OHANA International Financial Management

2. OHANA International Financial Management

3. Presented to Sir Tasawar Javed

4. Group members Iqra Butt 25 Rashid Badar 38 Nadia Perveen 49 Sariya Manzoor 59 Sheraz Irshad 63

5. Introduction International financial management encompasses a number of key areas. These include • Management of Global cash flow • Foreign exchange risk management • Capital expenditure analysis • Capital budgeting

6. Decision in each of these areas can significantly impact the others. For example, if the exchange rate of Mexican peso sharply decline against the dollar the multinational may decide to transfer more dollars to its Mexican subsidiary so that the unit can continue paying for imports from the US.

7. Objectives • Provide assistance to all geographic operations • To limit financial losses through the use of carefully formulated cash flow guidelines • Timely execution of foreign exchange risk strategies • Prudent capital expenditures • Careful capital budgeting

8. The responsibility for these activities is spread thought the organization and some of these decisions are made on day-to day basis whereas others are determine periodically • Some decisions are made by the parent company whereas others fall within the preview of the subsidiary.

9. Determining parent-subsidiary relationship • Parent companies firmly establish the relationship that will exist regarding financial planning and control authority • Each branch or subsidiary should be responsible for its own planning and control system • There must be some central control in order to coordinate overall operations and to ensure both efficiency and profitability

10. Addressing these challenges, MNEs tend to operate for one of three solutions • Polycentric solution • Ethnocentric solution • Geocentric solution

11. Polycentric solution • An approach to determining parent- subsidiary relation • It involves treating the MNE as a holding company and decentralizing decision making to the subsidiary level

12. Advantages of polycentric approach are those commonly obtained with decentralization • Decision are made on the spot by those most informed about market conditions and international subsidiary tend to be more flexible, motivated, efficient and competitive • It reduce the authority of the home office and senior corporate management often dislike this dilution of authority

13. Ethnocentric solution • It involves treating all foreign operations as if they were extensions of domestic operations • Advantage of this approach is that management is able to coordinate overall operations carefully • Drawback of this approach is that it can cause problem for the individual subsidiary which may feel that it need more cash than is left on hand or that it is hindered in its efforts to expand because the parent company is siphoning off necessary resources

14. Geocentric solution • Handling financial planning and controlling decisions on a global basis • These decisions influcend by two factors • Nature and location of subsidiary For example British investment in north America has predominantly been via holding companies, the polycentric approach, since the quality of local management largely rewards decentralization.

15. A second influencing factor is the gains that can be achieved by coordinating all units in a carefully synchronized way. • Example????

16. Managing Global Cash Flows • Internal Funds Flows • Funds positioning techniques • multilateral netting.

17. Internal Funds Flows 1.Working Capital. • Difference between current assets and current liabilities. For example • If GM German subsidiary wants to heir more employees it may be able to pay for this payroll increase out of the funds it generates from on going operations.

18. 2.Borrowing from a local bank. • For Example an MNE’s Chilean subsidiary will get a loan from the parent company or the German subsidiary and then repay the money with interest out of operations. • 3.By having the parent company increase its equity capital investment in the subsidiary.

19. Funds positioning techniques • Strategies that are used to to move monies from one multinational operations to another. • Three most common approaches are • Transfer pricing • Tax havens • Fronting loans

20. Transfer pricing • An internal price set by a company in intrafirm trade such as the price at which one subsidiary will sell a product to another subsidiary. • Exapmle?????

21. Tax Havens • Low tax countries that are hospitable to business.

22. Tax Havens • It involves a subsidiary selling its output at a very low cost to a subsidiary in a tax haven which in turn sells the merchandise at a very high price to a third subsidiary.

23. Transfer Pricing through Tax Havens

24. Tax Haven: International Business Strategy in Action • Switzerland, Bahamas, Monaco and Andora. • What led to creation of Tax Haven??? -No single international tax standard • Each tax haven jurisdiction has its own sets of laws on taxation and transparency.

25. Tax Haven: International Business Strategy in Action • OECD factors for identifying a tax haven are, • Impose no or nominal taxes and is used by foreigners to escape tax in their own countries. • Has laws or administrative practices which prevent the exchange of information with other governments on taxpayers benefiting from low taxation.

26. Tax Haven: International Business Strategy in Action iii. Lack transparency iv. Does not require substantial productive operations in the country, suggesting policies geared to attracting income only on a preferential basis

27. Fronting Loans • “A funds positioning strategy that involves having a third party manage the loan”. • For example, if a US multinational decided to set up operations in china , the MNE might be concerned with the political risk that accompanies such a decision.

28. Fronting Loans • For protecting their investment, the parent company could deposit funds with a major international bank that has strong ties to china and is on good terms with the government. • In turn the subsidiary would apply for a loan with this bank and the multinational company’s deposit would be given to the subsidiary in the form of a loan.

29. Multilateral Netting • “The process of determining the net amount of money owed to subsidiaries through multilateral transactions”.

30. Multilateral dollar flows between subsidiaries. Germany subsidiary Chilean subsidiary Mexican subsidiary Japanese subsidiary

31. Centralized Netting Process in Action Germany subsidiary Chilean subsidiary Central Clearing Account Japanese subsidiary Mexican subsidiary

32. Multilateral Netting • The clearing account manager is responsible for seeing that this process occurs quickly and correctly. • These transfers usually take place in the currency of the payer.

33. Multilateral Netting • Advantages: • Helps the parent company to ensure that financial interactions between the units are quickly brought to completion. • Units that are owed money have faster access to their funds • Parent company knows which subsidiaries are amassing large amounts of cash and can tap these sources if necessary to support activities in other locales. • The cost of converting foreign exchange is minimized.

34. Multilateral Netting • Disadvantages: • Many governments place controls on these operations by allowing them only for trade transactions. • Government have required that payment fir imports be delayed until these goods clear customs, thus slowing down the netting process by as much as 60 to 90 days.

35. Multilateral Netting 3.Reluctance to cooperate on the part of managers whose cash outflows are substantially larger than their inflows. Inherent Problem in this process is of foreign exchange risk.

36. Foreign Exchange Risk Management • Areas of attention when examining foreign exchange risk management are, • Inflation and its impact on foreign exchange • Type of exposure that exchange rate create. • Hedging strategies used to minimized risk • Types of forecasting and reporting systems that must be developed in order to plan and control company responses

37. Inflation • Inflation encourages buyers to purchase now while prices are lower. • It affects interest rates by driving up the cost of loans. • Affects value of local currency in international marketplace.

38. Inflation • Financial strategies used when MNE’s do business in a country facing rapid inflation are, • Rapid depreciation of equipment ii. Slower payments of outstanding accounts to sellers who are taking payment in local currency

39. Inflation iii. Greater emphasis on collecting current receivables since this currency is losing its value each month. iv. Holding minimum amounts of local currency while transferring the rest of these funds into more stable or appreciating currencies

40. Inflation v. Looking for other sources of capital since local borrowers are going to be increasing interest rate in order to protect the real return on investment. Multinationals will also consider raising their prices so as to protect their profitability in the face of inflation.

41. Addressing exchange rate fluctuations • For reducing exchange rate fluctuations techniques used are, • Translation Exposure • Transaction Exposure • Economic Exposure

42. Translation Exposure– Relates to the change in accounting income and balance sheet statements caused by changes in exchange rates. • Transactions Exposure– Relates to settling a particular transaction at one exchange rate when the obligation was originally recorded at another. • Economic Exposure – Involves changes in expected future cash flows, and hence economic value, caused by a change in exchange rates.

43. Hedging Strategies • A form of protection used against an adverse movement of an exchange rate most common forms of hedging are • Operating financial strategies • Forward exchange contracts • Currency options

44. Operating financial strategies • Design to minimize the effect of changing exchange rate on a local unit’s profitability • In this we use two strategies: • Lead strategies • Lag strategies

45. Lead strategy • A hedging strategy that calls for collecting foreign currency receivables before they are due if the currency is expected to weaken and paying foreign currency payables before they are due if the currency is expected to strengthen

46. Lag strategy • A hedging strategy that calls for delaying the receipts of foreign currency payments if this foreign currency is expected to strengthen and delaying foreign currency payables when the local currency is expected to weaken

47. Forward exchange contracts • A legally binding agreement between a firm and a bank that calls for the delivery of foreign currency at the specific exchange rate on a predetermined future date

48. Currency options • An instrument that gives the purchaser the right to buy or sell a specific amount of foreign currency at a predetermined rate within a specified time period

49. Capital expenditure analysis and capital budgeting • Capital expenditures are major projects in which the cost are to be allocated over a number of years. Example includes major acquisitions the building of new plants and refurbishing of existing equipment. • Mathematical techniques of analysis are often used including discounting cash flow technique such as net present value (NPV) and internal rate of return

50. Who should conduct the analysis, parent or the foreign subsidiary? • Initial analysis is done at the subsidiary or branch level and then passed to the head office