Financial Management for Global Operations

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Chapter 14
International Business Oded Shenkar and Yadong Luo

• Financial Management for Global Operations

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Do You Know?

• The ways that sound financial management
  contributes to Multinational Enterprise global
  success?
• The major financial issues that are especially
  important to global operations?
• How payment methods differ between domestic and
  international transactions?

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Do You Know?

• How global payments are commonly conducted?
• The major sources of financing in global business
  and export?
• The major steps involved in listing stocks on the
  international exchanges?

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Do You Know

• How to reduce risk from foreign exchange
  fluctuation?
• The differences between foreign exchange risk and
  foreign exchange exposure?

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Minimizing Exposure in RTZ

• How does a company manage international risk? It
  isnt easy. When RTZ realized that foreign
  exchange fluctuation, risk, and exposure
  influenced net profits and could reduce
  shareholder wealth, they reorganized F(x) into
  the executive suite.

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Minimizing Exposure in RTZ

• The strategy they created had RTZ borrowing and
  conducting revenue operations with dollars, yen,
  and pounds.
• In operational locations presenting foreign
  exchange risk, they hold large reserves in
  domestic currency to preserve purchasing power
  and maintain ability to meet obligations in the
  foreign location.

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Why Learn Financial Management?

• Financial Management should be required knowledge
  for all international business managers.
• Financial management is, however, much more
  complex than the domestic equivalent because
  management must deal with differing financial
  markets, environments, institutions, and systems.
  

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Why Learn Financial Management?

• Many times, financial management in an
  Multinational Enterprise global operations occurs
  in an environment characterized by volatile
  foreign exchange rates, restrictions on capital
  flows, varying country and political risk,
  differing tax systems, and a wide spectrum of
  institutional settings.

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Why Learn Financial Management?

• Knowledge of financial management helps the firm
  in two ways
• It helps the financial manager decide what steps
  should be taken to exploit opportunities and
  protect the firm from financial threats
• It helps the manager anticipate events and make
  profitable decisions before events occur

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Why Learn Financial Management?

• Financial management for global operations deals
  with the following major issues
• International Trade Finance
• Financing Global Operations
• Managing Foreign Exchange Risk and Exposure
• Working Capital Management

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International Trade Finance

• Options for International Trade Payment are
• Cash in Advance
• Letter of Credit
• Documentary Collection
• The Open Account

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International Trade Finance

• Cash In Advance affords the exporter the greatest
  protections because payment is received before
  shipment, or when goods arrive.
• This is mainly used in countries where there is
  political instability, or where the buyers
  credit is shaky.
• Political crises and/or foreign exchange controls
  often necessitate the Cash in Advance Deal.

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International Trade Finance

• Letters of Credit (l/c) are the means by which
  the majority of international transactions occur.
  
• This is a letter written to the seller, signed by
  the buyers bank.
• It promises to honor drafts drawn on the bank, if
  the seller follows the rules set in the letter,
  which are usually the same as in the purchasing
  contract. If they are different, both conditions
  apply.

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Advantages of L/Cs

• They eliminate Credit Risk, if the bank is in
  good standing
• They reduce uncertainty for payment, because the
  seller knows all the rules for obtaining payment
• They stabilize production by assuring payment
  before a production run begins
• They facilitate financing because they assure a
  ready foreign buyer

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International Trade Finance

• L/C Terminology
• Documentary Requirement L/C is required for
  most import/export transactions
• Clean L/C presented without other documents, it
  is useful for overseas bank guarantees, escrow
  arrangements, and security purchases
• Irrevocable L/C cannot be revoked without the
  specific permission of all parties involved,
  including the exporter
• Confirmed L/C is issued by on bank and
  confirmed by another, obligating both banks to
  honor drafts drawn in compliance

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International Trade Finance

• Unconfirmed L/C is the obligation of only the
  issuing bank. Most would prefer the confirmed,
  irrevocable L/C.
• The Transferable L/C is where a beneficiary has
  the right to instruct the paying bank to make
  credit available to one or more secondary
  beneficiaries
• The Back to Bank L/C exists where the exporter,
  as beneficiary, offers its credit as security in
  order to finance the opening of a second credit
• The Revolving L/C exists where the tenor or
  amount of the L/C is automatically renewed
  pursuant to terms and conditions. These can be
  cumulative or non-cumulative /

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International Trade Finance
Exhibit 14-1 Process of using letter of credit
(L/C)
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International Trade Finance

• The Documentary Collection is a payment mechanism
  that allows exporters to retain ownership of
  goods until they receive payment or are
  reasonable certain they will receive it. These
  documents are generally titles to the goods.
• The Open Account involves shipping goods, and
  then billing the importer later. The credit
  terms are arranged between the importer and the
  exporter. These are usually afforded to
  longstanding partners, or to foreign affiliates
  where payment is reasonably assumed.

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International Trade Finance
Exhibit 14-2 Documents against payment (D/P) flow
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International Trade Finance
Exhibit 14-3 Documents against acceptance (D/A)
flow
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International Trade Finance

• Means of Payment are traditionally done through
  the Airmail Payment, the Telex, the Society for
  Worldwide Information and Funds Transfer (SWIFT),
  the bank draft, the money order, and the
  inter-bank email system.

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Export Financing

• Export Financing is important because many export
  projects require a large amount of startup cost.
  Sources of funds come from the Private Source,
  and the Governmental Source.

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Financing Private Sources

• Commercial Banks
• Export Finance Companies
• Factoring Houses
• Forfeit Houses
• International Leasing Companies
• In-House Finance Companies
• Private Insurance Companies

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Financing Government Sources

• Export-Import Bank Financing (Ex-Im Bank)
• Foreign Credit Insurance

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Financing Global Business

• Compared to financing international trade, the
  financing of global production is much more
  complex. These options include
• Intercompany Financing - where parent and sister
  subsidiaries competitiveness-finance one another
• Equity Financing Where financing is conducted
  through issuing stock in home or host country, or
  cross listing shares on multiple exchanges

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Financing Global Business
Exhibit 14-4 Sources of financing global
operations
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Financing Global Business

• Debt Financing through using Eurocurrency
  Markets, Eurocredits, or Euronotes. There are
  also Eurobonds, foreign bonds, Yankee Bonds,
  Samurai Bonds, and Bulldogs (issued in the United
  Kingdom)
• Local Currency Financing through bank loans,
  non-bank sources, discounting, and parallel loans

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Financing Global Business
Exhibit 14-5 Tapping Wall Street three stages
for non-U.S. MNEs to be traded in the United
States
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Managing Foreign Exchange Risk and Exposure

• Foreign Exchange Risk concerns the variance of
  the domestic currency value of an asset,
  liability, or operating income that is
  attributable to unanticipated variances in the
  exchange rates.
• Foreign Exchange Exposure refers to the
  sensitivity of changes in the real
  domestic-currency value of assets, liabilities,
  or operating incomes to unanticipated changes in
  exchange rates.

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Transaction and Economic Exposure

• Transaction Exposure is concerned wit how
  changes in exchange rates affect the value of
  anticipated cash flows in foreign currency and
  their settlements.
• Economic Exposure also known as operating
  exposure, measures the change in the present
  value of the firm resulting from any change in
  the future operating cash flows caused by an
  unexpected change in exchange rates and
  macroeconomic factors.

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Translation Exposure

• Translation Exposure,refers to the potential for
  accounting derived changes in owners equity to
  occur because of the need to consolidate foreign
  currency financial statements.

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Translation Exposure
Exhibit 14-6 Framework of managing foreign
exchange exposure
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Managing Transaction Exposure

• To manage transaction exposure, financial
  managers hedge with financial instruments. They
  use the
• Forward Markets, hedging for anticipated
  exchanges in the future
• Futures Markets, hedging via the futures markets
• Options Markets, Using calls (buying a number of
  currency units in the future at some specific
  price), or puts (selling a number of currency
  units in the future at a specific price) /

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Managing Transaction Exposure
Exhibit 14-7 Forward hedging example
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Managing Transaction Exposure

• Spot Markets, buying and selling currency in
  current time when there is unpredictable
  fluctuation
• Bartering, buying and selling goods in exchange
  for other goods

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Cash Management

• Firms need to create a global management system
  for working capital, cash flow.
• HQ must clearly define what aspects of cash
  management are centralized (like in RTZ) and what
  should be decentralized.
• They should formalize policies that help them
  manage international accounts receivable.