International Cash Management PDF

Managing Working Capital: International Cash Management IFM, T. Tzanov, UNWE; IFM, Madura, J. South-Western/Thomson Learning ©  Outline To stress on the importance of working capital & cash management; Differences between a subsidiary perspective and a parent perspec...

Managing Working Capital: International Cash Management IFM, T. Tzanov, UNWE; IFM, Madura, J. South-Western/Thomson Learning ©  Outline To stress on the importance of working capital & cash management; Differences between a subsidiary perspective and a parent perspective in analyzing cash flows; To explain the various techniques used to optimize cash flows within the firm; To explain common complications in optimizing cash flows (ST), and To explain the potential benefits and risks of foreign ST investments. IFM, T.Tzanov, UNWE - 2  ST Asset and Liability Management: Working Capital Short-term financing (ST liabilities) vs. ST investment decisions (ST assets). ST financing focusing mainly on (international) trade and investment decisions (reflected in inventory management, accounts receivable, cash management). ST financing through borrowing ST funds, issuing ST securities (e.g., commercial papers sold by large corporations in the U.S.). Thus, management of working capital. IFM, T.Tzanov, UNWE - 3  ST Asset and Liability Management: Working Capital Working capital = Current Assets – Current Liabilities Current assets should exceed current liabilities, otherwise a firm may run into trouble paying back to creditors in ST. Working capital (current) ratio = Current Assets/ Current Liabilities ¤ Levels < 1 indicate negative Working Capital (W/C) ¤ Anything > 2 the firm is not investing excess assets. ¤ W/C ratio between 1.2 and 2.0 sufficient (Investopedia) IFM, T.Tzanov, UNWE - 4  Other Liquidity ratios Quick ratio (QR) = (current assets – inventories) / current liabilities, or ¤ Quick ratio = (cash & cash equivalents + marketable securities + accounts receivable) / CL. ¤ The higher the ratio, the better the company’s liquidity position. Acceptable QR = 1 or > 1. Cash ratio = (cash & cash equivalents) / CL. ¤ Most commonly used as a measure of company’s liquidity; ¤ Advisable: Should not fall below 0.2-0.25. IFM, T.Tzanov, UNWE - 5 Working Capital & Cash Flow Analysis The management of working capital has a direct influence on the amount and timing of cash flow : ¤ inventory management ¤ accounts receivable management ¤ cash management ▪ Subsequently, liquidity management. IFM, T.Tzanov, UNWE - 6 Working Capital & Cash Flow Analysis The management of working capital has a direct influence on the amounts of liquidity (cash & cash equivalents): Current assets Current liabilities BGN ‘000 BGN ‘000 Inventory ST loans 15250 7860 Trade receivables Trade payables 12150 10240 Cash & cash equivalents Other current liabilities 5234 8240 IFM, T.Tzanov, UNWE - 7  Cash Flow Analysis: Subsidiary Perspective Subsidiary Expenses International purchases of raw materials or supplies are more likely to be difficult to manage because of exchange rate fluctuations, quotas, etc. If the sales volume is highly volatile, larger cash balances may need to be maintained in order to cover unexpected inventory demands. IFM, T.Tzanov, UNWE - 8  Cash Flow Analysis: Subsidiary Perspective Subsidiary Revenue International sales are more likely to be volatile because of exchange rate fluctuations, business cycles, etc. Looser credit standards (selling of goods and services by extending credit to customers) may increase sales (accounts receivable), though often at the expense of slower cash inflows. IFM, T.Tzanov, UNWE - 9  Cash Flow Analysis: Subsidiary Perspective Subsidiary Dividend Payments Cash installments to the parent: ¤ Forecasting cash flows will be easier if the dividend payments and fees (royalties and overhead charges) to be sent to the parent are known in advance, - denominated in the subsidiary’s, vs. parent’s currency. IFM, T.Tzanov, UNWE - 10  Cash Flow Analysis: Subsidiary Perspective Subsidiary Liquidity Management After accounting for all cash outflows and inflows, the subsidiary must either invest its excess cash or borrow to cover its cash deficiencies. If the subsidiary has access to lines of credit and overdraft facilities, it may maintain adequate liquidity without substantial cash imbalances. IFM, T.Tzanov, UNWE - 11  International Cash Management ICM focal issue: optimization of cash flows and investment of excess cash. From an international perspective – complex decisions. In addition, exchange rate fluctuations can affect the value of cross-border cash transfers. An important scope – subsidiary and HQ perspectives, thus leading to a certain centralization of ICM at MNC level. IFM, T.Tzanov, UNWE - 12  Centralized Cash Management While each subsidiary is managing its own working capital, a centralized cash management group is often needed to monitor, and possibly manage, the parent- subsidiary and inter-subsidiary cash flows. International cash management can be segmented into two (sub-)functions: ¤ optimizing cash flow movements (ST), and ¤ investing excess cash. IFM, T.Tzanov, UNWE - 13  Centralized Cash Management The centralized cash management division of an MNC cannot always accurately forecast the events that may affect parent- subsidiary or inter-subsidiary cash flows. It should, however, be ready to react to any event by considering ¤ any potential adverse impact on cash flows, and ¤ how to avoid such adverse impacts. IFM, T.Tzanov, UNWE - 14  Techniques to Optimize Cash Flows Accelerating Cash Inflows The more quickly the cash inflows are received, the more quickly they can be invested or used for other purposes. Common methods include the establishment of lockboxes (or accounts) around the world (to reduce mail float) and preauthorized payments (direct charging of a customer’s bank account – direct debit). IFM, T.Tzanov, UNWE - 15  Techniques to Optimize Cash Flows Minimizing Currency Conversion Costs Netting reduces administrative and transaction costs through the accounting of all transactions that occur over a period to determine one net payment. A bilateral netting system involves transactions between two units, while a multilateral netting system usually involves more complex interchanges. IFM, T.Tzanov, UNWE - 16  Techniques to Optimize Cash Flows Netting (inter-subsidiary payments matrix) Monitoring of payments between parent- subsidiaries and inter-subsidiaries. Payments owed BGN value (in Thousand) owed to by subsidiaries subsidiary per country of location (country of location) Bulgaria U.K. Bulgaria - 4000 U.K. 6000 - Net position (U.K.) 2000 - IFM, T.Tzanov, UNWE - 17  Techniques to Optimize Cash Flows Managing Blocked Funds A government may require that funds remain within the country in order to create jobs and reduce unemployment. The MNC should then reinvest the excess funds in the host country, adjust the transfer pricing policy (such that higher fees have to be paid to the parent), borrow locally rather than from the parent, etc. IFM, T.Tzanov, UNWE - 18  Techniques to Optimize Cash Flows Managing Intersubsidiary Cash Transfers A subsidiary with excess funds can provide financing by paying for its supplies earlier than is necessary. This technique is called leading. Alternatively, a subsidiary in need of funds can be allowed to lag its payments. This technique is called lagging. IFM, T.Tzanov, UNWE - 19  Complications in Optimizing Cash Flows Company-Related Characteristics ¤ When a subsidiary delays its payments to the other subsidiaries, the other subsidiaries may be forced to borrow until the payments arrive. Government Restrictions ¤ Some governments may prohibit the use of a netting system, or periodically prevent cash from leaving the country. IFM, T.Tzanov, UNWE - 20  Complications in Optimizing Cash Flows Characteristics of Banking Systems ¤ The abilities of banks to facilitate cash transfers for MNCs may vary among countries. ¤ The banking systems in different countries usually differ too. IFM, T.Tzanov, UNWE - 21  Investing Excess Cash Excess funds can be invested in domestic or foreign short-term securities, such as Eurocurrency deposits, bills, and commercial papers. Sometimes, foreign short-term securities have higher interest rates. However, firms must also account for the possible exchange rate movements. IFM, T.Tzanov, UNWE - 22  Investing Excess Cash Centralized Cash Management – advantages Centralized cash management allows for more efficient usage of funds and possibly higher returns. When multiple currencies are involved, a separate pool may be formed for each currency. The investment securities may also be denominated in the currencies that will be needed in the future. IFM, T.Tzanov, UNWE - 23 Cash pooling: Practical case Aurubis Bulgaria AD: Group cash pooling A cash pool with affiliates includes cash in bank accounts of the ultimate parent company. As part of the group's liquidity management policy, the parent company provides centralized services for securing necessary loans to subsidiaries as well as depositing their available cash. IFM, T.Tzanov, UNWE - 24 Cash pooling: Practical case Aurubis Bulgaria AD: Group cash pooling Current assets BGN ‘000 Cash pool with affiliates 200,493 Cash & cash equivalents 44,337 Source: Statement of financial position for FYE 31.12.2020 The cash pooling in this case is in EUR and USD. Thus, exchange rate differences. IFM, T.Tzanov, UNWE - 25  Investing Excess Cash Determining the Effective Yield The effective rate for foreign investments rf = (1+if ) (1+ef ) – 1 where if = the quoted interest rate on the investment ef = the % D in the spot rate If the foreign currency depreciates over the investment period, the effective yield will be less than the quoted rate. IFM, T.Tzanov, UNWE - 26  Investing Excess Cash Implications of Interest Rate Parity (IRP) A foreign currency with a high interest rate will normally exhibit a forward discount that reflects the differential between its interest rate and the investor’s home interest rate. However, short-term foreign investing on an uncovered basis may still result in a higher effective yield. IFM, T.Tzanov, UNWE - 27  Investing Excess Cash Use of the Forward Rate as a Forecast If IRP exists, the forward rate can be used as a break-even point to assess the short- term investment decision. The effective yield will be higher if the spot rate at maturity is more than the forward rate at the time the investment is undertaken, and vice versa. IFM, T.Tzanov, UNWE - 28  Investing Excess Cash Use of Exchange Rate Forecasts Given an exchange rate forecast, the expected effective yield of a foreign investment can be computed, and then compared with the local investment yield. It may be useful to use probability distributions instead of point estimates, or to compute the break-even exchange rate that will equate foreign and local yields. IFM, T.Tzanov, UNWE - 29  Investing Excess Cash Diversifying Cash Across Currencies If an MNC is not sure of how exchange rates will change over time, it may prefer to diversify its cash among securities that are denominated in different currencies. The degree to which such a portfolio will reduce risk depends on the correlations among the currencies. IFM, T.Tzanov, UNWE - 30  Investing Excess Cash Use of Dynamic Hedging to Manage Cash Dynamic hedging refers to the strategy of hedging when the currencies held are expected to depreciate, and not hedging when they are expected to appreciate. The overall performance is dependent on the firm’s ability to accurately forecast the direction of exchange rate movements. IFM, T.Tzanov, UNWE - 31 Impact of International Cash Management on an MNC’s Value Returns on International Cash Management  n  n  E (CFj, t ) E (ER j, t )  j =1  Value =    t =1  (1 + k ) t    E (CFj,t ) = expected cash flows in currency j to be received by the parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t k = weighted average cost of capital of the parent IFM, T.Tzanov, UNWE - 32 THANK YOU FOR YOUR ATTENTION! IFM, T.Tzanov, UNWE - 33