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Questions and Answers
What effect does the management of working capital have on liquidity?
What effect does the management of working capital have on liquidity?
Why might a subsidiary need to maintain larger cash balances?
Why might a subsidiary need to maintain larger cash balances?
What is a potential downside of looser credit standards for a subsidiary?
What is a potential downside of looser credit standards for a subsidiary?
How can forecasting cash flows be simplified for a subsidiary?
How can forecasting cash flows be simplified for a subsidiary?
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What must a subsidiary do after accounting for all cash inflows and outflows?
What must a subsidiary do after accounting for all cash inflows and outflows?
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What is the primary focus of International Cash Management?
What is the primary focus of International Cash Management?
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Which function is NOT part of centralized cash management?
Which function is NOT part of centralized cash management?
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How can companies accelerate cash inflows?
How can companies accelerate cash inflows?
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What is the main advantage of a bilateral netting system?
What is the main advantage of a bilateral netting system?
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What is a potential disadvantage of centralized cash management?
What is a potential disadvantage of centralized cash management?
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What is the formula for calculating working capital?
What is the formula for calculating working capital?
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Which of the following is considered a common liquidity ratio?
Which of the following is considered a common liquidity ratio?
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What does a working capital ratio greater than 2.0 indicate?
What does a working capital ratio greater than 2.0 indicate?
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Which of the following indicates a potential liquidity risk for a firm?
Which of the following indicates a potential liquidity risk for a firm?
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What is a primary focus of short-term financing in working capital management?
What is a primary focus of short-term financing in working capital management?
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Study Notes
Managing Working Capital: International Cash Management
- Managing working capital and cash flow is crucial for businesses, especially international ones
- Analyzing cash flow from a subsidiary perspective differs from a parent perspective
- Various techniques optimize cash flow within a firm
- Optimizing short-term (ST) cash flow involves complications
- Foreign short-term investments have potential benefits and risks
ST Asset and Liability Management: Working Capital
- Short-term financing (ST liabilities) is contrasted with short-term investment decisions (ST assets)
- ST financing mainly focuses on international trade and investment decisions, impacting inventory, accounts receivable, and cash management
- ST financing involves borrowing ST funds and issuing ST securities (e.g., commercial papers)
- Working capital (current assets – current liabilities) is vital for paying creditors in the short term
Working Capital Ratio
- Working capital ratio = (Current Assets) / (Current Liabilities)
- Ratios less than 1 indicate negative working capital
- Ratios greater than 2 suggest excess investment of assets
- A ratio between 1.2 and 2.0 is considered sufficient (Investopedia)
Other Liquidity Ratios
- Quick ratio (QR) = (current assets – inventories) / current liabilities
- QR = (cash & cash equivalents + marketable securities + accounts receivable) / current liabilities
- A higher QR signifies better liquidity
- Acceptable QR is 1 or greater than 1
- Cash ratio = (cash & cash equivalents) / current liabilities
- This is the most frequent liquidity measure
- Advisable range: 0.2 to 0.25
Working Capital & Cash Flow Analysis
- Working capital management directly impacts cash flow amount and timing
- Key areas impacted are inventory management, accounts receivable management, cash management, and liquidity management
Cash Flow Analysis: Subsidiary Perspective
- International material purchases are challenging due to exchange rate fluctuations and quotas
- Volatile sales necessitate larger cash balances for unexpected inventory demands
- International sales are volatile due to exchange rate and business cycle fluctuations; and
- Looser credit standards can boost revenue, but may decrease cash inflow speed
Subsidiary Dividend Payments
- Forecasting cash flows is easier with known dividend payments, fees (royalties and overhead charges) communicated in advance, and denominated in similar currencies to the parent company
Subsidiary Liquidity Management
- After accounting for all cash flows, subsidiaries either invest excess cash or borrow to cover deficiencies
- Access to credit lines and overdraft facilities supports adequate liquidity without significant cash imbalances
International Cash Management
- ICM's primary focus is optimizing cash flow and reinvesting excess funds
- Exchange rate fluctuations significantly impact cross-border cash transfers
- Scope includes subsidiary and HQ perspectives, often leading to centralization of ICM at MNC level
Centralized Cash Management
- Centralized cash management is needed to oversee and often manage parent-subsidiary and inter-subsidiary cash flows
- International cash management is often segmented into optimizing cash flow movements (ST) and investing excess cash
Complications in Optimizing Cash Flows
- Subsidiary payment delays may force other subsidiaries to borrow money
- Certain governments restrict or prevent cash from leaving the country
Characteristics of Banking Systems
- Bank abilities to process MNC cash transfers can differ between countries
- Banking systems in various nations have different operations
Investing Excess Cash
- Excess funds may be invested in domestic or foreign short-term securities like Eurocurrency deposits, bills, and commercial papers
- Foreign short-term securities can sometimes offer higher interest rates
- Firms should consider potential exchange rate movements when investing
Centralized Cash Management - Advantages
- Centralized cash management enables more efficient fund utilization and improved returns
- Separating cash pools for each currency is beneficial in cases involving multiple currencies; investments can be denominated in the needed currencies
Cash Pooling: Practical Case (Aurubis Bulgaria AD)
- A cash pool with affiliates includes cash in bank accounts of the ultimate parent company
- The parent company centrally provides services for securing loans for subsidiaries and depositing their funds
Cash Pooling: Practical Case (Aurubis Bulgaria AD)
- Cash pool with affiliates = 200,493 thousand BGN
- Cash and equivalents = 44,337 thousand BGN
- Data from the statement of financial position for FYE 31.12.2020
Investing Excess Cash - Determining the Effective Yield
- The effective rate for foreign investments = [(1+i)(1+e)] - 1
- i = the quoted interest rate on the investment
- e = the % change in the spot interest rate
Investing Excess Cash - Implications of Interest Rate Parity (IRP)
- A high-interest foreign currency often has a forward discount related to the differential between its interest and the investor's home rate
- Short-term foreign, uncovered investments can still produce a higher effective yield than the local option
Investing Excess Cash - Use of the Forward Rate as a Forecast
- If IRP exists, then the forward rate can be used as a break-even point to evaluate a short-term investment decision
- The effective yield will be higher if the spot rate at maturity exceeds the forward rate at the investment's initiation
Investing Excess Cash - Use of Exchange Rate Forecasts
- Forecasts of exchange rates aid in calculating the projected effective yield of foreign investments and comparing it to local options
- Probability distributions can be used instead of point estimates to compute the break-even exchange rate that equates both yields
Investing Excess Cash - Diversifying Cash Across Currencies
- Diversifying cash among currencies is often preferred when exchange rates' future movements are uncertain
- Portfolio risk reduction is determined by currency correlations
Investing Excess Cash - Use of Dynamic Hedging
- Dynamic hedging strategically hedges when the currencies are expected to depreciate but not when they're predicted to appreciate
- Successful dynamic hedging relies on precise exchange rate movement forecasts
Impact of International Cash Management on an MNC's Value
- MNC value is determined by expected cash flow for a given currency multiplied by its expected exchange rate, all divided by (1+k), where k is the weighted-average cost of capital
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Description
This quiz explores the intricacies of managing working capital and cash flow in international business contexts. Participants will learn about the differences between subsidiary and parent perspectives, techniques for optimizing cash flow, and the complexities of short-term asset and liability management. Understanding the working capital ratio and its implications for financial health is also covered.
