icf group 3 working capital

International Working Capital Management

16 July, 2011

By

Group 3:

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

Presentation PathBasics 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 fundingComputing 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, Dell’s 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

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 company’s ability to take advantage of soft spots in tax laws and regulatory barriers.

The ability to transfer funds

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 opportunitiesThe 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 firm’s 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 Float1) 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 company’s 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 firm’s books and that of the Bank’s 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 company’s 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 fundsAlong 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.

2) 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 parent’s short-term debts.

3) They can centralize cash management in third countries, such as tax haven countries, and invest funds in marketable securities.

4) They can centralize cash management at headquarters, with subsidiaries holding only minimum amounts of cash for transaction purposes.

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 near-future needs of liquidity, marketability considerations are of major importance.

iii)The maturity of the investment should be tailored to the company’s 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 problemsof 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 PerspectiveMajor determinants of investment in inventory :

the level of salesthe 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 PerspectiveMajor determinants of investment in inventory :

the level of salesthe 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

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 expansionMore 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 company’s 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 company’s idle cash by $20 million per year, with a corresponding reduction in external debt

Contd…

Through a single IFSC vehicle, ABN centralized allintercompany lending and

hedging activity

• Alsoestablished a monthly netting system

designed an effective euro-based cash pool and

increased control with a simplified structure

• KIM Problems

Problem 1

Subsidiary Payments Receipts Net Paid Net Receive

USA 900 1900 1000

Japan 1000 1200 200

Germany 1600 500 1100

Canada 900 800 100

(b) Reduction by netting is from $ 4400 to $ 1300

(c) Percentage reduction done by netting is 70.45%

Problem 2

High Tax A Low Tax B Combined A+B

Sales Price 3200 7000 7000

COGS 2200 3200 2200

Gross Profit 1000 3800 4800

Operating Expense

800 1000 1800

EBT 200 2800 3000

Taxes 100 560 660

Net Income 100 2240 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 FrancsInterest Eared = 300 Swiss FrancsNet Money = 20300 * 0.4 = $ 8120

Hence, the company should keep the money in USA only

• KIM Closing Case

Case Problem 15: Navistar International’sNetting 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/

cash-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 International’sNetting 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/cash-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

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(Firm’s 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 company’s 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 objectivesFour 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 optionsFirms 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 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 paperIt 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 credit2) Fees to commercial banks3) Rating service fees

4)Costs of alternative financing options

Case-1 :: No TaxesLets assume a Mexican subsidiary can

borrow Pesos at 45% and Dollars at 11%Local currency loanDollar 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 calculation0.45(1+c)+c=0.11c=-0.2345 If c<-23.45% borrow pesos If c>-23.45% borrow dollarsC*=(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 loanAfter 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+0.4cBreak even value of c occurs when both are

equal0.066+0.4c=0.27(1+c)+cC*=-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. Volume of inter affiliate transactions

3. Foreign – affiliate ownership pattern

4. Degree of product and service standardization

5. Government regulations



1. Number of financial links

Since, each channel has different costs and benefits associated with its use, wider

the range of choice, greater a firm’s 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.



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 company’s ability to use mechanisms for transfer

pricing and fee adjustments.



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 bankEXIM Bank provides export credit facilities to

Indian companies Commercial banks Overseas entities

Facilities to Indian Companies Pre-shipment credit Supplier’s 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 PolicyFDI 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.


1. Accounts Receivable Financing

2. Factoring Receivables Financing

3. Letters of Credit

4. Banker’s Acceptance

5. Working Capital Financing

6. Medium term capital goods financing (forfaiting)

7. Countertrade

109


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


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.

111


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 exporter’s 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 buyer’s

behalf.

112


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 have already been sold.

113


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.

114

115

Comparison of Payment Methods

Method Usual Time of Payment

Goods Available to Buyers

Risk to Exporter Risk to Importer

Prepayment Before shipment After Payment None Relies completely on exporter to ship goods as ordered

Letter of credit When shipment is made

After payment Very little or none, depending on credit terms

Assured shipment made, but relies on exporter to ship goods described in documents

Sight draft; documents against payment

On presentation of draft to buyer

After payment If draft unpaid, must dispose of goods

Same as above unless importer can inspect goods before payment

Time draft; documents against acceptance

On maturity of drafts Before payment Relies on buyer to pay drafts

Same as above

Consignment At time of sale by buyer

Before payment Allows importer to sell inventory before paying exporter

None: improves cash flow of buyer

Open account As agreed Before payment Relies completely on buyer to pay account as agreed

None



2. Factoring Receivables Financing

3. Letters of Credit



6. Medium term capital goods financing (forfaiting)

7. Countertrade

116



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.

117


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)

118

Variations of Letter of Credit

Standby L/C – Buyer’s 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

120

Advising bank

121

Example of an irrevocable Letter of Credit



Bill of exchange, or time draft, drawn on and accepted by a bank. It

is the accepting bank’s obligation to pay the holder of the draft at

maturity.


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.

122

Banker’s Acceptance

123

Life Cycle of a Typical Banker’s Acceptance (B/A)

124


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.

125

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

4.) export credit insurance.

126

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.

127

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_finance/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-face-short-term-funding-stress/834392/

Ranbaxy’s working capital management improves in 2010

In 2010, Ranbaxy Laboratories Ltd’s 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/Ranbaxy8217s-working-capita.html

How to Improve Working Capital Management

What Affects Working Capital Management1. 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 Management1. 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-working-capital-management/

Page Numbers From Text Books

KIMOpening 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)ShapiroDesigning global remittance policy- Chapter 20(Page-706-709 Including

case study)Short term financing options:: (Page 669-676)

Thank You

16 July, 2011

icf group 3 working capital

Documents

supply chain

date effectively

local inventoriesshould

date effectively

flexible banking

imported goodsshould

locally acquired

inventories