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Working Capital Management for the Multinational Corporation

Mr. Jyoti Prakash Behera Ravenshaw University

International Financial Management

Learning Objectives
How does multinational working capital

management differ from domestic working capital management? What are the objectives of international cash management? What techniques are used by MNCs for making cross-border payments? What key factors are associated with a firms funding strategy? What short-term financing options are available?

Multinational Working Capital Management


Funds Availability

Additional Risks
Movement of Capital

Decisions
Taxes

International Cash Management


A set of activities, which consists of: Cash management - the levels of cash balances held throughout the MNC Cash settlements and processing - the facilitation of its movement across borders

Cash Management
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


Goal: Minimize cash balances without reducing

operations or increasing risk. Steps:


Cash Planning - anticipating cash flows over future days, weeks, or months. Cash Collection getting cash into the firm as soon as possible. Cash Mobilization moving cash within the firm to the location where needed. Cash Disbursements planning procedures for distributing cash. Covering Cash Shortages managing anticipated cash shortages by borrowing locally. Investing Surplus Cash managing anticipated cash surpluses by investing locally or controlling them centrally.

Cash Positioning Decision


Currency of location Type of liquid asset held Maturities, yields, and liquidity

characteristics

Objectives of an Effective Cash Management System


Minimizing overall cash requirements

Minimizing currency exposure risk


Minimizing political risk

Minimizing transactions costs


Taking full advantage of economies of scale

Complexities of the International Cash Positioning Decision


Conflicting nature of cash management

objectives Government restrictions Multiple taxation systems Multiple currencies

International Cash Settlements and 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

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


Key: Centralizing the cash positioning function to gain operational

benefits.
Subsidiaries hold minimum cash for their own transactions and no cash for precautionary purposes All excess funds are remitted to a central cash depository Centralized depositories provide the following advantages: 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 Interest rate advantages as funds can be borrowed at a lower cost and invested at a more advantageous rate. Location can provide tax benefits, access to international communications, clearly defined legal procedures.

Multilateral Netting
Netting involves offsetting receivables

against payables so that only the net amounts are transferred among affiliates. Types
Bilateral netting Multilateral netting

Payments netting is useful primarily when a

large number of separate foreign exchange transactions occur between subsidiaries.

Payments Netting
Example: A Belgian affiliate owes an Italian

affiliate $5,000,000, while the Italian affiliate simultaneously owes the Belgian affiliate $3,000,000.
Bilateral settlement calls for $2,000,000 payment from Belgium to Italy and cancellation of the remainder via offset. Multilateral netting is an extension of bilateral netting.
Assume that payments are due between Apexs European operations each month. Without netting Apex de France would make three separate transactions each way.

Financing Working Capital


Financing working capital requirements of a

MNCs foreign affiliates poses a complex decision problem. Financing options for a subsidiary include:
Intercompany loans from the parent or a sister affiliate. Local currency financing.

Key Factors Underlying the Funding Strategy


Interest Rate Without forward contracts With forward contracts Exchange Risk Degree of Risk Aversion Taxes

Political Risk

Financing Objectives
Minimize covered after-tax interest costs

Minimize expects costs


Trade-off between expected cost and

reducing the degree of cash flow exposure

Intercompany Loans
The cost of an intercompany loan is

determined by the following factors:


Opportunity cost of funds Interest rate Tax rates and regulations Currency of denomination Expected exchange rate change

Local Currency Financing


Bank Loans Term Loans Line of Credit Overdraft Revolving Credit Agreement Discounting

Commercial Paper

Effective Interest Rate on Bank Loans


Simple interest loan

Discount loan
Loan with compensating balance

requirement
Simple interest loan Discount loan

Effective Annual Percentage Cost Illustration


The Olivera Corporation, a manufacturer of olive oil

products, needs to acquire 1 million in funds today to expand a pimiento-stuffing facility. Banca di Roma has offered them a choice of an 11% loan payable at maturity or a 10% loan on a discount basis. Which loan should Olivera choose?

Calculating the Dollar Costs of Alternative Financing Options


In deciding on a particular financing option,

a firm needs to estimate and then compare the effective after-tax dollar costs of local currency financing and dollar financing.
In reality, the value of the currency borrowed will most likely change with respect to the borrowers local currency over time. Breakeven analysis can be used to determine the least expensive financing source for each future exchange rate.

Effective Financing Rate: No Taxes


Suppose that Ford has an affiliate in Mexico,

which can borrow pesos at 80% or dollars at 12% for one year.
If the peso is expected to devalue from MP$ 7.50/$ at the beginning of the year to MP$ 10.23/$ at the end of the year, what is the expected before-tax dollar cost of the peso loan? What is the cost of the dollar loan to Ford? What is the breakeven rate of currency change at which the dollar cost of borrowing pesos is just equal to the cost of dollar financing?

Effective Financing Rate: No Taxes


Dollar cost of local currency (LC) loan rH (LC) = rL (1 + c) + c Cost of dollar loan (HC) rH (HC) = rH Breakeven rate of currency change rL (1 + c) + c = rH

Effective Financing Rate: With Taxes


Suppose the Mexican corporate tax rate is

53%.
What is the expected after-tax dollar cost of borrowing pesos? What is the expected after-tax cost of the dollar loan? What is the breakeven rate of currency change at which the after-tax dollar cost of local currency financing is just equal to the after-tax cost of dollar financing?

Effective Financing Rate: With Taxes


After-tax dollar cost of borrowing local

currency
rH (LC) = rL (1 - Ta)(1 + c) + c

After-tax cost of dollar loan rH (HC) = rH (1 - Ta) + cTa Breakeven rate of currency change rL(1 - Ta)(1 + c) + c = rH(1 - Ta) + cTa

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