International
Financial Management
by
Jeff Madura
Florida Atlantic University
Chapter
6
International Financing and Cash
Management
Chapter Objectives
 To describe the Financing of International Trade and common
trade financing methods;
 To describe the International short term Financing and its
sources;
 To Explain working capital management from a subsidiary
perspective versus a parent perspective;
 Explain how cash management can be centralized in order to
ensure that cash is used more efficiently;
 Explain the decision to invest cash internationally
Introduction to chapter
 Financing means The act of providing funds for business
activities, making purchases or investing. Financial institutions
and banks are in the business of financing as they provide
capital to businesses, consumers and investors to help them
achieve their goals. so
 International Financing means providing funds to carry out
international trade and provide funds on short term basis to
MNCs.
 International cash management means the management of
cash or working capital by MNCs in their subsidiaries and
parent company.
Financing International Trade
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Introduction
 The financing of international trade means lending, issuing
letters of credit, factoring, export credit and insurance.
 Companies involved with international trade finance include
importers and exporters, banks and financiers, insurers and
export credit agencies, as well as other service providers.
 Trade finance is of vital importance to the global economy, with
the World Trade Organization estimating that 80 to 90% of
global trade is reliant on this method of financing.
Payment Methods for International Trade
Following are the Five basic methods of payment used to settle
international transactions.
Each methods has a different degree of risk to the exporter and
importer:
■ Prepayment
■ Letters of credit
■ Drafts (sight/time)
■ Consignment
■ Open account
Exhibit 19.1 Comparison of
Payment Methods
Continued…
1. Prepayment
1. Same as cash in advance
2. Payment usually by wire transfer
3. Method offers exporter greatest degree of protection
4. Usually requested when
 First time buyer
 Danger of pre-shipment cancellation
 Importer country has high political risk
Continued…
2. Letters of Credit
 A letter of credit is a document issued by a financial institution,
or a similar party, assuring payment to a seller of goods and/or
services provided certain documents have been presented to
the bank.
 These are documents that prove that the seller has performed
the duties under an underlying contract (e.g., sale of goods
contract) and the goods (or services) have been supplied as
agreed. In return for these documents, the beneficiary receives
payment from the financial institution that issued the letter of
credit. The letter of credit serves as a guarantee to the seller
that it will be paid regardless of whether the buyer ultimately
fails to pay.
Continued…
3. Drafts (or bill of exchange)
 An unconditional promise drawn by one party, usually the
exporter, instructing the buyer to pay the face amount of the
draft upon presentation.
 Draft represents the exporter’s formal demand for payment
from the buyer.
 Draft affords the exporter less protection than an L/C
because the banks are not obligated to honor payments on
the buyer’s behalf.
Continued…
4. Consignment
1. Exporter ships the goods to the importer while still retaining
actual title to the merchandise.
2. The importer has access to the inventory but does not have
to pay for the goods until they have been sold to a third
party.
3. The exporter is trusting the importer to remit payment for
the goods sold at that time.
4. If the importer fails to pay, the exporter has limited recourse
because no draft is involved and the goods have already
been sold.
Continued…
5. Open Account

The opposite of prepayment - the exporter ships the
merchandise and expects the buyer to remit payment
according to the agreed-upon terms.

The exporter is relying fully upon the financial
creditworthiness, integrity, and reputation of the buyer.

Method is used when the seller and buyer have mutual trust
and a great deal of experience with each other.
International Trade Finance
Methods
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Trade Finance Methods
Following are the Six basic methods of Trade Finance used to
settle international transactions.
1. Accounts receivable financing/ Factoring
2. Letters of credit (LOCs)
3. Banker’s acceptances
4. Working capital financing
5. Medium-term capital goods financing (forfaiting)
6. Countertrade
Continued …
1. Accounts Receivable Financing/ Factoring
 Could take the form of an open account shipment or a time
draft. The bank will provide a loan to the exporter secured
by an assignment of the account receivable. Accounts
receivable financing is a way to quickly convert receivables
into cash.
 Factoring, also known as accounts receivable financing, is a
form of asset-based lending that can boost a company’s
short-term cash flow. Companies sell their invoices to a
factoring company in exchange for an immediate advance
on the total.
Continued …
2. Letters of Credit ( L/C )
 A letter from a bank guaranteeing that a buyer's payment to a
seller will be received on time and for the correct amount. In
the event that the buyer is unable to make payment on the
purchase, the bank will be required to cover the full or
remaining amount of the purchase.
A. Use of Drafts
 Also known as a bill of exchange, a draft is an unconditional
promise drawn by one party, usually the exporter, requesting
the importer to pay the face amount of the draft at sight or at a
specified future date.
Continued …
B. Bill of Loading (B/L)
 serves as a receipt for shipment and a summary of freight
charges. It conveys title to the merchandise. A B/L includes the
following provisions:







A description of the merchandise
Identification marks on the merchandise
Evidence of loading (receiving) ports
Name of the exporter (shipper)
Name of the importer
Status of freight charges (prepaid or collect)
Date of shipment
Continued …
C. Commercial Invoice (currency)
 exporter’s (seller’s) description of the merchandise being sold
to the buyer is the commercial invoice, which contains:







Name and address of seller
Name and address of buyer
Date
Terms of payment
Price, including freight, handling, and insurance if
applicable
Quantity, weight, packaging, etc.
Shipping information
Continued …
3. Banker’s Acceptance
Bill of exchange, or time draft, drawn on and accepted by a
bank. It is the accepting bank’s obligation to pay the holder of
the draft at maturity.
4. Working Capital Financing
The bank may provide short-term loans beyond the banker’s
acceptance period.
5. Medium-Term Capital Goods Financing (Forfaiting)
Similar to factoring in that the forfeiter (or factor) assumes
responsibility for the collection of payment from the buyer,
the underlying credit risk, and the risk pertaining to the
countries involved.
Continued …
6. Countertrade
 Denotes all types of foreign trade transactions in which the
sale of goods to one country is linked to the purchase or
exchange of goods from that same country.
 Some types of countertrade, such as barter, have been in
existence for thousands of years.
 Recently countertrade gained popularity and importance.
Exhibit 19.3 Documentary Credit Procedure
23
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
Exhibit 19.4 Banker’s Acceptance
24
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
Exhibit 19.5 Life Cycle of a Typical Banker’s Acceptance
(B/A)
25
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
International Short-Term Financing
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Introduction
 All firms make short-term financing decisions periodically.
Beyond the trade financing discussed in the previous slides,
MNCs obtain short-term financing to support other operations
as well.
 Because MNCs have access to additional sources of funds, their
short-term financing decisions are more complex than those of
other companies.
 Financial managers must understand the possible advantages
and disadvantages of short term financing with foreign
currencies so that they can make short-term financing decisions
that maximize the value of the MNC.
Sources of short term Financing
 MNC parents and their subsidiaries typically use various
methods of obtaining short term funds to satisfy their liquidity
needs.
 Following are common methods;
1. Short-Term Notes
2. Commercial Paper
3. Bank Loans
4. Internal financing
5. Financing with foreign currency
Continued …
1. Short-Term Notes:
 Issuing of short-term notes, or unsecured debt securities is one
of the common methods used by MNCs to meet short term
deficits .
 In Europe, the securities are referred to as Euro-notes. The
interest rates on these notes are based on the interest rate
Euro-banks charge on interbank loans.
 Short-term notes typically have maturities of 1, 3, or 6 months.
Some MNCs continually roll them over as a form of
intermediate-term financing. Commercial banks underwrite the
notes for MNCs, and some commercial banks purchase them for
their own investment portfolios.
Continued …
2. Commercial Paper:
 In addition to short-term notes, MNCs also issue commercial
paper to meet their short term financial needs .
 In Europe, this is sometimes referred to as Euro-commercial
paper.
 Dealers issue commercial paper for MNCs without the backing
of an underwriting syndicate, so a selling price is not
guaranteed to the issuers. Maturities can be tailored to the
issuer’s preferences.
 Dealers may make a secondary market by offering to
repurchase commercial paper before maturity.
Continued …
3. Bank Loans:
 They are Direct loans from banks, which are typically utilized to
maintain a relationship with banks.
 They are another popular source of short-term funds for MNCs.
 If other sources of short-term funds become unavailable, MNCs
rely more heavily on direct loans from banks.
 Most MNCs maintain credit arrangements with various banks
around the world.
 Some MNCs have credit arrangements with more than 100
foreign and domestic banks.
Continued …
4. Internal short-term financing:
 Before an MNC’s parent or subsidiary in need of funds searches
for outside funding, it should check other subsidiaries’ cash flow
positions to determine whether any internal funds are available.
Internal Control over Funds - An MNC should have an internal
system that consistently monitors the amount of short-term
financing by all subsidiaries.
 Previously 3 other types are external sources of short term
financing. MNCs had limited access to short-term funding during
the credit crisis.
 This process is especially feasible during periods when the cost
of obtaining funds in the parent’s home country is relatively high.
Continued …
5. Financing with foreign currency:
 Regardless of whether an MNC parent or subsidiary decides to
obtain financing from subsidiaries or from some other source, it
must also decide which currency to borrow. Even if it needs its
home currency, it may prefer to borrow a foreign currency.
 Reasons for this preference follow:
 MNCs borrow foreign currency, sometimes to match future
cash inflows.
 Comparison of interest rates among currencies./ to reduce cost
 Developing countries tend to have higher inflation and a low
level of saving, causing interest rates to be relatively high.
Determining the Effective Financing Rate
The actual or “effective” financing rate will differ from the
quoted rate based on:
1. The interest rate charged by the bank.
2. The movement in the borrowed currency’s value over the
  St 1  S 
time of the loan.
rf  (1  i f ) 1  
  1
  S 
where rf = effective financing rate
S = spot rate
if = interest rate of the foreign currency
International Cash Management /
Working Capital Management
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Multinational Working Capital Management
Subsidiary Expenses
The subsidiary will normally have a more difficult time
forecasting future outflow payments if its purchases are
international rather than domestic because of exchange
rate fluctuations.
Subsidiary Revenue
Subsidiaries’ sales volume may be more volatile than if the
goods were only sold domestically. Accounts receivable
management is an important part of the subsidiary’s
working capital management because of its potential impact
on cash inflows.
Multinational Working Capital Management
Subsidiary Dividend Payment
When dividend payments and fees are known in advance and
denominated in the subsidiary's currency, forecasting cash
flows is easier..
Subsidiary Liquidity Management
After accounting for all outflow and inflow payments, the
subsidiary may have excess or deficient cash. It uses liquidity
management to invest excess cash or borrow to cover cash
deficiencies.
Centralized Vs. Decentralized Cash Management
 Decentralized management is not optimal because it
will force MNC to maintain larger cash investment
than necessary.
 MNCs commonly use centralized cash management
to monitor and manage the parent-subsidiary and
inter-subsidiary cash flows.
38
Exibit 21.1 Cash Flow of the Overall MNC
39
Accommodating Cash Shortages
A key role of the centralized cash management division is to
facilitate the transfer of funds from subsidiaries with excess funds
to those that need funds.
Technology Used to Facilitate Fund Transfers
A centralized cash management system needs continual flow
of information about currency positions to determine whether
one subsidiary’s shortage of cash can be covered by another
subsidiary’s excess cash.
Monitoring of Cash Positions
The centralized cash management division serves as a monitor
over the subsidiaries because it can detect potential financial
problems.
Optimizing Cash Flows

Accelerating Cash Inflows using lockboxes and preauthorized
payments.

Minimizing currency conversion costs by netting, using a
bilateral netting system or a multilateral netting system.

Managing blocked funds by incurring costs within the country
or using transfer pricing.

Managing intersubsidiary cash transfers by using a leading or
lagging strategy.
Complications in Optimizing Cash Flow
Company related characteristics
If one of the subsidiaries delays payments to other
subsidiaries, the other subsidiaries may be forced to borrow. A
centralized approach that monitors all intersubsidiary
payments should minimize such problems.
Government restrictions
The existence of government restrictions can disrupt a cash
flow optimization policy.
Limitations of Banking Systems
The abilities of banks to facilitate cash transfers for MNCs vary
among countries.
Exhibit 21.4 Considerations When Investing Excess Cash
Chapter Review
 Financing International Trade
 International trade payment methods
■ Prepayment
■ Letters of credit
■ Drafts (sight/time) ■ Consignment
■ Open account
 International trade Financing methods
1. Accounts receivable financing/ Factoring
2. Letters of credit (LOCs)
3. Banker’s acceptances
4. Working capital financing
5. Medium-term capital goods financing
5. Countertrade
 International Short-Term Financing
 Sources of short term Financing
1. Short-Term Notes 2.Commercial Paper 3. Bank Loans 4.Internal financing
5. Financing with foreign currency
 International Cash Management / Working Capital Management
1. Subsidiary Expenses 2.Subsidiary Revenue 3.Centralized Vs. Decentralized Cash Management
etc..