Current Asset Management and Short-Term Financing Chapter 19

INTERNATIONAL CASH MANAGEMENT Goals of an International Cash Manager: similar to domestic manager 1. Quick and efficient cash control 2. Optimal conservation and usage response

I. INTERNATIONAL CASH MANAGEMENT A. Seven Key Areas Involve Issues about 1. Organization 2. Collection/Fund Disbursement 3. Interaffiliate Payments 4. Investment of Excess Funds 5. Optimal Global Cash Balances 6. Cash Planning/Budgeting *7. Bank Relations

INTERNATIONAL CASH MANAGEMENT Issue (#1): Centralize Organization 1. Advantages: a. Efficient liquidity levels b. Enhanced profitability c. Quicker headquarter response

INTERNATIONAL CASH MANAGEMENT 1. Advantages (con’t) d. Decision making enhanced e. Better volume currency quotes f. Greater cash management expertise g. Less political risk

INTERNATIONAL CASH MANAGEMENT Issue (#2): Collection/Disbursement of Funds 1. Key Element: Accelerate collections 2. Acceleration Methods: a. Electronic fund transfers b. Mobilization centers

INTERNATIONAL CASH MANAGEMENT 3. Methods to Expedite Cash Payments a. Correspondent Banking: Establish accounts in client’s bank b. Negotiate with banks - obtain value dating

INTERNATIONAL CASH MANAGEMENT Issue (#3): Interaffiliate Payments Use Payments Netting 1. Definition: offset payments of affiliate receivables/payables net amounts only are transferred.

INTERNATIONAL CASH MANAGEMENT 2. Create Netting Center a. set up a subsidiary in a location with minimal exchange controls b. Coordinate interaffiliate payment flows c. Netting Center’s value: a direct function of the volume of transfers.

INTERNATIONAL CASH MANAGEMENT Issue (#4): Excess Funds Investment 1. Major task: a. determine minimum cash balances b. short-term investment of excess balances

INTERNATIONAL CASH MANAGEMENT 2. Requirements: a. Forecast of cash needs b. Knowledge of minimum cash position

INTERNATIONAL CASH MANAGEMENT 3. Investment Selection Criteria: a. Degree of Government regulations b. Market structure c. Leniency of Foreign tax laws

INTERNATIONAL CASH MANAGEMENT Issue (#5) Optimal Global Cash Balances 1. Establish centrally managed cash pool 2. Require affiliates to hold minimum amounts

INTERNATIONAL CASH MANAGEMENT 3. Benefits of Optimal Centralized Global Cash Balances a. Less outside borrowing needed b. More excess fund for investment c. Reduced internal expense d. Reduced currency exposure

INTERNATIONAL CASH MANAGEMENT Issue (#6) Cash Planning and Budgeting

INTERNATIONAL CASH MANAGEMENT Issue (#7) Bank Relations 1. Good Relations Will Avoid a. Lost interest income b. Overpriced services e.g. check fees, monthly svc chgs, notary services. c. Redundant services

INTERNATIONAL CASH MANAGEMENT 2. Common Bank Relations Problems a. Too many banks b. High costs such as compensating balances c. Inadequate reporting d. Excessive clearing delays

II. ACCOUNTS RECEIVABLE MANAGEMENT A. Trade Credits extended in anticipation of profit by 1. expanded sales volume 2. retaining existing customers

ACCOUNTS RECEIVABLE MANAGEMENT B. Credit Terms Should Consider 1. Sales force customer selection criteria 2. Adjusting sales bonuses for cost of uncollected credit sales.

III. INVENTORY MANAGEMENT A. Problems: MNCs seem to have more difficulties due to 1. Long,variable transits 2. Lengthy customs procedures

INVENTORY MANAGEMENT B. Issue: Production Location 1. Overseas location may incur larger inventories due to a. larger amounts of work-in- progress b. more finished goods 2. Why?

Advanced Inventory Purchases inventory stockpiling. INVENTORY MANAGEMENT C. Subsidiary May Practice : Advanced Inventory Purchases aka inventory stockpiling.

INVENTORY MANAGEMENT D. Reason for Stockpiling: reduce risk of shipping delays Results of Stockpiling: Higher carrying costs F. Solution to higher carrying costs: Adjust subsidiary’s profit margins to reflect added costs.

PART 2 Short-Term Financing CHAPTER 19 PART 2 Short-Term Financing

SHORT-TERM FINANCING EIR IV. SHORT-TERM FINANCING A. Strategy 1. Identify: 3 key guidelines 2. Formulate/evaluate: objectives 3. Describe: available options 4. Develop a methodology: to calculate/compare costs EIR

SHORT-TERM FINANCING Key Guidelines: 1. Deviations from Int’l Fisher Effect? a. If yes trade-off required between cost and exchange risk b. If no costs are same everywhere

SHORT-TERM FINANCING a. Yes. Currency is irrelevant. 2. Does Interest Rate Parity Hold? a. Yes. Currency is irrelevant. b. No. Cover costs may differ -added risk may mean the forward premium/discount does not offset interest rate differentials.

SHORT-TERM FINANCING 3. Political Risk: If high, a. MNCs should 1.) maximize local financing. 2.) Faced with confiscation or currency controls, fewer assets at risk

SHORT-TERM FINANCING OBJECTIVES C. Short-Term Financing Objectives 1. Possible Objectives: a. Minimize expected cost. b. Minimize risk without regard to cost.

SHORT-TERM FINANCING OBJECTIVES D. Short-Term Financing Options 1. Three Possibilities a. Inter-company loans b. Local currency loans c. Eurocurrency market

SHORT-TERM FINANCING OBJECTIVES 2. Local Currency Financing: Bank Loans a. Short-term in nature: - Definition of term - The term structure of interest rates

SHORT-TERM FINANCING OBJECTIVES b. Forms of Local Currency bank credits 1.) Term loan: bank loan to a company, with a fixed maturity and often featuring amortization of principal 2.) Line of credit: W hat is the cleanup clause? Its purpose? 3.) Discounting 4.) Compensating balances

EFFECTIVE INTEREST RATE 3. Calculating Interest Costs a. Effective interest rate (EIR): - most efficient measure of cost b. Basic formula: EIR = Annual Interest Paid Funds Received

EFFECTIVE INTEREST RATE Sample Problem #1 Pro Logic Co. receives a loan for $10,000 at 11% interest payable at maturity at the end of one year. What is the EIR? EIR = $1,100 (10,000x.11) $10,000 10,000 = 11%

EFFECTIVE INTEREST RATE Sample Problem #2 Discounting the loan Pro Logic Co. receives a loan for $10,000 at 11% on a discounted basis for one year. What is the EIR? EIR = $1,100 (10,000x.11) $8,900 10,000-1100 = 1100 8900 = 12.4%

EFFECTIVE INTEREST RATE Sample Problem #3: Compensating Balances Pro Logic Co. receives a loan for $10,000 at 11% with a 15% compensating balance requirement for one year. What is the EIR? EIR = $1,100 (10,000x.11) $8,500 10,000-1500 = 1100 8500 = 12.9%

EFFECTIVE INTEREST RATE Sample Problem #4: Compensating Balance on a discounted loan Pro Logic Co. receives a loan for $10,000 at 11% on a discounted basis and a 15% compensating balance requirement for one year. What is the EIR? EIR = $1,100 (10,000x.11) $7,400 10,000-1100-1500 = 14.9%

COMMERCIAL PAPER 4. Non-bank lending : Commercial Paper a. Definition: short-term unsecured promissory note generally sold by large MNCs on a discount basis. b. Standard maturities c. Bank fees charged for: 1.) Backup line of credit 2.) Credit rating service