International Finance Chapter 18: Multinational Cash Management.

International Finance

Chapter 18:

Multinational Cash Management

Cash Management for a Global Firm

• A global firm’s cash management is actually part of the larger issue of working capital management.– Working capital = current assets – current liabilities.– Current assets:

• Cash, accounts receivable, inventories, short term investments.

– Current liabilities:• Accounts payable, bank loans and notes payable, current

taxes payable.

Working Capital Management

• Broader issue than cash.

• Global firm needs to manage the:– Individual components in its working capital

structure.– Ensure that funds are available when needed

to meet current liabilities as they come due.• If internal funds are not available, need to enter

short term money markets to cover.

Focus on Cash Management

• Issues for Global Firms:– Size of cash balances– Currency denominations of cash balances– Where cash balances are located among the global

firm’s foreign affiliates.

• Goal of Global Firms:– Minimize the size of cash balances.

• Non-interest earning assets!

– Reduce foreign exchange transaction expenses and exposure.

Additional Objectives of Cash Management

• When sourcing short term funds to cover cash flow needs:– Do so at the lowest possible borrowing cost.

• When investing short term (“excess” cash) funds:– Do so where the greatest returns can be earned.

• Both objectives need to consider:– Risk– Foreign exchange expsoure

Operational Consideration

• Global firm must decide whether its cash management shall be done:

• Centrally (e.g., at headquarters), or– Centralized organizational structure.

• Locally (e.g., at the affiliate level).– Decentralized organizational structure.

Cash Management Techniques

• The following are the two major techniques which are used by global firms in managing their cash positions:– Netting Systems

• Bilateral and Multilateral– Netting the cash positions of the various affiliates. Transferring

the net amounts (not the gross amounts).

– Transfer Pricing• Establishing prices among affiliates for the intra-global firm

selling of produces and services.• Means of moving (repositioning) cash within the global firm.

Netting Systems

• Begins with an analysis of the global firm’s internal cash flows (i.e., among affiliates and the parent).– What are the amount of the payments that each entity expects to

pay and expects to receive.

• Netting the above amounts is a way of reducing the amount of cash flow (and its associated cost) within the organization.– Netting is an efficient and cost-effective mechanism for settling

interaffiliate foreign exchange transactions.

• However, not all countries allow MNCs to net payments– If this is the case, larger foreign exchange transactions flow

through the local (host country) banking system.

Exposure Netting: an Example

Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions:

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30

Bilateral Netting: an Example

Bilateral Netting would reduce the number of foreign exchange transactions as follows; Examine U.S and Canadian affiliate

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30


Bilateral Netting: U.S. and Canada net out at $10

$10 $35 $40$30$25

$60

$40$10

$10

$20$30


Bilateral Netting: Canadian and U.K. affiliates.

$10 $35 $40$30$25

$60

$40$10

$10

$20$30


Bilateral Netting: Canadian and U.K. affiliates net out at $10

$10 $35 $10$25

$60

$40$10

$10

$20$30


Bilateral Netting: U.K. and German affiliates.

$10 $35 $10$25

$60

$40$10

$10

$20$30


Bilateral Netting: U.K. and German affiliates net out at $10

$10 $35 $10$25

$60

$40$10

$10

$10


Bilateral Netting: U.S. and German affiliate.

$10 $35 $10$25

$60

$40$10

$10

$10


Bilateral Netting: U.S. and German affiliate net out at $25.

$25 $10$25

$60

$40$10

$10

$10


Bilateral Netting: U.S. and U.K. affiliate.

$25 $10$25

$60

$40$10

$10

$10


Bilateral Netting: U.S. and U.K. affiliate net out at $20.

$25 $10$25

$20$10

$10

$10


Bilateral Netting: German and Canadian affiliates.

$25 $10$25

$20$10

$10

$10


Bilateral Netting: German and Canadian affiliates net out at $15

$25 $10$15 $20

$10

$10

Bilateral Netting

• Before bilateral netting:– Total funds (gross) to be moved: $350

• With bilateral netting:– Total funds (net( to be moved: $90

• This is a reduction of $260 in foreign exchange transactions.

Multilateral Netting: an Example

Consider simplifying the bilateral netting with multilateral netting: Start with the bilateral amounts.

$25 $10$15 $20

$10

$10


U.K. affiliate owes the German affiliate $10; the German affiliate owes U.S. $10.

$15 $10$15 $20

$10

$10

$10


Thus, the U.K. affiliate nets its payment to the U.S. of $10.

$15 $10$15 $20

$10

$10


U.K. net payment of $10 to U.S. is combined with the $20 it owes.

$15 $10$15 $20

$10

$10


U.K. affiliates owes $30 to U.S.

$15 $10$15 $30

$10


Consider Canadian and German affiliates.

$15 $10$15 $30

$10


Canadian affiliate owes German affiliate $15 and the German affiliate owes the U.S. $15.

$15 $10$15 $30

$10


Canadian affiliate nets its payment to the U.S. of $15; total Canadian affiliate payment to U.S. $25.

$10

$15

$30

$10


Consider Canadian and U.K. affiliate

$10

$15

$30

$10


U.K. affiliate owes Canadian affiliate $10; Canadian affiliate owes U.S. $10.

$10

$15

$30

$10


U.K. affiliate nets its payment to the U.S. of $10.

$10

$15

$30


Combine this $10 with the $30 the U.K. affiliate owes the U.S.

$10

$15

$30


U.K. affiliate owes the U.S. $40.

$15

$40


Total funds to be moved under multilateral netting is $55.

$15

$40

Summary of Netting

Compare this (before netting).

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30

Bilateral Netting

To this.

Bilateral Netting: Total funds moved = $90

$25 $10$15 $20

$10

$10

Multilateral Netting

With this.

Multilateral netting: Total funds moved = $55

$15

$40

Government Policies and Netting

• As noted, not all governments permit global firms to net their account:– Who does without request:

• United States, U.K., Canada, Germany, Switzerland, Hong Kong.

– Who does upon request and approval:• Italy, the Netherlands, Belgium.

– Who doesn’t:• Spain. Austria, the Philippines.• Why: Want transactions to flow through local banking

system (generate fees for local banks).

Benefits of Netting

• Studies have shown the following:– Decrease in the expenses associated with

moving funds internationally.– Decrease in the number of foreign exchange

transactions (also reduces costs).– Reduction in intra-company float (wire

transfers can take up to 5 days).– Savings in administrative time.

Transfer Pricing

• Refers to the prices being assigned to goods and/or services transferred among the affiliates (including the parent) within a global organization.– The transfer price will reposition funds (cash)

within the organization.• High transfer price transfers to selling entity!

Reasons for Transfer Pricing

• Reposition funds.– Out of high risk areas

• Concerns about exchange rate changes, host government policy changes affecting funds transfers, political risk…

– Move funds (profits) into low tax rate countries.

• Minimize the consolidated tax liability of the global firm.

Government Involvement in Transfer Pricing

• Most governments monitor the use of transfer pricing by firms within their political boundaries.– Concerned with companies attempting to

escape their “appropriate” tax liabilities.

• Most governments insist that the transfer price be:– An “arm’s-length” price, or what the selling

affiliate would charge an unrelated customer.

Calculating the “Arm’s-Length” Price

• United States (IRS) government uses the following procedures for calculating an “arm’s-length” price:– Comparable uncontrolled price.

• Between affiliate and unrelated parties

– Third party price• Similar goods/services sold in the market place.

– Cost-plus price• Appropriate profit added to the cost of production

International Finance Chapter 18: Multinational Cash Management.

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Transcript of International Finance Chapter 18: Multinational Cash Management.