex and possibly contradictory tax structures of various national governments through whose jurisdictions funds might pass. A firm does not want funds in transit eroded by a sequence of nibbling tax collectors in every jurisdiction through which such funds might flow. Transaction costs: Foreign exchange transaction costs are incurred when one currency is exchanged for another. These costs, in the form of fees and/or the difference between bid and offer quotations, are revenue for the commercial banks and dealers that operate the foreign exchange market. Liquidity needs: Despite the overall advantage of worldwide cash handling, liquidity needs in each individual location must be satisfied and good local banking relationships maintained. The size of appropriate balances is in part a judgmental decision not easily measurable. Nevertheless, such needs constrain a pure optimization approach to worldwide cash positioning.

Intra-firm Working Capital

The MNE itself poses some unique challenges in the management of working capital. Many multinationals manufacture goods in a few specific countries and then ship the intermediate products to other facilities globally for completion and distribution. The payables, receivables and inventory levels of the various units are a combination of intra firm and inter firm. The varying business practices observed globally regarding payment terms - both days and discounts - create severe mismatches in some cases. International Cash Management International cash management is the set of activities determining the levels of cash balances held throughout the MNE, and the facilitation of its movement cross border. These activities are typically handled by the international treasury of the MNE.

Motives for Holding Cash

The level of cash maintained by an individual subsidiary is determined independently of the working capital management decisions. Cash balances, including marketable securities, are held partly to enable normal day-to-day cash disbursements and partly to protect against unanticipated variations from budgeted cash flows. These two motives are called the transaction motive and the precautionary motive. Efficient cash management aims to reduce cash tied up unnecessarily in the system, without diminishing profit or increasing risk, so as to increase the rate of return on invested assets.

Some of the International Cash Settlements and Processing modes

Multinational business increases the complexity of making payments and settling cash flows between related and unrelated firms. Over time, a number of techniques and services have evolved which simplify and reduce the costs of making these cross-border payments. We focus here on four such techniques: wire transfers, cash pooling, payment netting, and Electronic fund transfers.
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
Cash Pooling and Centralized Depositories:

Any business with widely dispersed operating subsidiaries can gain operational benefits by centralizing cash management. Internationally, the procedure calls for each subsidiary to hold minimum cash for its own transactions and no cash for precautionary purposes.

Netting
Multilateral netting is defined as the process that cancels via offset, all, or part, of the debt owed by one entity to another related entity. Multilateral netting is useful primarily when a large number of separate foreign exchange transactions occur between subsidiaries in the normal course of business. Netting reduces the settlement cost of what would otherwise be a large number of crossing spot transactions. Multilateral netting is an extension of bilateral netting. Before Netting: After Netting:

Assume Trident Brazil owes Trident China $5,000,000 and Trident China simultaneously owes Trident Brazil $3,000,000, a bilateral settlement calls for a single payment of $2,000,000 from Brazil to China and the cancellation, via offset, of the remainder of the debt.

Managing Receivables
A firms operating cash inflow is derived primarily from collecting its accounts receivable. Multinational accounts receivable are created by two separate types of transactions: sales to related subsidiaries and sales to independent or unrelated buyers. Management of accounts receivable from independent customers involves two types of decisions: In what currency should the transaction be denominated, and what should be the terms of payment? Terms of payment are another bargaining factor. Considered by themselves, receivables from sales in weak currencies should be collected as soon as possible to minimize loss of exchange value between sales date and collection date.

Inventory Management
Operations in inflationary, devaluation-prone economies sometimes force management to modify its normal approach to inventory management. In some cases, management may choose to maintain inventory and reorder levels far in excess of what would be called for in an economic order quantity model. Under conditions where local currency devaluation is likely, management must decide whether to build up inventory of imported items in anticipation of the expected devaluation. After the devaluation, imported inventory will cost more in local currency terms. Under conditions where local currency devaluation is likely, management must decide whether to build up inventory of imported items in anticipation of the expected devaluation. After the devaluation, imported inventory will cost more in local currency terms.

Reference: http://wps.prenhall.com/wps/media/objects/13070/13384693 (as on 14th Nov. 2012) International Financial Management, O.P. Agarwal (Himalaya Publishing House)