International Financial Management S Plan: S Section I S 3.2 Working capital management S 1)The essence of international financial management S 3.3 Trade Finance S S 3.4 Letter of credit 1.1 Concept and main functions of IFM S 3.5 Bank Guarantee S 3.6 Collection and discounting of bills S 3.7 Dividend Police S 3.8 Risk management S S S 1.2 Nature & Scope 1.3 International Trade Theories 2) International Business Methods S Section II S 3)General directions of International Financial Management The essence of international financial management S IFM- is a popular concept which means management of finance in an international business environment, it implies, doing of trade and making money through the exchange of foreign currency. S The international financial activities help the organizations to connect with international dealings with overseas business partnerscustomers, suppliers, lenders. It is also used by government organization and non-profit institutions. The essence of international financial management S The main objective of international financial management is to maximise shareholder wealth. S Adam Smith wrote in his famous title, “Wealth of Nations” that if a foreign country can supply us with a commodity Cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own in which we have some advantage. Basic Functions S This function involves generating funds from internal as well as external sources. S The effort is to get funds at the lowest cost possible. Basic Functions S It is concerned with deployment of the acquired funds in a manner so as to maximize shareholder wealth. S Other decisions relate to dividend payment, working capital and capital structure etc. S In addition, risk management involves both financing and investment decision. Nature & Scope The treasurer is responsible for : S S S S S S financial planning analysis fund acquisition investment financing cash management investment decision and risk management functions related to : S S S S S S external reporting tax planning and management management information system financial and management accounting budget planning and control, and accounts receivables etc. Environment at International Level International financial management practitioners are required the knowledge in the following fields: S S the knowledge of latest changes S investment behavior of investors in forex rates S export and import trends instability in capital market S Competition interest rate fluctuations S banking sector performance macro level charges S inflationary trends micro level economic indicators S demand and supply conditions etc. savings rate S consumption pattern S S S S Foreign exchange risk S In a domestic economy this risk is generally ignored because a single national currency serves as the main medium of exchange within a country. S When different national currencies are exchanged for each other, there is a definite risk of volatility in foreign exchange rates. S The present International Monetary System set up is characterized by a mix of floating and managed exchange rate policies adopted by each nation keeping in view its interests. S In fact, this variability of exchange rates is widely regarded as the most serious international financial problem facing corporate managers and policy makers Political risk S Political risk ranges from the risk of loss (or gain) from unforeseen government actions or other events of a political character such as acts of terrorism to outright expropriation of assets held by foreigners. S For example, in 1992, Enron Development Corporation, a subsidiary of a Houston based Energy Company, signed a contract to build India’s longest power plant. Unfortunately, the project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not require the power plant. The company had spent nearly $ 300 million on the project Expanded Opportunity Sets S When firms go global, they also tend to benefit from expanded opportunities which are available now. S They can raise funds in capital markets where cost of capital is the lowest. S The firms can also gain from greater economies of scale when they operate on a global basis International Trade Theories Theory of Mercantilism • This theory is during the sixteenth to the three-fourths of the eighteenth centuries. • It beliefs in nationalism and the welfare of the nation alone, planning and regulation of economic activities for achieving the national goals, restriction imports and promoting exports. • It believed that the power of a nation lied in its wealth, which grew by acquiring gold from abroad. Theory of Mercantilism • Mercantilists failed to realize that simultaneous export promotion and import regulation are not possible in all countries, and the mere control of gold does not enhance the welfare of a people. • Keeping the resources in the form of gold reduces the production of goods and services and, thereby, lowers welfare. S It was rejected by Adam Smith and Ricardo by stressing the importance of individuals, and pointing out that their welfare was the welfare of the nation. Theory of Absolute Cost Advantage • This theory was propounded by Adam Smith (1776), arguing that the countries gain from trading, if they specialise according to their production advantages. S The pre-trade exchange ratio in Country I would be 2A=1B and in Country II IA=2B. Theory of Absolute Cost Advantage • • • If it is nearer to Country I domestic exchange ratio then trade would be more beneficial to Country II and vice versa. Assuming the international exchange ratio is established IA=IB. The terms of trade between the trading partners would depend upon their economic strength and the bargaining power. Theory of Comparative Cost Advantage • Ricardo (1817), though adhering to the absolute cost advantage principle of Adam Smith, pointed out that cost advantage to both the trade partners was not a necessary condition for trade to occur. S According to Ricardo, so long as the other country is not equally less productive in all lines of production, measurable in terms of opportunity cost of each commodity in the two countries, it will still be mutually gainful for them if they enter into trade. Theory of Comparative Cost Advantage S In the example given, the opportunity cost of one unit of A in country I is 0.89 (80/90) unit of good B and in country II it is 1.2 (120/100) unit of good B. S On the other hand, the opportunity cost of one unit of good B in country I is 1.125 (90/80)units of good A and 0.83 (100/120) unit of good A, in country II. Theory of Comparative Cost Advantage • The opportunity cost of the two goods are different in both the countries and as long as this is the case, they will have comparative advantage in the production of either, good A or good B, and will gain from trade regardless of the fact that one of the trade partners may be possessing absolute cost advantage in both lines of production. S Thus, country I has comparative advantage in good A as the opportunity cost of its production is lower in this country as compared to its opportunity cost in country II which has comparative advantage in the production of International Business Methods S Licensing S Franchising S Subsidiaries and Acquisitions S Strategic Alliances S Exporting Licensing S License -means to give permission. A license may be granted by a party ("licensor") to another party ("licensee") as an element of an agreement between those parties. S A license may be issued by authorities, to allow an activity that would otherwise be forbidden. It may require paying a fee and/or proving a capability. The requirement may also serve to keep the authorities informed on a type of activity, and to give them the opportunity to set conditions and limitations. Franchising S Franchising is the practice of selling the right to use a firm's successful business model. For the franchisor, the franchise is an alternative to building 'chain stores' to distribute goods that avoids the investments and liability of a chain. The franchisor's success depends on the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because he or she has a direct stake in the business. S The franchisor is a supplier who allows an operator, or a franchisee, to use the supplier's trademark and distribute the supplier's goods. In return, the operator pays the supplier a fee. Subsidiaries and Acquisitions S A subsidiary is a company that is completely or partly owned by another corporation that owns more than half of the subsidiary's stock, and which normally acts as a holding corporation which at least partly or a parent corporation, wholly controls the activities and policies of the daughter corporation. S Mergers and acquisitions are both aspects of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture. Strategic Alliances S A strategic alliance is an agreement between two or more parties to pursue a set of agreed upon objectives needed while remaining independent organizations. This form of cooperation lies between Mergers & Acquisition M&A and organic growth. S Partners may provide the strategic alliance with resources such as products, distribution channels, manufacturing capability, project funding, capital equipment, knowledge, expertise, or intellectual property. The alliance is a cooperation or collaboration which aims for a synergy where each partner hopes that the benefits from the alliance will be greater than those from individual efforts. Section II Capital Budgeting S It is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure. S It is the process of allocating resources for major capital, or investment, expenditures. S One of the primary goals of capital budgeting investments is to increase the value of the firm to the Methods of capital Budgeting S Accounting rate of return S Payback period S Net present value S Profitability index S Internal rate of return S Modified internal rate of return S Equivalent annuity S Real options valuation These methods use the incremental cash flows from each potential investment, or project Factors influencing Capital Budgeting S Availability of funds S Structure of capital S Lending Policies of Financial Institutions S Economic Value of the Project S Taxation Policy S Government Policy S Immediate need of the Project S Earnings S Working Capital S Accounting Practice S Capital Return S Trend of Earning Foreign Portfolio Investment S Foreign portfolio investment is the entry of funds into a country where foreigners make purchases in the country’s stock and bond markets, sometimes for speculation. S It is a usually short term investment, as opposed to the longer term Foreign Direct Investment partnership, involving transfer of technology and "know-how". S Foreign Portfolio Investment (FPI): passive holdings of securities and other financial assets, which do NOT entail active management or control of the securities' issuer. FPI is positively influenced by high rates of return and reduction of risk through geographic diversification. The return on FPI is normally in the form of interest payments or non-voting Working Capital Management S Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the interrelations that exist between them. S Current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash within one year without undergoing a diminution in value and without disrupting the operations of the firm. Examples- cash, marketable securities, accounts receivable and inventory. S Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or the earnings of the concern. Examples- accounts payable, bills payable, bank overdraft and outstanding expenses Goal of Working Capital Management S To manage the firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained. Concepts and Definitions of Working Capital There are two concepts of working capital: Gross and Net S Gross working capital- means the total current assets. S Net working capital- can be defined in two wayso The difference between current assets and current liabilities. o The portion of current assets which is financed with long term funds Determinants of Working capital Requirement S General nature of business S Level of taxes S Production cycle S Dividend policy S Business cycle fluctuations S Depreciation policy S Production policy S Price level changes S Credit policy S Operating efficiency S Growth and expansion S Profit level Working capital: Policy and Management S The working capital management includes and refers to the procedures and policies required to manage the working capital. There are three types of working capital policies which a firm may adopt : S Moderate working capital policy S Conservative working capital policy S Aggressive working capital policy. These policies describe the relationship between the sales level and the level of current assets. Types of working capital needs S The working capital need can be bifurcated into permanent working capital and temporary working capital. S Permanent working capital- There is always a minimum level of working capital which is continuously required by a firm in order to maintain its activities like cash, stock and other current assets in order to meet its business requirements irrespective of the level of operations. S Temporary working capital- Over and above the permanent working capital, the firm may also require additional working capital in order to meet the requirements arising out of fluctuations in sales volume. This extra working capital needed to support the increased volume of sales is known as temporary or fluctuating working capital. Trade Finance S For a trade transaction there should be a Seller to sell the goods or services and a Buyer who will buy the goods or use the services. Various intermediaries such as (banks , Financial Institutions) can facilitate this trade transaction by financing the trade. S While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods that have been shipped. Banks may assist by providing various forms of support. The following are the most famous products/services offered by various Banks and Financial Institutions in Trade Finance Segment: Letter of Credit S It is an undertaking promise given by a Bank/Financial Institute on behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents the complying documents to the Buyer's designated Bank/Financial Institute as specified by the Buyer/Importer in the Purchase Agreement then the Buyer's Bank/Financial Institute will make payment to the Seller/Exporter Bank Guarantee S It is an undertaking promise given by a Bank on behalf of the Applicant and in favour of the Beneficiary. Whereas, the Bank has agreed and undertakes that, if the Applicant failed to fulfill his obligations either Financial or Performance as per the Agreement made between the Applicant and the Beneficiary, then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary. Collection and Discounting of Bills S It is a major trade service offered by the Banks. The Seller's Bank collects the payment proceeds on behalf of the Seller, from the Buyer or Buyer's Bank, for the goods sold by the Seller to the Buyer as per the agreement made between the Seller and the Buyer. Dividend Policy S Dividend policy is concerned with financial policies regarding paying cash dividend in the present or paying an increased dividend at a later stage. Whether to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated profit and influenced by the company's longterm earning power. When cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. Risk Management S Risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. S Risks can come from uncertainty in financial markets, threats from project failures (at any phase in design, development, production, or sustainment life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. Methods of risk management S Identify, characterize threats S Assess the vulnerability of critical assets to specific threats S Determine the risk (the expected likelihood and consequences of specific types of attacks on specific assets) S Identify ways to reduce those risks S Prioritize risk reduction measures based on a strategy Principles of risk management S Risk management should: S create value – resources expended to mitigate risk should be less than the consequence of inaction, or (as in value engineering), the gain should exceed the pain S be an integral part of organizational processes S be part of decision making process S explicitly address uncertainty and assumptions S be systematic and structured process S be based on the best available information S be tailorable S take human factors into account S be transparent and inclusive S be dynamic, iterative and responsive to change S be capable of continual improvement and enhancement S be continually or periodically re- assessed Conclusions S Compared to national financial markets international markets have a different shape and analytics. Proper management of international finances can help the organization in achieving same efficiency and effectiveness in all markets, hence without IFM sustaining in the market can be difficult. S Companies are motivated to invest capital in abroad for the following reasons: S -Efficiently produce products in foreign markets than that domestically. S -Obtain the essential raw materials needed for production S -Broaden markets and diversify S -Earn higher returns Thank You for Attention!