International Working Capital Management

By
Group 3: Ankit kumar Ankur (12) Jesudas Pradeep (26) Rahul Desmukh (44) Srikanth Gali (60) Thirupathi Birudu (64) Varun Marwaha (66)

16 July, 2011

Presentation Path
Basics of Working Capital Management Cash Management Accounts Receivable Inventory Management Kim opening case: An Efficient Global Treasury Structure KIM Problems KIM Closing Case Short Term Financing of Working capital Designing a Global Remittance Policy Services Of EXIM bank Major Policy Changes during 2010- 2011 Payment Methods for International Trade Trade Finance Methods Articles

Basics of Working Capital Management

Net working capital funding

Computing the net working capital of a company on a days sales basis on three values:

(1) days receivables (accounts receivable divided by the average daily sales);
(2) days inventory (inventory divided by the average daily sales); and

(3) days payables (accounts payable divided by the average daily sales).
days working capital = days receivables + days inventory days payables.

For example, Dells net working capital level of a negative 2 days indicates that a level of accounts payable exceeds the sum of accounts receivable and inventory

Economic constraints of current asset management

MNCs face regulatory, tax, foreign exchange, and other economic constraints. So, to achieve a predetermined objective of current assets, the financial manager must give special consideration to these constraints

FOREIGN-EXCHANGE CONSTRAINTS
Foreign-exchange constraints are an important limiting factor on fund flows from one country to another. International fund flows involve foreign exchange transaction costs and exchange rate fluctuations.

REGULATORY CONSTRAINTS
Regulatory constraints can block dividend repatriation or other forms of fund remittances.

This blockage occurs because of restrictions on the international movement of funds and other exchange controls.

TAX CONSTRAINTS
Tax constraints limit the free flow of affiliate funds to a parent or to sister affiliates. These may occur because higher taxes on all corporate earnings or extra taxes on dividends may be imposed to curb inflation.

A SUMMARY OF CONSTRAINTS
Inflation and interest rates, also have an important impact on the international mobility of corporate funds. Major tasks of current asset management consist of

(1) the ability to transfer funds, (2) the positioning of funds within a multinational firm, (3) arbitrage opportunities, and (4) different channels to move funds

The ability to transfer funds

An MNC has the ability to adjust intra-company fund flows and profits on a global basis is the most important advantage that MNCs enjoy. Financial transactions within an MNC stem from the internal transfer of goods, services, technology, and capital. Many of the gains achieved through intra-company fund flows derive from some questionable business practices.

For example, the amount of gains could depend on a companys ability to take advantage of soft spots in tax laws and regulatory barriers.

Positioning of funds
Another main task of current asset management
position working cash balances or excess liquidity within an MNC.

The division of funds among various affiliates involves the choice of country and the selection of currency denomination for all liquid funds.
In domestic businesses, fund flows among units of a large company confer no advantage because tax rates and regulations are uniform throughout the country.

With wide variations in national tax systems and regulatory barriers, many different types of market imperfections increase the value of internal fund flows among units of an MNC. These market imperfections include foreign-exchange markets, financial markets, and commodity markets

Arbitrage opportunities The ability to relocate working cash balances and profits on a global basis provides MNCs with 3 types of arbitrage opportunities: (1) tax arbitrage, (2) financial market arbitrage, (3) regulatory system arbitrage. LEADS AND LAGS MNCs can accelerate (lead) or delay (lag) the timing of foreign-currency payments in order to reduce foreign-exchange exposure or to increase working capital available. TRANSFER PRICING Transfer prices are prices of goods and services sold between related parties such as a parent and its subsidiary. There are increasing transfers of goods and services between related units in different countries, as MNCs have become larger and more diversified.

INTRACOMPANY LOANS Many different types of intra company loans - but direct loans, credit swaps, and parallel loans are the most important. Direct loans involve straight dealings between the lending unit and the borrowing unit, but credit swaps and parallel loans normally involve an intermediary. A credit swap is a simultaneous spot-and-forward loan transaction between a private company and a bank of a foreign country. PAYMENT ADJUSTMENTS There are many different forms of payments by foreign subsidiaries to the parent company. These payments can be adjusted to remove blocked funds. Dividend payments are by far the most important form of fund flows from foreign subsidiaries to the parent company

UNBUNDLING FUND TRANSFERS

MNCs frequently unbundle remittances into separate flows for such purposes as royalties and management fees, rather than lumping all flows under the heading of profit (dividend).

Host countries are then more likely to perceive the so-called remittance of profits as essential purchases of specific services that would benefit the host country.

Unbundling makes it possible for MNCs to recover funds from their affiliates without irritating host-country sensitivities with large dividend drains

Cash Management

WHY DOES A FIRM HOLD CASH.?

TRANSACTION MOTIVE PRECAUTIONARY MOTIVE SPECULATIVE MOTIVE

TO PAY THE COST FOR GETTING SERVICES FROM

BANKS TO MAINTAIN ITS CREDIT RATING IN THE MARKET

The term cash management is used to mean optimization of cash flows and investment of excess cash Excess level of cash is undesirable as it is not an earning asset Low level of cash can cause liquidity problem due to which firm day to day operations can get affected

Sources & Uses of Cash

Sources- dividends, royalties and fees, cash sales and
collections on accounts receivable, depreciation, sales of new securities, loans from banks or nonbank financial institutions, and advance cash payments on contracts.

Uses- interest and dividend payments, retirement of debt

and other securities, income tax payments, payments on accounts payable, wages and salaries, and purchases of fixed assets

Objectives of Cash Management

To minimize the cost of funds To improve liquidity- Use of centralized cash management & electronic fund transfer To reduce risk- Use of insurance, forward contracts, currency options To improve the ROI

Float
The difference between the available or collected balance at the bank and the firms book or ledger balance It refers to the status of funds in the process of collection. In International operations, the problem of float is twofold: (1) the loss of income on the funds tied up during the longer transfer process; and (2) their exposure to foreign-exchange risk during the transfer period.

5 types of Float
1) Invoicing float- It refers to funds tied up in the process of preparing invoices.

2) Mail float- It includes funds tied up from the time customers mail their remittance checks until he time the company receives them.
3) Processing float- It consists of funds tied up in the process of sorting and recording remittance checks until they can be deposited in the bank. 4) Transit float- It involves funds tied up from the time remittance checks are deposited until these funds become usable to the company.

5) Disbursing float- It refers to funds available in a companys bank account until these funds are actually disbursed by the company.

HOW TO PLAN AND CONTROL CASH FLOWS .?

One can plan and control CASH in the following ways: Synchronizing cash inflows and cash outflows: manage cash in such a manner that provide cash at a time when it is needed. Use Float: float is defined as the difference between the bank balance

shown by the firms books and that of the Banks books.

Accelerate Collections. Speed up the Cheque Clearing process.

Controlling Disbursements.

Collection & Disbursement of Funds

The overall efficiency of international cash management depends on various collection and disbursement policies. To maximize available cash, an MNC must accelerate its collection process and delay its payments These policies have become even more important in recent years because of high interest rates, wide fluctuations in foreign-exchange rates, and widespread credit restrictions

ACCELERATION OF COLLECTIONS
Principal goals of speeding the collection process are To reduce floats, To minimize the investment in accounts receivable, and To reduce banking and other transaction fees.

Delay of Payment
In addition to accelerating collections, international cash managers can produce a faster turnover of cash by controlling disbursements efficiently. By delaying disbursements, a company keeps cash on hand for longer periods. An MNC can delay its payments in a number of ways: (1) mail, (2) more frequent requisitions, and (3) floats.

Cost of Cash Management

The value of careful cash management depends on the opportunity cost of funds invested in cash. The opportunity cost of these funds in turn depends on the companys required rate of return on short-term investments.

For example, assume that the adoption of a lock-box system is expected to reduce the investment in cash by $100,000. If a company earns 11 percent on short-term investments, the opportunity cost of the current system is $11,000. Hence, if the cost of the lock-box system is less than $11,000, it can be adopted to improve earnings performance.

Advantages of Cash Pooling

Centralized cash management has a number of advantages over decentralized cash management: The central cash center can collect information more quickly and make better decisions on the relative strengths and weaknesses of various currencies. Funds held in a cash center can quickly be returned to a subsidiary with cash shortages by wire transfer, or by providing a worldwide banking system with full collateral in hard currency. By holding all precautionary balances in a central cash center, an MNC can reduce the total pool without any loss in the level of production.

Investing excess funds

Along with optimization of cash flows, the other key function of international cash management is to make certain that excess funds are wisely invested 1) PORTFOLIO MANAGEMENT-There are at least three types of portfolio management available to international cash managers. i) MNCs can optimize cash flows worldwide with a zero portfolio. All excess funds of subsidiaries are remitted to the parent and then used to pay the parents short-term debts. They can centralize cash management in third countries, such as tax haven countries, and invest funds in marketable securities. They can centralize cash management at headquarters, with subsidiaries holding only minimum amounts of cash for transaction purposes.

ii) iii)

2) PORTFOLIO GUIDELINES - If MNCs invest funds in marketable securities such as Treasury bills, they should follow sound portfolio guidelines. i) Instruments in the short-term investment portfolio should be diversified to maximize the yield for a given amount of risk, or to minimize the risk for a given amount of return. ii) For companies that hold marketable securities for nearfuture needs of liquidity, marketability considerations are of major importance. iii) The maturity of the investment should be tailored to the companys projected cash needs. iv) The securities chosen should be limited to those with a minimum risk of default. v) The portfolio should be reviewed daily to decide what new investments will be made and which securities will be liquidated.

International cash management practices

Following table indicates the relative frequencies of the five cash management techniques used by Fortune 200 companies.

These companies appear to have a high level of sophistication. More than 80 percent of the respondents use wire transfers often, 50 percent pool their cash often, and almost half net payments and transfer funds electronically often.

Accounts Receivable

Accounts Receivable
The level of accounts receivable depends upon the volume of credit sales and the average collection period. These two variables, in turn, depend upon credit standards, credit terms, and collection policy A company should liberalize its credit policy to the point at which the marginal profit on its increased sales equals the marginal cost of credit One truly unique problem area of multinational accounts receivable management has to do with the risk of currency value changes There are at least two ways in which the accounts receivable manager can alleviate currency value problems: currency denomination and the use of factors. Leading and lagging can be used to alleviate currency value problems of intra-company credit sales

Inventory Management

Why efficiency in Inventory management important ?

Because :
inventories represent a significant segment of total assets for most MNCs they are the least liquid of current assets; thus, errors in inventory management are not quickly remedied

Many US and European MNCs have recently adopted a Japanese inventory management system known as the just-in-time inventory system The goal on the part of the company is to reduce inventory balances to practically zero

MNC Perspective
Major determinants of investment in inventory :
the level of sales the length of the production cycle and the durability of the product

MNCs attempt to balance their inventory level in such a way that both carrying costs and stock out costs are minimized MNC can take advantage of lower costs in a particular country by shifting its production or storage function to that country. MNC disadvantages as tariff levels and other forms of import restrictions used by governments.

Contd.
MNC must determine whether to buy inventory in advance or to delay purchase until the inventory is actually needed because
Possibility of higher costs either through inflation or devaluation

Despite the desire for optimizing inventory levels, usually MNCs maintain overstocked inventory accounts because
fears of continued inflation raw materials shortages environmental constraints anticipated import bans in foreign countries anticipated delivery delays caused by dock strikes and slowdowns the lack of sophisticated production and inventory control systems and increased difficulty in obtaining foreign exchange for inventory purchases.

If a subsidiary of a MNC relies heavily on imported goods

should build its inventory of supplies, equipment, and components in advance of an expected devaluation, because
devaluation at a later date effectively increases the costs of imported goods

For example: if a host country declares a 10 % devaluation of its currency in relation to the dollar
a subsidiary should pay 10 % more local currency for the same amount of imported goods from the USA.

If a subsidiary of a MNC depends heavily upon locally purchased goods

Should seek to minimize its inventory of supplies, equipment, and components, because
devaluation at a later date effectively reduces the dollar value of inventories acquired locally

If inventories are translated at current rather than at historical exchange rates, a 10 % devaluation of the local currency against the dollar would reduce the dollar value of its inventory by 10 %.

if a subsidiary relies almost equally on imported inventories and local inventories

should seek to reduce its locally acquired inventories and to increase its imported inventories in advance of an expected devaluation.

If accurate forecasts of devaluation are not possible, a company should maintain the same amount of imported goods and locally purchased goods to avoid foreign-exchange risks, because
a devaluation would affect both types of inventories equally, and thus the subsidiary would experience neither a gain nor a loss

Why efficiency in Inventory management important ?

Because :
inventories represent a significant segment of total assets for most MNCs they are the least liquid of current assets; thus, errors in inventory management are not quickly remedied

Many US and European MNCs have recently adopted a Japanese inventory management system known as the just-in-time inventory system The goal on the part of the company is to reduce inventory balances to practically zero

MNC Perspective
Major determinants of investment in inventory :
the level of sales the length of the production cycle and the durability of the product

MNCs attempt to balance their inventory level in such a way that both carrying costs and stock out costs are minimized MNC can take advantage of lower costs in a particular country by shifting its production or storage function to that country. MNC disadvantages as tariff levels and other forms of import restrictions used by governments.

Contd.
MNC must determine whether to buy inventory in advance or to delay purchase until the inventory is actually needed because
Possibility of higher costs either through inflation or devaluation

Despite the desire for optimizing inventory levels, usually MNCs maintain overstocked inventory accounts because
fears of continued inflation raw materials shortages environmental constraints anticipated import bans in foreign countries anticipated delivery delays caused by dock strikes and slowdowns the lack of sophisticated production and inventory control systems and increased difficulty in obtaining foreign exchange for inventory purchases.

If a subsidiary of a MNC relies heavily on imported goods

should build its inventory of supplies, equipment, and components in advance of an expected devaluation, because
devaluation at a later date effectively increases the costs of imported goods

For example: if a host country declares a 10 % devaluation of its currency in relation to the dollar
a subsidiary should pay 10 % more local currency for the same amount of imported goods from the USA.

If a subsidiary of a MNC depends heavily upon locally purchased goods

Should seek to minimize its inventory of supplies, equipment, and components, because
devaluation at a later date effectively reduces the dollar value of inventories acquired locally

If inventories are translated at current rather than at historical exchange rates, a 10 % devaluation of the local currency against the dollar would reduce the dollar value of its inventory by 10 %.

If a subsidiary relies almost equally on imported inventories and local inventories

should seek to reduce its locally acquired inventories and to increase its imported inventories in advance of an expected devaluation. If accurate forecasts of devaluation are not possible, a company should maintain the same amount of imported goods and locally purchased goods to avoid foreignexchange risks, because
a devaluation would affect both types of inventories equally, and thus the subsidiary would experience neither a gain nor a loss

Kim opening case: An Efficient Global Treasury Structure

Geo Logistics Corporation

Formed in 1996 as a global provider of logistics and transportation services for
manufacturers and distributors in technology, communications, and aerospace.

Within 30 months:
5 major acquisitions with operations in 32 countries 1999 sales of $1.5 billion, 50 % from outside North America.

With expansion
More than 80 banks serving 30 countries in Europe and Asia challenge for the greater control over international treasury operations company to find workable solutions that meet its needs and budgets.

Solution for control

To establish an efficient global treasury structure that
reduces debt improve settlement practices and increase the efficiency of cash management

Company selected ABN AMRO Bank of Ireland as its sole treasury service provider. To achieve the companys objectives, ABN established
IFSC agency capability an international network and the treasury outsourcing expertise

Why Ireland
It meets company needs like:
favourable tax environments and agency or outsourcing capabilities

The Dublin International Financial Service Centre (IFSC) established by the Irish government in 1987provides
licenses to financial institutions offers treasury agency services to foreign companies

How efficient global treasury structure

As per GeoLogistics operational guidelines, ABN outlined policies for
investments Lending Funding foreign exchange disbursements and financial reporting

ABN reduced the companys idle cash by $20 million per year, with a corresponding reduction in external debt

Contd
Through a single IFSC vehicle, ABN centralized all
intercompany lending and hedging activity

Also
established a monthly netting system designed an effective euro-based cash pool and increased control with a simplified structure

 KIM Problems

Problem 1 Subsidiary USA Japan Payments 900 1000 Receipts 1900 1200 Net Paid Net Receive 1000 200

Germany Canada

1600 900

500 800

1100 100

(b) Reduction by netting is from $ 4400 to $ 1300 (c) Percentage reduction done by netting is 70.45%

Problem 2

High Tax A
Sales Price COGS 3200 2200

Low Tax B
7000 3200

Combined A+B
7000 2200

Gross Profit
Operating Expense EBT

1000
800 200

3800
1000 2800

4800
1800 3000

Taxes
Net Income

100
100

560
2240

660
2340

Benefit = 2340 2100 = $ 240

Problem 3 The company should get some of its payments in form of royalty because these payments have less chances to get taxed Although cash dividends from foreign subsidiary to parent company are also not taxed most of the times

Problem 4 Earnings if the money is kept in USA = $ 100 Earnings if the money is kept in Swiss Francs Money converted = 10000*2 = 20000 Swiss Francs Interest Eared = 300 Swiss Francs Net Money = 20300 * 0.4 = $ 8120

Hence, the company should keep the money in USA only

 KIM Closing Case

Case Problem 15: Navistar Internationals Netting System

Ans1) Switzerland is a Tax haven and has flexible banking system and there are many large banks have shops in Switzerland, that is why Navistar chose its clearing system in this country Ans2) Because of Netting the number of intra company transactions reduced by 80% and hence the transaction costs of these 80% are reduced. Ans3) Besides transaction costs there is reduction in foreign exchange exposure and hence minimal losses in case of foreign exchange fluctuation Bid-Ask spread amount is reduced, which could otherwise have to be paid to banks in case the transactions are settled without Netting

 Ans4) Multilateral Netting should be used extensively Advantage of lagging and leading payments should be leveraged to the extent possible Encourage Intra company loans by subsidiaries which fall under bilateral or multi-lateral treaties to reduce tax Raw material sourcing done through subsidiaries located in countries where tax component is high to lessen the taxable amount

 Ans5) Bank of America http://corp.bankofamerica.com/public/public.portal?_p d_page_label=products/trade/index Bank of Montreal(BoM) http://www.bmo.com/home/commercial/banking/cas h-management/doing-business-globally?nav=left Cash Management Services at BoM Managing receivables Managing Payables Import-Export Trade Managing Information Global trade and Supply chain solutions

KIM Closing Case

Case Problem 15: Navistar Internationals Netting System

Ans1) Switzerland is a Tax haven and has flexible banking system and there are many large banks have shops in Switzerland, that is why Navistar chose its clearing system in this country Ans2) Because of Netting the number of intra company transactions reduced by 80% and hence the transaction costs of these 80% are reduced. Ans3) Besides transaction costs there is reduction in foreign exchange exposure and hence minimal losses in case of foreign exchange fluctuation Bid-Ask spread amount is reduced, which could otherwise have to be paid to banks in case the transactions are settled without Netting

Ans4) Multilateral Netting should be used extensively Advantage of lagging and leading payments should be leveraged to the extent possible Encourage Intra company loans by subsidiaries which fall under bilateral or multi-lateral treaties to reduce tax Raw material sourcing done through subsidiaries located in countries where tax component is high to lessen the taxable amount

Ans5) Bank of America http://corp.bankofamerica.com/public/public.portal?_pd_ page_label=products/trade/index Bank of Montreal(BoM) http://www.bmo.com/home/commercial/banking/cashmanagement/doing-business-globally?nav=left Cash Management Services at BoM Managing receivables Managing Payables Import-Export Trade Managing Information Global trade and Supply chain solutions

Short Term Financing of Working capital

Short-term overseas financing strategy, of Working capital, consists of four aspects

1) Identifying the key factors 2) Formulating and evaluating objectives

3) Describing available short-term borrowing options

4) Developing a methodology for calculating and comparing the effective dollar costs of these alternatives

1) Key factors
Costs and risks in an international funding strategy are influenced by six key factors

Factor-1
If forward contracts are unavailable, whether differences in nominal interest rates among currencies are matched by anticipated changes in exchange rate or not, meaning whether there is any deviation from international Fischer effect or not.

If deviations do exist, then expected dollar borrowing costs vary by currency, leading to decision problem. Trade-offs must be made between expected borrowing costs and exchange risks associated with each financing option

Factor-2 ( Exchange Risk)

Element of exchange risk, firms borrow locally to provide an offsetting liability for their exposed local currencies Borrowing a foreign currency in which firm has no exposure will increase a firms exchange risk

Factor-3(Firms degree of risk aversion)

The more risk averse the firm is , the higher the price it should be willing to pay to reduce its currency exposure.

Risk aversion affects the companys risk cost trade off and consequently in the absence of forward contracts, influences the selection of currencies in which the firm borrow.

Factor-4
If forward contracts are available, currency risk should not be a factor in the firms borrowing strategy. Instead firms relative borrowing costs are based on covered basis

The key issue is whether interest rate parity holds or not.

Factor-5
Even if the IRP does hold before tax, the currency denomination of corporate borrowings does matter where tax asymmetries are present.

These tax asymmetries are based on the differential treatment of foreign exchange gains and losses on either forward contracts or loan repayments

Factor-6 (Political risk)

MNCs use local resources to the extent possible if expropriation or exchange controls are imposed by the local governments, even if local financing is not the minimum cost option.

2) Short term financing objectives Four objectives guide a firm in deciding where and in which currencies to borrow

1) Minimize expected cost 2)Minimize risk without regard to cost 3) Trade off expected cost and systematic risk 4) Trade off expected cost and total risk

3)Short term financing options Firms typically prefer to finance the temporary component of current assets with short-term funds. The three principal short term financing options available to an MNC are

1) Intercompany financing 2) Local currency financing 3) Bank loans

Forms of Bank Credit

1) Term loans 2) Line of credit

3) Over drafts
4) Revolving Credit arrangements 5) Discounting

Interest rates on Bank loans

Effective Interest rate=Annual Interest paid Funds e.g. 10000 borrowed at 11% per year Effective interest rate when interest is paid at maturity=1100/10000=11% Effective interest rate on discounted loan=1100/8900=12.4%

Effective interest rate with compensating balance requirement=Annual interest paid/Usable funds E.g. 10000 loan with 15% compensating balance, and 11% interest rate Effective IR paid at maturity =1100/(10000-1500)=12.9% Effective IR on discounted loan =1100/(8500-1100)=14.9%

Commercial paper
It is a short term unsecured promissory note that is generally sold by large corporations on a discount basis to institutional investors and or other corporations Average maturity period varies from 20 to 25 days There are 3 major noninterest costs associated with using Commercial papers 1) Backup lines of credit 2) Fees to commercial banks 3) Rating service fees

4)Costs of alternative financing options

Case-1 :: No Taxes Lets assume a Mexican subsidiary can borrow Pesos at 45% and Dollars at 11%
Local currency loan Dollar cost of borrowing local currency(LC) at an interest rate of rL and a currency change of C is the sum of dollar interest cost plus the percentage change in the exchange rate Dollar cost of LC loan=Interest rate+ Exchange rate change
=rL(1+C)+C

Dollar loan Interest rate=11% Analysis:::: Break even exchange rate calculation 0.45(1+c)+c=0.11 c=-0.2345 If c<-23.45% borrow pesos If c>-23.45% borrow dollars C*=(rH-rL)/(1+rL)

Case -2 Taxes Tax rate (ta)=40%

Local Currency loan After-tax dollar cost of LC loan= Interest rate + Exchange rate change =rL(1+c)(1-ta) +c =0.45(1+c)(1-0.40)+c =0.27+1.27c

Dollar loan After tax cost of Dollar loan=Interest cost to subsidiary Tax gain(Loss) = rH(1-ta)+cta =0.11(1-0.4)+0.4c =0.066+0.4c Break even value of c occurs when both are equal 0.066+0.4c=0.27(1+c)+c C*=-0.2345

C*=(rH-rL)/(1+rL) From the above analysis we can see that the Break even value of Exchange rate remains same whether tax comes into effect or not

Designing a Global Remittance Policy

To Maximize value for a multinational firm as a whole the following interrelated decisions are important
How much money to remit When to do so Leading and lagging Where to transmit these funds Based on interest rate differentials between lending and borrowing rates in the different countries, Deploying funds in affiliates (than parent and subsidiary)

Which transfer methods to use Transfer pricing, Parallel loans, royalty etc.,

Inferior choice - Satisfies rather than Optimize

Due to complex financial linkages in multi national operations

Typically a parent company with n units will have n(n+1)/2 financial

linkages leading to exponential growth of intercompany relationships system optimization impossible Most parent cos. repatriate most of their affiliates cash except that required to meet their fund requirements. Still, the MNC must search for relatively high yield use of its internal financial system Optimize flows among the affiliates that account for an overwhelming majority of intercompany fund flows for most MNCs it is fewer than 10 affiliates

Factors affecting an MNCs ability to benefit from its internal financial transfer system
1. Number of financial links

2.
3. 4. 5.

Volume of inter affiliate transactions

Foreign affiliate ownership pattern Degree of product and service standardization Government regulations

Factors affecting an MNCs ability to benefit from its internal financial transfer system
1. Number of financial links

Since, each channel has different costs and benefits associated with its use, wider
the range of choice, greater a firms ability to achieve its goals of optimum profits. Eg: some links best suited to avoid exchange control and others to reduce taxes. Here two way flow of funds will give greater flexibility in deploying funds than if all

links are in one direction.

2. Volume of inter affiliate transactions Say a 1% change in transfer price on goods between 2 affiliates will have 10 times greater absolute effect if annual sales are $10 million than $ 1 million. Similarly, altering credit terms by 30 days is a more effective means of transferring funds as intercompany payables and receivables increases.

Factors affecting an MNCs ability to benefit from its internal financial transfer system
3. Foreign Affiliate Ownership Pattern

100% ownership of all foreign affiliates removes a major impediment to

the efficient allocation of funds. In JVs firms have to confirm to agreed set of mutually agreed upon rules on transfer activities 4. Degree of product and service standardization More standardized the products and services, lesser opportunities a firm has to adjust its transfer prices, fess and royalties. Conversely, a high technology product, strong product differentiation, and short product lifecycle enhance a companys ability to use mechanisms for transfer pricing and fee adjustments.

Factors affecting an MNCs ability to benefit from its internal financial transfer system
5. Government regulations

Government tax, credit allocation, and exchange control policies cause

firms to engage in international fund maneuvers at the same time these regulations most impede the flow of funds.

Hence to take full advantage of global financial system, the detailed

information on all these factors is required

Information Requirements of a Global Remittance Policy

Subsidiary financing requirements Sources/costs of external capital Local investment yields

Financial Channels available

Transaction volume Relevant tax factors Government restrictions on transfer of funds

Pros and Cons of International Finance Management

- Though boosts after-tax global profits for the firm as a whole it may

destroy incentive systems based on profit centers

- Can cause confusion and computational chaos - Subsidiaries may raise objection when it affects their own performance evaluations - Firms must clearly spell out the rules and adjust profit centre results to reflect true affiliate earnings

Transfer Pricing and Tax evasion - Example

- Swiss based commodities trading firm Marc Rich & Co, evaded tax to the tune of

$100 million by having its US affiliate, Pincus Green pay the Swiss parent
artificially high prices for oil thereby transferring profit to its Swiss parent. - US Gypsum company, mined gypsum rock in Canada was sold at a low price,

keeping Canadian profit and taxes down and was resold to the US unit at a high
price keeping US profits and taxes down. The profit was siphoned into another subsidiary which was a paper company in the low- tax bracket that owned the rock only while it fell from the Canadian conveyor belt to the hold of a US ship. - In both cases the US justice department registered won cases against these evasions and the companies had to pay penalties.

Services Of EXIM bank

EXIM Bank provides export credit facilities to Indian companies Commercial banks Overseas entities

Facilities to Indian Companies Pre-shipment credit Suppliers Credit Credit to Project Exporters For Exporters of Consultancy and Technological Services Guarantee Facilities Finance for Deemed Exports

For Commercial Banks Rediscounting facilities Refinance of Suppliers Credit For Overseas entities Buyers credit

Finance for Export Oriented Units

Overseas Investment Finance Lines of Credit SME & Agri-finance Film Finance Rural Initiatives Export Services

Major Policy Changes during 2010- 2011

Credit Policy Policy Rates Repo rate=8.25% Reverse Repo Rate=7.25% Reserves Ratio CRR increased from 5.75 to 6 in Apr 2010 SLR stands at 24%

Trade Policy
DEPB(Duty entitlement pass book) scheme ended on June 30, 2011 EPCG (Export promotion capital goods scheme) extended till March 2012 256 new products added under the FPS(Focus products scheme) Increase in incentives under the FMS(Focus market scheme) from 2.5 to 3% and those under FPS from 1.25 to 2 %

Investment Policy
FDI in the agriculture sector permitted for the development and production of seeds and planting material without stipulation of having to do so under controlled conditions SEBI registered MFs permitted to accept subscription from Foreign investors who meet KYC requirements for equity schemes

FII limit for investment in infrastructure bonds raised

Allowing IFCs to avail ECBs including the outstanding ECBs up to 50% of their owned funds under the automatic route, subject to their compliance with prudential guidelines in place Permission to corporates in the hotel, hospital and s/w industries to avail ECBs beyond $100 million.

Trade Finance Methods

1. Accounts Receivable Financing 2. 3. 4. Factoring Receivables Financing Letters of Credit Bankers Acceptance

5.
6. 7.

Working Capital Financing

Medium term capital goods financing (forfaiting) Countertrade

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Payment Methods for International Trade

1. Prepayment a. Same as cash in advance b. Payment usually by wire transfer c. Method offers exporter greatest degree of protection

d. Usually requested when

1.) First time buyer 2.) Danger of pre shipment cancellation

3.) Importer country has high political risk

110

Payment Methods for International Trade

2. Letters of Credit (L/C) a. An instrument issued by a bank b. on behalf of the importer (buyer) c. promising to pay the exporter (beneficiary) upon

presentation of
d. shipping documents in compliance with the terms stipulated therein.

e. In effect, the bank is substituting its credit for that of

the buyer.

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Payment Methods for International Trade

3. Drafts (or bill of exchange) a. An unconditional promise drawn by one party, usually the exporter, b. instructing the buyer to pay the face amount of the draft upon presentation. c. draft represents the exporters formal demand for payment from the buyer. d. draft affords the exporter less protection than an L/C because the banks are not obligated to honor payments on the buyers behalf.
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Payment Methods for International Trade

4. Consignment a. exporter ships the goods to the importer while still retaining actual title to the merchandise. b. The importer has access to the inventory but does not have to pay for the goods until they have been sold to a third party. c. The exporter is trusting the importer to remit payment for the goods sold at that time. d. If the importer fails to pay, the exporter has limited recourse because no draft is involved and the goods
113

have already been sold.

Payment Methods for International Trade

5. Open Account a. The opposite of prepayment - the exporter ships the merchandise and expects the buyer to remit payment according to the agreed - upon terms. b. The exporter is relying fully upon the financial creditworthiness, integrity, and reputation of the buyer. c. method is used when the seller and buyer have mutual trust and a great deal of experience with each other.

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Comparison of Payment Methods

Method Usual Time of Payment Before shipment Goods Available to Buyers After Payment Risk to Exporter Risk to Importer

Prepayment

None

Relies completely on exporter to ship goods as ordered Assured shipment made, but relies on exporter to ship goods described in documents Same as above unless importer can inspect goods before payment Same as above

Letter of credit

When shipment is made

After payment

Very little or none, depending on credit terms

Sight draft; documents against payment Time draft; documents against acceptance Consignment

On presentation of draft to buyer On maturity of drafts

After payment

If draft unpaid, must dispose of goods Relies on buyer to pay drafts Allows importer to sell inventory before paying exporter Relies completely on buyer to pay account as agreed

Before payment

At time of sale by buyer As agreed

Before payment

None: improves cash flow of buyer None

Open account

Before payment

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Trade Finance Methods

1. Accounts Receivable Financing 2. 3. 4. Factoring Receivables Financing Letters of Credit Bankers Acceptance

5.
6. 7.

Working Capital Financing

Medium term capital goods financing (forfaiting) Countertrade

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Trade Finance Methods

1. Accounts Receivable Financing a. could take the form of an open account shipment or a time draft b. the bank will provide a loan to the exporter secured

by an assignment of the account receivable.

2. Factoring Receivables the exporter sells the accounts receivable without

recourse.

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Trade Finance Methods

3.Letters of Credit ( L/C ) Trade related letters of credit known as commercial letters of credit or import/export letters of credit a. Types of Letters of Credit Revocable and Irrevocable b. Use of Drafts Bill of exchange - Sight and Time 30 180 days c. Bill of Lading: Key Document Title of merchandise Straight and Negotiable, Endorsing to next party d. Commercial Invoice (currency)

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Variations of Letter of Credit

Standby L/C
Buyers bank guarantees invoice payments to supplier. Seller supplies on open account terms if provided with Stand-by L/C.

Transferable L/C Allows the first beneficiary to transfer all or part of original L/C to the third party who gets the same rights & protection. Used by brokers. To pay suppliers who demand payment in advance.

Assignment of Proceeds Original beneficiary of the L/C pledges (assigns) the proceeds to end supplier. Bank will pay end supplier according to assignment instructions. Assignment is valid only if the beneficiary presents documents that comply with the L/C.

Documentary Credit Procedure

Advising bank

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Example of an irrevocable Letter of Credit

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Trade Finance Methods

4. Bankers Acceptance Bill of exchange, or time draft, drawn on and accepted by a bank. It is the accepting banks obligation to pay the holder of the draft at maturity. 5. Working Capital Financing 6. Medium-Term Capital Goods Financing (Forfaiting) Similar to factoring in that the forfaiter (or factor) assumes responsibility for the collection of payment from the buyer, the underlying credit risk, and the risk pertaining to the countries involved.
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Bankers Acceptance

123

Life Cycle of a Typical Bankers Acceptance (B/A)

124

Trade Finance Methods

7. Countertrade a. Denotes all types of foreign trade transactions in which the sale of goods to one country is linked to the purchase or exchange of goods from that same country. b. Some types of countertrade, such as barter, have been in existence for thousands of years. c. Other types compensation, counterpurchase d. Recently countertrade gained popularity and importance.
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Agencies That Motivate International Trade

1. Export-Import Bank of the United States a. Established in 1934 with the original goal of facilitating

Soviet- American trade.

b. Its mission today is to finance and facilitate the export of American goods and services c. Maintain the competitiveness of American companies in overseas markets. d. Programs that are classified as 1.) guarantees 2.) loans 3.) bank insurance

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4.) export credit insurance.

Agencies That Motivate International Trade

2. Private Export Funding Co. (PEFCO) a. Is owned by a consortium of commercial banks and industrial companies. b. Provides medium and long-term fixed rate financing

to foreign buyers.
3. Overseas Private Investment Corporation (OPIC) A self-sustaining federal agency responsible for insuring direct U.S. investments in foreign countries against the risks of currency inconvertibility, expropriation, and other political risks.
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Articles

Distribution Finance

Distribution finance provides funding and liquidity for manufacturers , from the time of product completion, through the distribution of goods via dealerships until the ultimate sale to end user. GE capital provides financing and servicing programmes that facilitate product distribution and the sale process. http://www.gecapital.eu/en/our_solutions/distribution_fina nce/whatis_distribution_finance.html

Zara's Secret for Fast Fashion-Inventory Management

The relentless introduction of new products in small quantities, ironically, reduces the usual costs associated with running out of any particular item. Indeed, Zara makes a virtue of stock-outs. Empty racks don't drive customers to other stores because shoppers always have new things to choose from. Being out of stock in one item helps sell another, since people are often happy to snatch what they can. In fact, Zara has an informal policy of moving unsold items after two or three weeks. This can be an expensive practice for a typical store, but since Zara stores receive small shipments and carry little inventory, the risks are small; unsold items account for less than 10 percent of stock, compared with the industry average of 17 percent to 20 percent. Furthermore, new merchandise displayed in limited quantities and the short window of opportunity for purchasing items motivate people to visit Zara's shops more frequently than they might other stores. Consumers in central London, for example, visit the average store four times annually, but Zara's customers visit its shops an average of 17 times a year. The high traffic in the stores circumvents the need for advertising: Zara devotes just 0.3 percent of its sales on ads, far less than the 3 percent to 4 percent its rivals spend. http://hbswk.hbs.edu/archive/4652.html

European Banks face short term funding stress

Renewed fears that the euro-zone debt crisis could infect the financial system put pressure on the short-term funding markets on Thursday, forcing some European banks to pay higher rates for US dollar loans. Banks rely on money markets for cash to fund their trades and loans. Fear about the safety of banks exposed to highly indebted countries reduces willingness to lend to them. In the extreme cases, such as the days immediately after the collapse of Lehman Brothers in September 2008, investors could stop funding banks completely, wreaking havoc on the entire economy. http://www.financialexpress.com/news/European-banks-faceshort-term-funding-stress/834392/

Ranbaxys working capital management improves in 2010

In 2010, Ranbaxy Laboratories Ltds financial health improved not only because of higher growth in revenue, aided by some key product launches in the US market, but also because of better working capital management. In 2009, its performance got affected by regulatory issues in the US market, but it recovered in 2010. The higher level of revenue did see its inventories rise by Rs381 crore, which could have affected its cash flow, but Ranbaxy controlled its debtors and lengthened its payables. That led to cash flow from operations rising to Rs2,157 crore, compared with just Rs80 crore in the previous year. As a result, its cash and bank balance rose by over 2.5 times to Rs3,264 crore during the year... http://www.livemint.com/2011/04/20225359/Ranbaxy8217sworking-capita.html

How to Improve Working Capital Management

What Affects Working Capital Management 1. Organizations are generally focused on cash, accounts payable, and supply chain issues. However, external issues like the legal and business environment, or internal mechanisms like organization structure and information systems, can significantly impact working capital. 2. Owing to market pressures, companies are led to paying a lot of attention to producing good quarterly results quarter after quarter. Undue focus on this may sometimes produce a flattering but inaccurate snapshot of working capital performance. This also happens in companies that have a marked seasonality of operations with working capital requirements varying widely from quarter to quarter. Measures to Improve Working Capital Management 1. The essence of effective working capital management is proper cash flow forecasting. This should take into account the impact of unforeseen events, market cycles, loss of a prime customer, and actions by competitors. The effect of unforeseen demands on working capital should be factored in http://www.performancexpress.org/2011/09/how-to-improve-workingcapital-management/

Page Numbers From Text Books

KIM Opening Case -An Efficient Global Treasury Structure (Page 369) 15.1 Basics of Working Capital Management (Page 370-382) 15.2 Cash Management (Page 382-388) 15.3 Accounts Receivable Management(Page 388-389) 15.4 Inventory Management (Page389-392) Problems KIM(1 To 4)(Page 393-394) Shapiro Designing global remittance policy- Chapter 20(Page-706-709 Including case study) Short term financing options:: (Page 669-676)

Thank You

16 July, 2011