Chapter 23 Sojan & Sreehari

8/7/2019 Chapter 23 Sojan & Sreehari

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R

MANAGING SHORT-TERM

INTERNATIONAL FINANCIALTRANSACTIONS

By

Sojan Jose

Sreehari


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It is the process of planning and controlling the level and mix of current

assets of the firm as well as financing of these assets

It involves the use of certain prescribed aids such as

Risk-return tradeoff

Credit Standards

Inventory models

Management ofworking capital can viewed as either as

Static responsibility ordynamic flow process

The static approach focuses on individual processes such as

management of cash, account receivable and inventories

Dynamic approach focuses on transfer of liquid funds from one

geographic locations or currency to another

assets


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Objective of WCM is to determine

Optimal amount of investment in various current assetaccounts

It is the level of current asset holdings that maximizesreturn on investment

To provide various current assets and short term creditnecessary to support the anticipated sales by minimizingthe investment in current assets

Constraints faced by MNCs

Political, tax, foreign exchange, inflation and interest rates


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International Cash Management

It is defined as the cross border movement of funds from and

to other companies as well as within the company

Cash management is divided into two

Movement of money

Movement of information relating to the movement of money

Ground rules for a well designed cash management program

A cash management center that receives and distributes timely

information relating to cash movements within the bankaccounts

Short payment channel involving minimum number of banksallow for maximum control


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Modern communication systems are used

Efficient bank with high standards of customer service areemployed

Cash management is divided in to four areas

Collection

Disbursement

Intercompany payments

Control


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Collection

Cash Managers motto is

As soon as the customer has initiated payment to us, the money isours

Typical method is to establish collection accounts close to the

customers

These collection points are called lock boxes

International collection systems require collection accounts inthe countries of the currencies of the payment not neccassrily inthe countries of customer

Example:

A German company with dollar receivable on a British buyer should

receive the funds on a US collection account rather than channeling

the dollars to its local bank


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Transfer Pricing

Transfer pricing is the rates or prices that are utilized when

selling goods or services between company divisions and

departments, or between a parent company and a

subsidiary

Generally, transfer pricing is considered to be a relatively

simple method of moving goods and services among the

overall corporate family.

Trade between related firms is called intrafirm trade

When intrafirm trade crosses national borders, it is called

international transfer pricing

International transfer pricing is the valuation of

crossborder transactions between units of a multinational

enterprise.


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International Transfer Pricing

Objective of International transfer pricing is tax

minimization

Economic advantage can be attained if transfer price shifts

profit from country with high tax rate to a country with low

tax rate

Other objectives of transfer pricing involves

Profit maximization

Performance evaluation

Factors that influence transfer pricing

Import duties

Avoidance of financial problems

Currency fluctuations


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Import Duties

Company benefits if it transfer products at low prices to a

country with high import duties

It can reduce total cost by reducing import duties

Reducing import duties does not always guarantee profit

Sometimes countries with low import duties will have high taxand vice versa

Balancing import duties and income taxes is more complicated

than minimizing taxes

Different prices may draw attention of custom and income tax authorities

This will lead to

This may lead to review of pricing practices

Company suffers great deal of bad publicity


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Avoiding Financial Problems

Transfer pricing can help to overcome economic restriction

placed by countries

Countries place restriction on the amount of profit that can

leave the country

The best way around is to charge high price for imports

Countries disallow certain expenses against taxable income

An example is companies disallow certain expenses if they are

incurred in some other country

Transfer pricing can help to improve financial condition of an

affiliate

Low transfer prices can provide affiliate a competitive edge

during startup period of a new venture


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Currency Fluctuations

Currency instability can affect the performance report of

foreign affiliates

Currency fluctuation should be taken into account while

deciding the transfer price

Indexing formula is applied to arrive at a transfer price

NTP= OTP X (CER/PER)

NTP- new transfer price

OTP- old transfer price

CER- current exchange rate

PER-Planned exchange rate

Indexing formula can isolate exchange fluctuations


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Intercompany Payments

Payment among group companies have greater degree of control by the cash

manager.

Eg: subsidiary A => B cheque transfer, A has float benefit but group suffers.(out of control for cash & Foreign exchange mgmt purposes).

A => B takes a week to complete causing interest lost in A & B, hence out of

control.

Payment systems generally used

Fixed intercompany payment day for a month

All foreign exchange conversion through 1 bank

Multilateral netting system

Type of system depends on

Structure of companies cash flow, form of organization, savings

generated. Few banks have know-how to implement these systems


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Inter company payments

When foreign exchange dealings are numerous & complex, the group mayprovide a captive finance company or reinvoicing company to take over thereceivables of the entire group.

Loan to be arranged between group companies at such rates that both the

companies are at a benefit.

Control

Control Problems faced

fragmented banking system

separate international & domestic banking operating system

only monthly statement of account available.


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International Receivables Management

Level of receivables depends on` Volume of credit sales

Average collection period

These in turn depend on credit standards, credit term & collection policy

In theory the credit standard shall be liberalized to such extent so that

Marginal profit on increased sales = Marginal cost of credit

MNC sell for credit for sales, volume expansion & profits

Multinational Accounts receivables 2 types

sales to outside the corporate group

Intra company sales


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Sales

Account receivables from independent buyer involves 2 decisions :

Denomination of currency used for payment

Terms of payment

Domestic sales in domestic currency

Export sales in either importer currency or exporter currency or in third countrycurrency

Exporter will prefer strongest currency while the importer the weakest, hencea tradeoff between the currency and terms of payment takes place


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International Inventory Management

Inventory represents a significant segment of total assets Least liquid of current assets

Inventory management depends on

the level of sales

the length of production cycle

durability of the product

In domestic operated countries the carrying cost & stock outcost is minimized.

Companies that reply on imported inventories maintain overstock inventories due to

fears of continued inflation

raw material shortages

number of environmental constraints


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Protective measures against inflation

MNC that relies heavily on imported goods shall seek to built upmaximum number of parts & equipment before any devaluation ofcurrency is done.

MNC that relies heavily on export goods shall seek to minimize the

number of parts & equipment before any devaluation of currency isdone

Pricing

Due to exchange rate fluctuations a company can take 2 steps

Step1 : maintain the original price of inventory to undercut competition

Step 2: increase price of inventory to earn dollar profit( qty of goodssold might reduce)


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Reducing vulnerability towards inflation & devaluation

When inflation continues and devaluation is imminent thencash balance should be minimum & foreign debt conversionin convertible currency should be liquidated.

when host government is about to put foreign exchangecontrols remittance shall be increased & any excess fund

must be turned in asset.

speed up collection process & delay payments.

If funds are needed on short term basis need to get it from

local banks.

During high price increase level loans from banks areunobtainable hence need to pledge inventory to get localcurrency. Else the overdraft facility shall be used.

Chapter 23 Sojan & Sreehari

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