Working Capital Management for
the Multinational Corporation
International Financial Management
Dr. A. DeMaskey
Learning Objectives
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How does multinational working capital
management differ from domestic
working capital management?
What are the objectives of international
cash management?
What techniques are used by MNCs for
making cross-border payments?
What key factors are associated with a
firm’s funding strategy?
What short-term financing options are
available?
Multinational Working Capital
Management
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Funds Availability
Additional Risks
Movement of Capital
Decisions
Taxes
International Cash Management
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A set of activities, which consists of:
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Cash management - the levels of cash
balances held throughout the MNC Cash settlements and processing - the
facilitation of its movement across
borders
Cash Management
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Cash levels are determined independently
of working capital management decisions
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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.
International Cash Management
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Goal: Minimize cash balances without reducing
operations or increasing risk.
Steps:
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Cash Planning - anticipating cash flows over future
days, weeks, or months.
Cash Collection – getting cash into the firm as soon
as possible.
Cash Mobilization – moving cash within the firm to
the location where needed.
Cash Disbursements – planning procedures for
distributing cash.
Covering Cash Shortages – managing anticipated
cash shortages by borrowing locally.
Investing Surplus Cash – managing anticipated cash
surpluses by investing locally or controlling them
centrally.
Cash Positioning Decision
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Currency of location
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Type of liquid asset held
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Maturities, yields, and liquidity
characteristics
Objectives of an Effective Cash
Management System
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Minimizing overall cash
requirements
Minimizing currency exposure risk
Minimizing political risk
Minimizing transactions costs
Taking full advantage of economies
of scale
Complexities of the International Cash
Positioning Decision
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Conflicting nature of cash
management objectives
Government restrictions
Multiple taxation systems
Multiple currencies
International Cash Settlements
and Processing
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Four techniques for simplifying and
lowering the cost of settling cash
flows between related and unrelated
firms
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Wire transfers
Cash pooling
Payment netting
Electronic fund transfers
Wire Transfers
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Variety of methods but two most popular
for cash settlements are CHIPS and
SWIFT
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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
Cash Pooling and Centralized
Depositories
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Key: Centralizing the cash positioning function to gain
operational benefits.
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Subsidiaries hold minimum cash for their own transactions
and no cash for precautionary purposes
All excess funds are remitted to a central cash depository
Centralized depositories provide the following
advantages:
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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
Interest rate advantages as funds can be borrowed at a
lower cost and invested at a more advantageous rate.
Location can provide tax benefits, access to international
communications, clearly defined legal procedures.
Multilateral Netting
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Netting involves offsetting receivables
against payables so that only the net
amounts are transferred among affiliates.
Types
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Bilateral netting
Multilateral netting
Payments netting is useful primarily when
a large number of separate foreign
exchange transactions occur between
subsidiaries.
Payments Netting
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Example: A Belgian affiliate owes an Italian
affiliate $5,000,000, while the Italian affiliate
simultaneously owes the Belgian affiliate
$3,000,000.
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Bilateral settlement calls for $2,000,000 payment
from Belgium to Italy and cancellation of the
remainder via offset.
Multilateral netting is an extension of bilateral
netting.
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Assume that payments are due between Apex’s
European operations each month.
Without netting Apex de France would make three
separate transactions each way.
Financing Working Capital
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Financing working capital
requirements of a MNC’s foreign
affiliates poses a complex decision
problem.
Financing options for a subsidiary
include:
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Intercompany loans from the parent or
a sister affiliate.
Local currency financing.
Key Factors Underlying the Funding
Strategy
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Interest Rate
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Without forward contracts
With forward contracts
Exchange Risk
Degree of Risk Aversion
Taxes
Political Risk
Financing Objectives
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Minimize covered after-tax interest
costs
Minimize expects costs
Trade-off between expected cost
and reducing the degree of cash
flow exposure
Intercompany Loans
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The cost of an intercompany loan is
determined by the following factors:
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Opportunity cost of funds
Interest rate
Tax rates and regulations
Currency of denomination
Expected exchange rate change
Local Currency Financing
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Bank Loans
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Term Loans
Line of Credit
Overdraft
Revolving Credit Agreement
Discounting
Commercial Paper
Effective Interest Rate on Bank Loans
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Simple interest loan
Discount loan
Loan with compensating balance
requirement
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Simple interest loan
Discount loan
Effective Annual Percentage Cost
Illustration
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The Olivera Corporation, a manufacturer of olive
oil products, needs to acquire €1 million in funds
today to expand a pimiento-stuffing facility.
Banca di Roma has offered them a choice of an
11% loan payable at maturity or a 10% loan on a
discount basis. Which loan should Olivera
choose?
Calculating the Dollar Costs of
Alternative Financing Options
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In deciding on a particular financing
option, a firm needs to estimate and then
compare the effective after-tax dollar
costs of local currency financing and
dollar financing.
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In reality, the value of the currency borrowed
will most likely change with respect to the
borrower’s local currency over time.
Breakeven analysis can be used to determine
the least expensive financing source for each
future exchange rate.
Effective Financing Rate:
No Taxes
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Suppose that Ford has an affiliate in
Mexico, which can borrow pesos at 80%
or dollars at 12% for one year.
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If the peso is expected to devalue from MP$
7.50/$ at the beginning of the year to MP$
10.23/$ at the end of the year, what is the
expected before-tax dollar cost of the peso
loan?
What is the cost of the dollar loan to Ford?
What is the breakeven rate of currency change
at which the dollar cost of borrowing pesos is
just equal to the cost of dollar financing?
Effective Financing Rate:
No Taxes
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Dollar cost of local currency (LC)
loan
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Cost of dollar loan (HC)
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rH (LC) = rL (1 + c) + c
rH (HC) = rH
Breakeven rate of currency change
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rL (1 + c) + c = rH
Effective Financing Rate:
With Taxes
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Suppose the Mexican corporate tax rate is
53%.
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What is the expected after-tax dollar cost of
borrowing pesos?
What is the expected after-tax cost of the
dollar loan?
What is the breakeven rate of currency change
at which the after-tax dollar cost of local
currency financing is just equal to the after-tax
cost of dollar financing?
Effective Financing Rate:
With Taxes
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After-tax dollar cost of borrowing
local currency
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After-tax cost of dollar loan
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rH (LC) = rL (1 - Ta)(1 + c) + c
rH (HC) = rH (1 - Ta) + cTa
Breakeven rate of currency change
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rL(1 - Ta)(1 + c) + c = rH(1 - Ta) + cTa