Chapter 19
Financial Management and
Accounting in the Global Firm
International Business
Strategy, Management
& the New Realities
Cavusgil, Knight & Riesenberger
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International Financial Management
The acquisition, management, and use of funds for
cross-national trade, investment, and other
commercial activities. It involves:
• Conducting transactions in various currencies;
• Operating in environments characterized by
significant risk, capital flow restrictions, and varying
accounting and tax systems;
• Seeking and accessing funds from banks, bond
markets, stock exchanges, venture capital firms, and
intra-corporate sources, located worldwide.
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International Financial Management Tasks
1.
2.
3.
4.
5.
6.
Decide on the Capital Structure. Determine the ideal longterm mix of debt versus equity financing.
Raise funds for the firm. Acquire equity, debt, or intracorporate financing for funding activities and investments.
Working Capital and Cash Flow Management. Manage
funds passing in and out of the firm’s value-adding activities.
Capital Budgeting. Assess financial attractiveness of major
investment projects (e.g., foreign market expansion).
Currency Risk Management. Manage multiple-currency
transactions and exposure to exchange-rate fluctuations.
Manage the Diversity of international Accounting and Tax
Practices. Operate in a global environment with diverse
accounting practices and international tax regimes.
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Task One: Decide on the Capital Structure
• Capital structure: the mix of long-term equity
financing and debt financing firms use to support
their international activities.
• Firm obtains equity financing by selling shares
of stock to investors or by retaining earnings.
• Shares of stock provide an investor with an
ownership interest, that is, equity, in the firm.
• Debt financing comes from either loans from
banks and other financial intermediaries or
money raised from the sale of corporate bonds.
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Task Two: Raising Funds
Global money market: financial markets where firms
and governments raise short-term financing.
Global capital market: financial markets where firms
and governments raise intermediate-term and long-term
financing.
• Most funding is longer term. The global capital
market is the meeting point of those who want to
invest money and those who want to raise funds.
• Main advantage of the global capital market: ability to
access funds from a wider range of sources at lower
cost.
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The Global Capital Market
is Huge and Growing (as of 2006)
• International issues of equity in world securities
markets were about $380 billion, up from $83b in
1996 and just $14b in 1986.
• Stock of cross-national bank loans and deposits
was $18,916b, up from $7,205b ten years earlier.
• There were $17,574b in outstanding international
bonds and notes, up from $3,081b in 1996.
• This is the ‘globalization of finance’.
• Main facilitating factors: Deregulation of global
finance; advanced ICTs; globalization of business
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Sources of Funding 1: Equity Financing
• The firm obtains capital by selling shares of
stock. In exchange, the shareholders obtain a
percentage of ownership in the firm and, often, a
stream of dividends.
• Global equity market: the worldwide market for
equity financing -- stock exchanges worldwide
where investors and firms meet to buy and sell
shares of stock.
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Sources of Funding 2: Debt Financing
• In debt financing, a firm borrows money from a
creditor in exchange for repayment of principal and
an agreed upon interest amount in the future.
Debt financing is obtained from loans and bonds.
• International Loans. The firm may borrow money
from banks in its home market or abroad.
• Eurocurrency Market is money deposited in banks
outside its country of origin, mainly U.S. dollars,
“eurodollars”. Other eurocurrencies include euros,
yen, and pounds, banked outside the home country
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Bonds: A Major Source of Debt Financing
• A bond enables the issuer (borrower) to raise capital
by promising to repay the principal along with interest
at a specified date.
• Global bond market is the international marketplace
where bonds are bought and sold, primarily via banks
and stockbrokers.
• Foreign bonds are sold outside the bond issuer’s
country and denominated in the currency of the
country in which they are issued.
• Eurobonds are sold outside the bond issuer’s home
country and denominated in its own currency (e.g.,
when Toyota sells yen-denominated bonds in Europe)
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Sources of Funding 3:
Intra-Corporate Financing
• Funds provided from sources inside the firm in the
form of equity, loans, and trade credits. Trade
credit arises when a supplier of goods and
services grants the customer the option to pay
later.
• Advantages: Often the lowest-cost capital;
minimizes the transactions costs typical of
obtaining funds from other sources; has little
effect on the parent firm’s balance sheet; avoids
risk of debt financing; avoids ownership-diluting
effects of equity financing.
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Task Three: Working Capital
and Cash Flow Management
• Working capital: the current assets of the firm.
• Working capital management aims to ensure cash is
available where and when it is needed.
• Cash flow needs arise from everyday business
activities, such as paying for labor or materials.
• Cash is generated from various sources and must
be transferred from one part of the MNE to another.
• International financial managers devise various
strategies for transferring funds within the firm’s
worldwide operations, to optimize global operations.
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Methods for
Transferring Funds within the MNE
• Through trade credit, a subsidiary defers payment for
goods and services received from the parent.
• Royalty payments: remuneration paid to the owners
of intellectual property, as parents often ‘license’ the
use of assets to subsidiaries.
• Fronting loan: a loan between the parent and its
subsidiary, channeled through a bank. The parent
deposits a sum in a foreign bank, which then transfers
the funds to the subsidiary as a loan.
• Transfer pricing: the prices that subsidiaries and
affiliates charge one another for transferred goods and
services within the same MNE.
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Multilateral Netting
• Strategic reduction of cash transfers within the
MNE family via elimination of offsetting cash flows.
• Involves three or more subsidiaries that hold
accounts payable or accounts receivable with
each other. MNEs with many subsidiaries may
establish a netting center.
• The center advises each subsidiary of the
amounts to pay and receive from other
subsidiaries on a specified date.
• Firms like Philips saves millions each year in
transaction costs due to multilateral netting.
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Task Four: Capital Budgeting
• Helps managers decide which international
expansion projects are economically desirable.
• The decision to accept or reject an investment
project depends on the project’s initial
investment requirement, its cost of capital, and
the benefits the project is expected to provide.
• Involves net present value analysis.
• Can be very complex, because there are many
variables to consider.
• Facilitated by spreadsheet analysis
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Task Five: Currency Risk Management
• Currency risk: the peril resulting from adverse
unexpected fluctuations in exchange rates.
• Exporters and licensors face currency risk
because foreign buyers pay in their own
currencies.
• Foreign direct investors face currency risk
because they receive both payments and incur
obligations in foreign currencies.
• Managers of foreign investment portfolios face
currency risk as the value of stocks fluctuate.
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Three Types of Currency Risk
• Transaction exposure. Arises when outstanding
accounts receivable or payable are denominated in
foreign currencies.
• Translation exposure. Results financial statements
denominated in a foreign currency are translated
into the functional currency of the parent, as part of
consolidating international financial results.
• Economic exposure. Results from exchange rate
fluctuations affecting the pricing of products, the
cost of inputs, and the value of foreign investments.
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Foreign Exchange Trading
• A small number of currencies facilitate international
trade and investment. Some 2/3 of foreign reserves
are in U.S. dollars, 25% in euros, 7% in yen and
British pounds, and only 2% in the world’s 150 other
currencies.
• Volume of currencies exchanged is huge. As of
2007, some $3 trillion worth of currency was traded
everyday, 10 times the value of daily stock and bond
turnover, and 100 times the value of daily
merchandise trade. One-third of all currency trading,
about $1 trillion per day, takes place in London.
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Specialized Terminology for Currency Trading
• Spot rate: the exchange rate applicable to the
trading of foreign currencies in which the current
rate of exchange is used and delivery is
considered ‘immediate.’
• Forward rate: the exchange rate applicable to
the collection or delivery of foreign currencies at
some future date, but a rate specified at the time
of the transaction.
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Exchange Rate Forecasting and Hedging
• Firms attempt to forecast exchange rate
fluctuations.
• Firms attempt to proactively manage exchange
rate exposure via hedging.
• Forecasts are available from banks and
business news sources.
• Online sources include the Bank for International
Settlements (www.bis.org), the World Bank
(www.worldbank.org), and the European Central
Bank (www.ecb.int).
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Task Six: Manage the Diversity of
International Accounting and Tax Practices
• The firm’s accounting systems must identify,
measure, and communicate financial information,
often in complex multi-country operations, with much
variation in national accounting systems.
• For example, there are dozens of approaches for
determining R&D expenditures, cost of goods sold,
asset valuation, net profits, etc.
• Financial statements prepared according to the rules
of one country may be difficult to compare with
those prepared in another country.
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Transparency in Financial Reporting
• Transparency is the degree to which firms regularly
and comprehensively reveal substantial information
about their financial condition and accounting
practices.
• In order to increase transparency in the United
States, the federal government passed the
Sarbanes-Oxley Act in 2002, making CEOs and
CFOs personally responsible for the accuracy of
annual reports and other financial data.
• In general, accounting standards are becoming
more standardized worldwide.
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Consolidating Financial
Statements of Subsidiaries
• Involves “translating” data denominated in foreign
currencies into the firm’s functional currency on
headquarters financial statements.
• Current rate method -- all foreign currency balancesheet and income statement items are translated at the
current exchange rate -- the spot exchange rate in effect
on the day the statements are prepared.
• Temporal method -- the choice of exchange rate
depends on the underlying method of valuation. If assets
and liabilities are normally valued at historical cost, then
they are translated at the historical rates. If assets and
liabilities are normally valued at market cost, they are
translated at the current rate of exchange.
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International Taxation
• A direct tax is imposed on income derived from the
firm’s business activities.
• An indirect tax applies to firms that license or
franchise products and services, or who charge
interest. In effect, the local government withholds
some percentage of payments as tax.
• A sales tax is a flat percentage tax on the value of
goods or services sold, and paid by the ultimate user.
• A value-added tax (VAT) is payable at each stage of
processing in the value chain of a product or service. It
is common in Canada, Europe, and Latin America.
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Tax Havens
• A country hospitable to business and inward
investment because of its low corporate
income tax.
• Examples: Bahamas, Luxembourg, Monaco,
Singapore, Switzerland
• They exist partly because MNEs want to
structure their global activities in ways that
minimize taxes.
• MNEs take advantage of tax havens either by
establishing operations in them or by funneling
business transactions through them.
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