INTERNATIONAL
BUSINESS
Professor H. Michael Boyd, Ph.D.
Accounting and Finance
in the International
Business
What Is
Financial Management?
 Financial management involves
1. Investment decisions –what to finance
2. Financing decisions –how to finance those
decisions
3. Money management decisions –how to
manage the firm’s financial resources most
efficiently
20-5
What Is Accounting?
 Accounting is the language of business
 it is the way firms communicate their financial
positions
 Accounting is more complex for international
firms because of differences in accounting
standards from country to country
 differences make it difficult for investors, creditors,
and governments to evaluate firms
 It is difficult to compare financial reports from
country to country because of national
differences in accounting and auditing standards
20-6
What Determines National
Accounting Standards?
 Several variables influence the
development of a country’s accounting
system including
 the relationship between business and the
providers of capital
 political and economic ties with other
countries
 the level of inflation
 the level of a country’s economic
development
 the prevailing culture in a country
20-7
How Do Providers Of Capital
Influence Accounting?
A country’s accounting system reflects the
relative importance of each constituency
as a provider of capital
accounting systems in the U.S. and Great
Britain are oriented toward individual investors
Switzerland and Germany focus on providing
information to banks
20-8
How Do Political And Economic
Ties Influence Accounting?
Similarities in accounting systems across
countries can reflect political or economic
ties
the U.S. accounting system influences the
systems in the Philippines
in the European Union, countries are moving
toward common standards
the British system of accounting is used by
many former colonies
20-9
How Do Levels of Development
Influence Accounting?
 Developed nations tend to have more
sophisticated accounting systems than
developing countries
 larger, more complex firms create accounting
challenges
 providers of capital require detailed reports
 Many developing nations have accounting
systems that were inherited from former colonial
powers
 lack of trained accountants
20-10
What Are Accounting And
Auditing Standards?
Accounting standards are rules for
preparing financial statements
they define useful accounting information
Auditing standards specify the rules for
performing an audit
the technical process by which an
independent person gathers evidence for
determining if financial accounts conform to
required accounting standards and if they are
also reliable
20-11
Why Are International
Accounting Standards Important?
 The growth of transnational financing and
transnational investment has created a need for
transnational financial reporting
 many companies obtain capital from foreign providers
who are demanding greater consistency
 Standardization of accounting practices across
national borders is probably in the best interests
of the world economy
 will facilitate the development of global capital
markets
20-12
Why Are International
Accounting Standards Important?
 The International Accounting Standards Board
(IASB) is a major proponent of standardization of
accounting standards
 most IASB standards are consistent with standards
already in place in the U.S.
 by 2011, 100 nations have adopted IASB standards
or permitted their use in reporting financial results
 the EU has mandated harmonization of accounting
principles for members
 there soon could be only two major accounting bodies
with substantial influence on global reporting
FASB in the U.S. and IASB elsewhere
20-13
How Does Accounting
Influence Control Systems?
 The control process in most firms is
usually conducted annually and involves
three steps
1. Subunit goals are jointly determined by the
head office and subunit management
2. The head office monitors subunit
performance throughout the year
3. The head office intervenes if the subsidiary
fails to achieve its goal, and takes corrective
actions if necessary
20-14
How Do Exchange Rates
Influence Control?
 Budgets and performance data are
usually expressed in the corporate
currency
 normally the home currency
 facilitates comparisons between
subsidiaries
 but, can create distortions in financial
statements
20-15
How Do Exchange Rates
Influence Control?
 The Lessard-Lorange Model
 firms can deal with the problems of exchange
rates and control in three ways
1. The initial rate
 the spot exchange rate when the budget is adopted
2. The projected rate
 the spot exchange rate forecast for the end of the
budget picture
3. The ending rate
 the spot exchange rate when the budget and
performance are being compared
20-16
What Is The
Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control Process
20-17
Why Separate Subsidiary and
Managerial Performance?
Subsidiaries operate in different
environments which influence profitability
the evaluation of a subsidiary should be kept
separate from the evaluation of its manager
A manager’s evaluation should
consider the country’s environment for
business
take place after making allowances for those
items over which managers have no control
20-18
What Is
Financial Management?
 Good financial management can create a
competitive advantage
 reduces the costs of creating value and adds
value by improving customer service
 Decisions are more complex in
international business
 different currencies, tax regimes, regulations
on capital flows, economic and political risk,
etc.
20-19
How Do Managers Make
Investment Decisions?
 Financial managers must quantify the benefits,
costs, and risks associated with an investment in
a foreign country
 To do this, managers use capital budgeting
 involves estimating the cash flows associated with the
project over time, and then discounting them to
determine their net present value
 If the net present value of the discounted cash
flows is greater than zero, the firm should go
ahead with the project
20-20
Why Is Capital Budgeting More
Difficult For International Firms?
Capital budgeting is more complicated in
international business
because a distinction must be made between
cash flows to the project and cash flows to the
parent company
because of political and economic risk
because the connection between cash flows
to the parent and the source of financing must
be recognized
20-21
What Is The Difference Between
Project And Parent Cash Flows?
 Cash flows to the project and cash flows to the
parent company can be quite different
 Parent companies are interested in the cash
flows they will receive, not the cash flows the
project generates
 received cash flows are the basis for dividends, other
investments, repayment of debt, and so on
 Cash flows to the parent may be lower because
of host country limits on the repatriation of
profits, host country local reinvestment
requirements, etc.
20-22
How Does Political Risk
Influence Investment Decisions?
 Political risk - the likelihood that political forces
will cause drastic changes in a country’s
business environment that hurt the profit and
other goals of a business
 higher in countries with social unrest or disorder, or
where the nature of the society increases the chance
for social unrest
 Political change can result in the expropriation of
a firm’s assets, or complete economic collapse
that renders a firm’s assets worthless
20-23
How Does Economic Risk
Influence Investment Decisions?
Economic risk - the likelihood that
economic mismanagement will cause
drastic changes in a country’s business
environment that hurt the profit and other
goals of a business
The biggest economic risk is inflation
reflected in falling currency values and lower
project cash flows
20-24
How Can Firms Adjust For
Political And Economic Risk?
 Firms analyzing foreign investment
opportunities can adjust for risk
1. By raising the discount rate in countries
where political and economic risk is high
2. By lowering future cash flow estimates to
account for adverse political or economic
changes that could occur in the future
20-25
How Do Firms Make
Financing Decisions?
 Firms must consider two factors
1. How the foreign investment will be
financed
 the cost of capital is usually lowest in the
global capital market
 but, some governments require local debt or
equity financing
 firms that anticipate a depreciation of the
local currency, may prefer local debt
financing
20-26
How Do Firms Make
Financing Decisions?
2. How the financial structure (debt vs.
equity) of the foreign affiliate should be
configured
 need to decide whether to adopt local capital
structure norms or maintain the structure
used in the home country
 Most experts suggest that firms adopt
the structure that minimizes the cost of
capital, whatever that may be
20-27
What Is Global
Money Management?
 Money management decisions attempt to
manage global cash resources efficiently
 Firms need to
1. Minimize cash balances - need cash balances
on hand for notes payable and unexpected
demands
 cash reserves are usually invested in money market
accounts that offer low rates of interest
 when firms invest in money market accounts they
have unlimited liquidity, but low interest rates
 when they invest in long-term instruments they have
higher interest rates, but low liquidity
20-28
What Is Global
Money Management?
2. Reduce transaction costs - the cost of
exchange
 every time a firm changes cash from one currency
to another, they face transaction costs
 Most banks also charge a transfer fee for
moving cash from one location to another
 Multilateral netting can reduce the number of
transactions between subsidiaries and the
number of transaction costs
20-29
How Can Firms Limit
Their Tax Liability?
 Every country has its own tax policies
 most countries feel they have the right to tax
the foreign-earned income of companies
based in the country
 Double taxation occurs when the income
of a foreign subsidiary is taxed by the
host-country government and by the
home-country government
20-30
How Can Firms Limit
Their Tax Liability?
 Taxes can be minimized through
1. Tax credits - allow the firm to reduce the taxes paid to
the home government by the amount of taxes paid to
the foreign government
2. Tax treaties - agreement specifying what items of
income will be taxed by the authorities of the country
where the income is earned
3. Deferral principle - specifies that parent companies
are not taxed on foreign source income until they
actually receive a dividend
4. Tax havens - countries with a very low, or no, income
tax – firms can avoid income taxes by establishing a
wholly-owned, non-operating subsidiary in the
country
20-31
How Do Firms Move
Money Across Borders?
 Firms can transfer liquid funds across
border via
1.
2.
3.
4.
Dividend remittances
Royalty payments and fees
Transfer prices
Fronting loans
20-32
What Are
Dividend Remittances?
 Paying dividends is the most common method of
transferring funds from subsidiaries to the parent
 The relative attractiveness of paying dividends
varies according to
 tax regulations – high tax rates make this less
attractive
 foreign exchange risk – dividends might speed up in
risky countries
 the age of the subsidiary – older subsidiaries remit a
higher proportion of their earning in dividends
 the extent of local equity participation – local owners’
demands for dividends come into play
20-33
What Are
Royalty Payments And Fees?
 Royalties - the remuneration paid to the owners
of technology, patents, or trade names for the
use of that technology or the right to
manufacture and/or sell products under those
patents or trade names
 can be levied as a fixed amount per unit or as a
percentage of gross revenues
 most parent companies charge subsidiaries royalties
for the technology, patents or trade names transferred
to them
20-34
What Are
Royalty Payments And Fees?
A fee is compensation for professional
services or expertise supplied to a foreign
subsidiary by the parent company or
another subsidiary
royalties and fees are often tax-deductible
locally
20-35
What Are Transfer Prices?
 Transfer prices - the price at which goods and
services are transferred between entities within
the firm
 Transfer prices can be manipulated to
1. Reduce tax liabilities by shifting earnings from hightax countries to low-tax countries
2. Move funds out of a country where a significant
currency devaluation is expected
3. Move funds from a subsidiary to the parent when
dividends are restricted by the host government
4. Reduce import duties when ad valorem tariffs are in
effect
20-36
What Makes
Transfer Prices Unattractive?
 But, using transfer pricing can be
problematic because
1. Governments think they are being cheated
out of legitimate income
2. Governments believe firms are breaking the
spirit of the law when transfer prices are used
to circumvent restrictions of capital flows
3. It complicates management incentives and
performance evaluation
20-37
What Are Fronting Loans?
Fronting loans are loans between a parent
and its subsidiary channeled through a
financial intermediary, usually a large
international bank
Firms use fronting loans
to circumvent host-country restrictions on the
remittance of funds from a foreign subsidiary
to the parent company
to gain tax advantages
20-38
What Are Fronting Loans?
An Example of the Tax Aspects of a Fronting Loan
20-39