Short Term Financial
Management in a
Multinational Corporation
Introduction
• The essence of short term financial
management can be stated as
– Minimize the working capital needs
consistent with other policies
– Raise short term funds at the minimum
possible cost and deploy short term cash
surpluses at the maximum possible rate of
return consistent with the firm's risk
preferences and liquidity needs
• In a multinational context, the added
dimensions are the multiplicity of currencies
and a much wider array of markets and
instruments for raising and deploying funds
• Focus on cash management since it is complex
because of possibility of raising and deploying
cash in many currencies, many locations, and
profit opportunities presented by imperfections
in international money and foreign exchange
markets
• Other aspects of short-term financial
management such as inventories,
receivables/payables management etc. not too
different in a multinational context as opposed
to a purely domestic firm.
• Even a purely domestic firm or a firm with
imports and exports but no cross-border
manufacturing facilities can "internationalize"
its cash management if the government of the
country permits free capital inflows and
outflows
• In India as of now, the capital account has not
been fully opened up; short-term borrowings
are generally discouraged and there are
restrictions on parking surplus funds abroad.
Also, restrictions on leading-lagging, netting
etc.
• Indian firms have been permitted access to
foreign money markets (through domestic
banks) for pre-shipment credits for exports and
settlement of import payments
• The Exchange Earners Foreign Currency
(EEFC) account facility is available to all
exporters (50% of FC earnings) with special
facilities for software firms 100% EOUs
(100%).
• Cannot access foreign markets for day-to-day
cash management
• Banks arbitrage between domestic and foreign
money markets so that forward margins closely
related to interest rate differentials.
• The passive approach confines itself to
minimizing cash needs and currency exposure
as well as optimal deployment of cash balances
arising out of the firm's operating
requirements
• The active approach deliberately creates cash
positions to profit from perceived market
imperfections or the firm's supposedly superior
forecasting ability
• Again a matter of risk-reward tradeoff.
Short Term Borrowing and Investment
• The principal dimensions of the borrowinginvestment decisions are the instrument,
currency, location of the financial center and
any tax related issues such as withholding
taxes, capital gains taxes versus ordinary
income taxes, double tax avoidance treaties etc.
• On a covered basis, the choice of currency of
borrowing does not matter. (Apart from any
tax considerations)
• Only when the borrower firm holds views
regarding currency movements which are
different from market expectations as
embodied in the forward rate, does the
currency of borrowing become an important
choice variable
Where should Surplus Cash be Held?
• Minimizing transaction costs: Funds received
in currency A, needed later in currency A then
hold them in currency A
• Liquidity: Funds should be held in a currency
in which they are most likely to be needed (not
necessarily same as the currency in which they
are received)
• Political risk
• Availability of investment vehicles and their
liquidity
• Withholding taxes
– One of the cheapest ways of covering shortterm deficits is internal funds
– A centralized cash management system with
cash pooling described below can efficiently
allocate internal surpluses
– External sources of short-term funding
consist of overdraft facilities, fixed term
bank loans and advances and instruments
like commercial paper, trade and bankers'
acceptances
Centralized Management Versus
Decentralized Cash Management
• Centralized cash management has several
advantages
– Netting
– Exposure Management
– Cash Pooling (Reduces cash requirements)
• Disadvantages of centralized management
– Some funds have to be held locally in each
subsidiary to meet unforeseen payments
Centralized Management Versus
Decentralized Cash Management
– Local problems in dealing with customers,
suppliers etc.
– Performance evaluation conflicts
– Conflicts of interest can arise if a subsidiary
is not wholly owned but a joint venture with
minority local stake
Netting with Central Depository
Some firms use a central depository as a cash pool
to facilitate funds mobilization and reduce the
chance of misallocated funds.
$15
$55
Central
depository
$40
Consider the case of an American multinational
with subsidiaries in France, Switzerland and the
UK. The parent operates a cash management center.
By a specific date each month - say the 15th - all
units, the subsidiaries as well as the parent report
their receivables and payables among themselves to
the CMC. The CMC uses the current spot rates to
convert all cash flows into a common denominator
viz.US dollars. Figure below shows the positions
reported by the various units. The spot rates are
assumed to be USD/CHF = 1.5000, GBP/USD =
1.6000 and EUR/USD = 1.2000
SWITZERLAND
CHF 1.5m
(USD 1m)
EUR 5m
(USD 6m)
GBP 1m
CHF 9m
(USD 1.6m) (USD 6m)
GBP 2m
(USD 3.2m)
FRANCE
UK
EUR 2.5m
(USD 3m)
USD 2m
USD 1m
USA
(PARENT)
GBP 3m
(USD 4.8 m)
The CMC nets out the receivables against payables of each
unit and informs the net payers to pay designated amounts to
the net receivers. The actual settlements take place at a
specified date - say the 25th of the month - for which the net
payers acquire the necessary currencies at the spot rate ruling
at that time. Any exchange gains or losses are attributed to the
individual units. The net positions of the various units, in
millions of dollars, are as follows (+ sign indicates inflow and a
- sign an outflow):
US: + 2 + 1 - 4.8 = -1.8
UK : +4.8 + 3.2 + 1.6 - 2.25 - 6.0 = +1.35
France : + 4.5 + 2.25 - 1.0 - 3.2 - 2.0 = 0.55
Switzerland : + 1.0 + 6.0 - 4.5 - 1.6 - 1.0 = -0.1