International Business

9e
By Charles W.L. Hill
McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies Inc! "ll rights reser#e$!

Chapter 20
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. oney management decisions how to manage the firm!s financial reso"rces most efficiently

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What Is Accounting?
#cco"nting is the lang"age of $"siness
it is the way firms comm"nicate their financial %ositions

#cco"nting is more com%le& for international firms $eca"se of differences in acco"nting standards from co"ntry to co"ntry
differences ma'e it diffic"lt for investors( creditors( and governments to eval"ate firms

It is diffic"lt to com%are financial re%orts from co"ntry to co"ntry $eca"se of national differences in acco"nting and a"diting standards
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What Determines National Accounting Standards?

)everal varia$les infl"ence the develo%ment of a co"ntry!s acco"nting system incl"ding
the relationshi% $etween $"siness and the %roviders of ca%ital %olitical and economic ties with other co"ntries the level of inflation the level of a co"ntry!s economic develo%ment the %revailing c"lt"re in a co"ntry
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o! Do "ro#iders $% Capital In%luence Accounting?

# co"ntry!s acco"nting system reflects the relative im%ortance of each constit"ency as a %rovider of ca%ital
acco"nting systems in the *.). and +reat Britain are oriented toward individ"al investors )wit,erland and +ermany foc"s on %roviding information to $an's

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o! Do "olitical And &conomic 'ies In%luence Accounting?

)imilarities in acco"nting systems across co"ntries can reflect %olitical or economic ties
the *.). acco"nting system infl"ences the systems in the -hili%%ines in the ."ro%ean *nion( co"ntries are moving toward common standards the British system of acco"nting is "sed $y many former colonies
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o! Do (e#els o% De#elopment In%luence Accounting?

/evelo%ed nations tend to have more so%histicated acco"nting systems than develo%ing co"ntries
larger( more com%le& firms create acco"nting challenges %roviders of ca%ital re0"ire detailed re%orts

any develo%ing nations have acco"nting systems that were inherited from former colonial %owers
lac' of trained acco"ntants
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What Are Accounting And Auditing Standards?

#cco"nting standards are r"les for %re%aring financial statements
they define "sef"l acco"nting information

#"diting standards s%ecify the r"les for %erforming an a"dit

the technical %rocess $y which an inde%endent %erson gathers evidence for determining if financial acco"nts conform to re0"ired acco"nting standards and if they are also relia$le
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Wh) Are International Accounting Standards Important?

1he growth of transnational financing and transnational investment has created a need for transnational financial re%orting
many com%anies o$tain ca%ital from foreign %roviders who are demanding greater consistency

)tandardi,ation of acco"nting %ractices across national $orders is %ro$a$ly in the $est interests of the world economy
will facilitate the develo%ment of glo$al ca%ital mar'ets
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Wh) Are International Accounting Standards Important?

1he International #cco"nting )tandards Board 2I#)B3 is a ma4or %ro%onent of standardi,ation of acco"nting standards
most I#)B standards are consistent with standards already in %lace in the *.). $y 2511( 155 nations have ado%ted I#)B standards or %ermitted their "se in re%orting financial res"lts the .* has mandated harmoni,ation of acco"nting %rinci%les for mem$ers there soon co"ld $e only two ma4or acco"nting $odies with s"$stantial infl"ence on glo$al re%orting F#)B in the *.). and I#)B elsewhere

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o! Does Accounting In%luence Control S)stems?

1he control %rocess in most firms is "s"ally cond"cted ann"ally and involves three ste%s
1. )"$"nit goals are 4ointly determined $y the head office and s"$"nit management 2. 1he head office monitors s"$"nit %erformance thro"gho"t the year 3. 1he head office intervenes if the s"$sidiary fails to achieve its goal( and ta'es corrective actions if necessary
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o! Do &*change +ates In%luence Control?

B"dgets and %erformance data are "s"ally e&%ressed in the cor%orate c"rrency
normally the home c"rrency facilitates com%arisons $etween s"$sidiaries $"t( can create distortions in financial statements

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o! Do &*change +ates In%luence Control?

1he Lessard6Lorange odel firms can deal with the %ro$lems of e&change rates and control in three ways
1. 1he initial rate the s%ot e&change rate when the $"dget is ado%ted 2. 1he %ro4ected rate the s%ot e&change rate forecast for the end of the $"dget %ict"re 3. 1he ending rate the s%ot e&change rate when the $"dget and %erformance are $eing com%ared
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What Is 'he (essard,(orange Model?

-ossi$le Com$inations of .&change 7ates in the Control -rocess

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Wh) Separate Su-sidiar) and Managerial "er%ormance?

)"$sidiaries o%erate in different environments which infl"ence %rofita$ility
the eval"ation of a s"$sidiary sho"ld $e 'e%t se%arate from the eval"ation of its manager

# manager!s eval"ation sho"ld

consider the co"ntry!s environment for $"siness ta'e %lace after ma'ing allowances for those items over which managers have no control
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What Is Financial Management?

+ood financial management can create a com%etitive advantage
red"ces the costs of creating val"e and adds val"e $y im%roving c"stomer service

/ecisions are more com%le& in international $"siness

different c"rrencies( ta& regimes( reg"lations on ca%ital flows( economic and %olitical ris'( etc.
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o! Do Managers Ma.e In#estment Decisions?

Financial managers m"st 0"antify the $enefits( costs( and ris's associated with an investment in a foreign co"ntry 1o do this( managers "se ca%ital $"dgeting
involves estimating the cash flows associated with the %ro4ect over time( and then disco"nting them to determine their net %resent val"e

If the net %resent val"e of the disco"nted cash flows is greater than ,ero( the firm sho"ld go ahead with the %ro4ect
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Wh) Is Capital Budgeting More Di%%icult For International Firms?

Ca%ital $"dgeting is more com%licated in international $"siness
$eca"se a distinction m"st $e made $etween cash flows to the %ro4ect and cash flows to the %arent com%any $eca"se of %olitical and economic ris' $eca"se the connection $etween cash flows to the %arent and the so"rce of financing m"st $e recogni,ed
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What Is 'he Di%%erence Bet!een "ro/ect And "arent Cash Flo!s?

Cash flows to the %ro4ect and cash flows to the %arent com%any can $e 0"ite different -arent com%anies are interested in the cash flows they will receive( not the cash flows the %ro4ect generates
received cash flows are the $asis for dividends( other investments( re%ayment of de$t( and so on

Cash flows to the %arent may $e lower $eca"se of host co"ntry limits on the re%atriation of %rofits( host co"ntry local reinvestment re0"irements( etc.
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o! Does "olitical +is. In%luence In#estment Decisions?

-olitical ris' 6 the li'elihood that %olitical forces will ca"se drastic changes in a co"ntry!s $"siness environment that h"rt the %rofit and other goals of a $"siness
higher in co"ntries with social "nrest or disorder( or where the nat"re of the society increases the chance for social "nrest

-olitical change can res"lt in the e&%ro%riation of a firm!s assets( or com%lete economic colla%se that renders a firm!s assets worthless
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o! Does &conomic +is. In%luence In#estment Decisions?

.conomic ris' 6 the li'elihood that economic mismanagement will ca"se drastic changes in a co"ntry!s $"siness environment that h"rt the %rofit and other goals of a $"siness 1he $iggest economic ris' is inflation
reflected in falling c"rrency val"es and lower %ro4ect cash flows

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o! Can Firms Ad/ust For "olitical And &conomic +is.?

Firms analy,ing foreign investment o%%ort"nities can ad4"st for ris'
1. By raising the disco"nt rate in co"ntries where %olitical and economic ris' is high 2. By lowering f"t"re cash flow estimates to acco"nt for adverse %olitical or economic changes that co"ld occ"r in the f"t"re

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o! Do Firms Ma.e Financing Decisions?

Firms m"st consider two factors 1. How the foreign investment will $e financed
the cost of ca%ital is "s"ally lowest in the glo$al ca%ital mar'et $"t( some governments re0"ire local de$t or e0"ity financing firms that antici%ate a de%reciation of the local c"rrency( may %refer local de$t financing
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o! Do Firms Ma.e Financing Decisions?

2. How the financial str"ct"re 2de$t vs. e0"ity3 of the foreign affiliate sho"ld $e config"red
need to decide whether to ado%t local ca%ital str"ct"re norms or maintain the str"ct"re "sed in the home co"ntry

ost e&%erts s"ggest that firms ado%t the str"ct"re that minimi,es the cost of ca%ital( whatever that may $e
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What Is 0lo-al Mone) Management?

oney management decisions attem%t to manage glo$al cash reso"rces efficiently Firms need to 1. inimi,e cash $alances 6 need cash $alances on hand for notes %aya$le and "ne&%ected demands
cash reserves are "s"ally invested in money mar'et acco"nts that offer low rates of interest when firms invest in money mar'et acco"nts they have "nlimited li0"idity( $"t low interest rates when they invest in long6term instr"ments they have higher interest rates( $"t low li0"idity

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What Is 0lo-al Mone) Management?

2. 7ed"ce transaction costs 6 the cost of e&change
every time a firm changes cash from one c"rrency to another( they face transaction costs

ost $an's also charge a transfer fee for moving cash from one location to another "ltilateral netting can red"ce the n"m$er of transactions $etween s"$sidiaries and the n"m$er of transaction costs

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o! Can Firms (imit 'heir 'a* (ia-ilit)?

.very co"ntry has its own ta& %olicies
most co"ntries feel they have the right to ta& the foreign6earned income of com%anies $ased in the co"ntry

/o"$le ta&ation occ"rs when the income of a foreign s"$sidiary is ta&ed $y the host6co"ntry government and $y the home6co"ntry government

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o! Can Firms (imit 'heir 'a* (ia-ilit)?

1a&es can $e minimi,ed thro"gh
1. 1a& credits 6 allow the firm to red"ce the ta&es %aid to the home government $y the amo"nt of ta&es %aid to the foreign government 2. 1a& treaties 6 agreement s%ecifying what items of income will $e ta&ed $y the a"thorities of the co"ntry where the income is earned 3. /eferral %rinci%le 6 s%ecifies that %arent com%anies are not ta&ed on foreign so"rce income "ntil they act"ally receive a dividend 8. 1a& havens 6 co"ntries with a very low( or no( income ta& firms can avoid income ta&es $y esta$lishing a wholly6owned( non6o%erating s"$sidiary in the co"ntry
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o! Do Firms Mo#e Mone) Across Borders?

Firms can transfer li0"id f"nds across $order via
1. 2. 3. 8. /ividend remittances 7oyalty %ayments and fees 1ransfer %rices Fronting loans

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What Are Di#idend +emittances?

-aying dividends is the most common method of transferring f"nds from s"$sidiaries to the %arent 1he relative attractiveness of %aying dividends varies according to
ta& reg"lations high ta& rates ma'e this less attractive foreign e&change ris' dividends might s%eed "% in ris'y co"ntries the age of the s"$sidiary older s"$sidiaries remit a higher %ro%ortion of their earning in dividends the e&tent of local e0"ity %artici%ation local owners! demands for dividends come into %lay
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What Are +o)alt) "a)ments And Fees?

7oyalties 6 the rem"neration %aid to the owners of technology( %atents( or trade names for the "se of that technology or the right to man"fact"re and9or sell %rod"cts "nder those %atents or trade names
can $e levied as a fi&ed amo"nt %er "nit or as a %ercentage of gross reven"es most %arent com%anies charge s"$sidiaries royalties for the technology( %atents or trade names transferred to them

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What Are +o)alt) "a)ments And Fees?

# fee is com%ensation for %rofessional services or e&%ertise s"%%lied to a foreign s"$sidiary $y the %arent com%any or another s"$sidiary
royalties and fees are often ta&6ded"cti$le locally

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What Are 'rans%er "rices?

1ransfer %rices 6 the %rice at which goods and services are transferred $etween entities within the firm 1ransfer %rices can $e mani%"lated to
1. 7ed"ce ta& lia$ilities $y shifting earnings from high6 ta& co"ntries to low6ta& co"ntries 2. ove f"nds o"t of a co"ntry where a significant c"rrency deval"ation is e&%ected 3. ove f"nds from a s"$sidiary to the %arent when dividends are restricted $y the host government 8. 7ed"ce im%ort d"ties when ad valorem tariffs are in effect

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What Ma.es 'rans%er "rices 1nattracti#e?

B"t( "sing transfer %ricing can $e %ro$lematic $eca"se
1. +overnments thin' they are $eing cheated o"t of legitimate income 2. +overnments $elieve firms are $rea'ing the s%irit of the law when transfer %rices are "sed to circ"mvent restrictions of ca%ital flows 3. It com%licates management incentives and %erformance eval"ation
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What Are Fronting (oans?

Fronting loans are loans $etween a %arent and its s"$sidiary channeled thro"gh a financial intermediary( "s"ally a large international $an' Firms "se fronting loans
to circ"mvent host6co"ntry restrictions on the remittance of f"nds from a foreign s"$sidiary to the %arent com%any to gain ta& advantages
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What Are Fronting (oans?

#n .&am%le of the 1a& #s%ects of a Fronting Loan

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