1. International Finance
FIN456 Michael Dimond

2. 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?

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

4. 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

5. 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

6. 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

7. 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

8. 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

9. Decentralized vs Centralized Cash Depositories

10. 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

11. Multilateral Matrix Before Netting (US$ 000s)

12. Multilateral Matrix Before Netting (US$ 000s)

13. 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:

14. 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

15. Working Capital Funding
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

16. 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

17. 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

18. 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.

19. Working Capital Financing
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

20. 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

21. Working Capital Financing
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

22. Working Capital Financing
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

23. 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

24. 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