Company forex management finance function


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Company forex management finance function

  1. 1. ~ Finance Function Anish Bengeri (5) Anirudh Jindal (22) Sachin Mittal (35)
  2. 2. Agenda • The Finance Function • Capital Structure • Global Capital Markets • Offshore Financing and Offshore Financial Centers • Capital Budgeting in Global Context • Internal Sources of Funds • Foreign Exchange Risk Management • Taxation of Foreign Source Income
  3. 3. Financial Functions In Multinational Firms  Finance is the Life Blood of the Business and so the case of MNCs also. The only difference in finance of domestic companies and MNCs is that the finance in domestic companies is in domestic currency where as in case of the MNCs the finance is in multi currencies.  Finance is required for many purposes like purchase of raw material, purchase of machinery, purchases of the related items, payment of salaries, meeting the operational expenses, etc., so the finance is required for all these purposes.  There are three types of financing namely :-  Short – Term Financing  Financing Foreign Trade  Long- Term Financing
  4. 4. Types of Financing • Financing the working capital requirements of multinational companies’ foreign affiliate’s poses a complex decision problem. • This complexity stems from the large number of financing options available to the subsidiary of an MNC. • Subsidiaries have access to funds from sister affiliates and the parent, as well as external sources. Short Term Financing • Foreign Trade is the main business of the traders of ever country. Almost all the MNCs are heavily involved of foreign trade in addition to their other international activities. • Hence, the people who are responsible for the management of the MNCs must have the practical knowledge of the institutions to facilitate the international movement of goods. Financing Foreign Trade • The following are the long term financing particularly for the capital equipment's and other big items given to the MNCs who are actively engaged in the Foreign Trade :- • Export Financing • Export Credit Subsidies and • Export Credit Insurance Long Term Financing
  5. 5.  Finance and Treasury Functions in the Internalization Process  Chief Financial Officer (CFO)—vice president of finance  Responsible for controllership and treasury functions  Acquires financial resources—generates funds from internal and external sources  Allocates financial resources—increases stockholders’ wealth by allocating funds to different projects and investment opportunities  Manages cash flows Role of CFO
  6. 6. OPERATIONS OBJECTIVES STRATEGY EXTERNAL INFLUENCES COMPETITIVE ENVIRONMENT PHYSICALAND SOCIETAL FACTORS Functions • Marketing • Exporting and importing • Global manufacturing • Supply chain management • Accounting • FINANCE • Human resources Modes MEANS Overlaying Alternatives Finance in International Business
  7. 7. VP, Sales/Marketing Controller Cash Manager Credit Manager Exposure Management Budget Planning Bid Support Process Foreign Currency Global Finance Capital Expenditure Financial Planning Treasurer VP, Finance VP, Operations VP, R&D President and COO Chairman and CEO Board of Directors Location of Treasury Function in the Corporate Organizational Structure
  8. 8. Capital Structure  Companies follow financing trends in their own country and industry  Companies can use local and international debt markets to raise funds Leveraging Debt Financing • The degree to which a firm funds the growth of the business by debt • Interest on debt is tax deductible • Amount of leverage used varies from country to country Equity Capital • Capital—stocks or shares • Dividends paid to investors are not deductible • Choice of debt versus equity affected by a variety of factors Debt Markets • Subsidiaries or foreign companies may find it easier to obtain credit than local companies • Back to back loan - made between a firm in country A with a subsidiary in country B and a bank in country B with a branch in country A
  9. 9.  EUROCURRENCIES - any currency that is banked outside of its country of origin • Major sources of Eurocurrencies include: – foreign governments or individuals who want to hold dollars outside of the U.S. – MNEs with excess cash – European banks with excess foreign currency – countries with large balance-of-trade surpluses held as reserves • Characteristics of Eurocurrency market – completely unregulated offshore market – both short and medium term – Eurocurrency deposits yield higher interest – Eurocurrency loans tend to be cheaper  LONDON INTER-BANK OFFERED RATE (LIBOR) - interest rate that banks charge each other on Eurocurrency loans Global Capital Markets
  10. 10. INTERNATIONAL BOND MARKET An attractive place to borrow money that fills an important niche in financing  Tends to be less expensive than local markets  Foreign bonds - sold outside of the borrower’s country but in the currency of the country of issue  Eurobonds - underwritten by banking syndicate and sold in countries other than the one in whose currency the bond is denominated • sold in several financial centers • some have currency options allowing the creditor to demand repayment in one of several currencies  Global bond - combination of domestic bond and Eurobond • registered in each national market
  11. 11. Equity Securities and the Euromarkets EQUITY SECURITIES Investor takes an ownership position in return for shares of stock, the promises of capital gain, and dividends. Many companies are using private placements to raise equity capital VENTURE CAPITALIST Invests money in a new venture in exchange for stock EQUITY CAPITAL MARKETS (stock markets) Listing may be on home country or foreign exchange MARKET CAPITALIZATION Total number of shares of stock listed times the market price per share in part the increase has resulted from privatization in emerging markets and global economic growth
  12. 12. EUROEQUITY MARKET Market for shares sold outside the issuing company’s home country Firms often list on only one big foreign exchange e.g., 379 foreign companies listed on the New York Stock Exchange Companies with investments in several countries may list on different exchanges AMERICAN DEPOSITARY RECEIPT (ADR) A negotiable certificate issued by a U.S. bank and representing shares of stock of a foreign company GLOBAL DEPOSITARY RECEIPTS and EUROPEAN DEPOSITARY RECEIPTS Other markets for Euro equities GLOBAL SHARE OFFERING Simultaneous offering of actual shares on different exchanges Electronic trading of stocks is a major source of competition for stock exchanges
  13. 13. 1986 3.60% 96.40% 1994 12.70% 87.30% 1998 93.10% 6.90% Emerging markets Developed markets Growth of Emerging Stock Markets
  14. 14. Cities or countries that engage in a variety of financial transactions  Provide significant tax advantages  Centers for the Eurocurrency market  Markets are less regulated than domestic markets  Provide an alternative, cheaper source of funding  May be: • Operational centers - extensive banking activities involving short-term financial transactions • Booking centers - little banking activity • financial transactions recorded to take advantage of secrecy and low tax rates  Good locations for establishing financial subsidiaries Offshore Financial Centers
  15. 15. Large foreign- currency market for loans/deposits Offshore Financial Center Good communications Pass-through for international loan funds Efficient and experienced financial community Favorable regulatory climate Economic and political stability Large net supplier of funds to world financial markets Good supportive services Characteristics of Offshore Financial Centers
  16. 16. Internal Sources of Funds FUNDS Working capital, i.e., the difference between current assets and current liabilities Used to expand operations or satisfy demands for capital SOURCES OF FUNDS MNEs have more complex arrangements due to the number of subsidiaries and the diverse environments in which they operate Loans Dividends Intercompany receivables and payables Investments through equity capital Funds may flow from subsidiaries to parent or vice versa
  17. 17. Dividends, royalties, and fees French Subsidiary Brazilian Subsidiary Parent Company Loans Extensions of accounts payable Invests more equity capital Loans Guarantee loans Internal Sources of Working Capital for MNEs
  18. 18. GLOBAL CASH MANAGEMENT Requires the collection and payment of cash resulting from the normal operational cycle  Generates and invests cash through dealings with financial institutions  Assesses a company’s cash needs using budgets and forecasts  Involves decisions about the degree of centralization of cash • transfers of cash may be in the form of dividends, royalties, management fees, and repayment of loans • governments concerned about the outflow of foreign exchange may curtail cash transfers abroad
  19. 19. MULTILATERAL NETTING Company establishes one center to handle all internal cash, funds, and financial transactions  Enables companies to reduce the amount of cash flow and move cash more quickly and efficiently  Advantages include: • optimizing the use of excess cash • reducing interest expenses and maximizing interest yields • reducing costly foreign exchange, swap transactions, and intercompany transfers • minimizing administrative paperwork • centralizing and speeding information  Multilateral cash flows in the absence of netting require each subsidiary to settle intercompany obligations • Not as advantageous as netting
  20. 20. German Subsidiary $150,000 $200,000 $200,000 $100,000 United Kingdom Subsidiary French Subsidiary $50,000 $50,000 $200,000 Italian Subsidiary Multilateral Cash Flows
  21. 21. French Subsidiary Italian Subsidiary German Subsidiary United Kingdom Subsidiary Clearing Account $100,000 $100,000$150,000 $150,000 Multilateral Netting
  22. 22. Foreign Exchange Risk Management Translation (accounting) exposure Transaction (commitment) exposure Foreign exchange risk Economic (operational) exposure
  23. 23.  Arises from converting financial statements expressed in foreign currencies into home currency  All foreign currency denominated assets and liabilities as well as revenues and costs have to be translated in one basic currency  Assets and liabilities translated at current exchange rate are exposed, and those translated at historical rate are not exposed because we use the same rate in this case. The exposure depends on the translation method to be used  Combined effect of the exchange-rate change is either a net gain or loss • Does not represent an actual cash flow effect because the cash is only translated into dollars, not converted into dollars TRANSLATION EXPOSURE
  24. 24.  Transaction exposure occurs when a company trades, borrows or lends in a foreign currency, or sells fixed assets of its subsidiaries in a foreign country. All these operations involve time delay between the commitment of the transaction (sale of an asset, for example) and the receipt or delivery of the payment  Arises because the receivable or payable changes in value as the exchange rate changes  In order to measure Transaction exposure, three techniques can be used:  the firm can measure the variability of each currency in which it has some transactions  the measurement based on the correlation between two currencies is also used  an increasingly implemented technique used for measurement is the VaR (Value-at-Risk) model TRANSACTION EXPOSURE
  25. 25.  Economic exposure measures the change in the present value of the firm resulting from any change in the future cash flows of the firm caused by an unexpected change in the exchange rates.  Economic risk arises, when a multinational firm incurs costs in one currency and generates sales in another. Changes in foreign exchange rates affect the competitive position of the firm.  Economic exposure (operating exposure) is potential for change in expected cash flows that arise from the: •Pricing of products •Sourcing and cost of inputs •Location of investments •Competitive position of the company in markets ECONOMIC EXPOSURE
  26. 26.  DEFINING AND MEASURING EXPOSURE • MNE must forecast the degree of exposure in each major currency in which it operates • Exchange-rate movements are forecasted using in-house or external experts  CREATING A REPORTING SYSTEM • Substantial participation from foreign operations combined with central control • Foreign input important to ensure forecasting effectiveness • Central control of exposure protects resources more efficiently  defines and controls overall company exposure • MNEs should devise uniform reporting system for its subsidiaries • Time periods of reports vary • Final reporting should be at corporate level Exposure-Management Strategy
  27. 27. Exposure-Management Strategy (Contd.) CENTRALIZED POLICY  Top management should determine hedging policy  Corporate treasurer should be able to design and implement a cost-effective program  Some decisions must be decentralized in order to react quickly to changes in the international monetary environment  Some companies run hedging operations as profit centers and nurture in-house trading desks FORMULATING HEDGING STRATEGIES  Safest position has exposed assets equal to exposed liabilities  Operational strategies • involve adjusting the flow of money and resources to reduce foreign- exchange risk • using local debt to balance local assets • taking advantage of leads and lags for intercompany payments
  28. 28.  A lead strategy means collecting foreign-currency receivables before they are due when the currency is expected to weaken, or paying foreign-currency payables before they are due when a currency is expected to strengthen.  A lag strategy means delaying collection of foreign-currency receivables if the currency is expected to strengthen, or delaying payment of foreign-currency payables when the currency is expected to weaken.  Contractual arrangements • Forward contract - Establishes a fixed exchange rate for future transactions • Foreign-currency option - Purchaser has the right, but not the obligation, to buy or sell a certain amount of foreign currency at a set exchange rate within a specified period of time • More flexible than forward contract
  29. 29. Capital Budgeting Decision in an International Context  Capital budgeting is the process whereby MNEs determine which projects and countries will receive capital investment funds.  Parent company needs to compare the net present value or internal rate of return of a foreign project with that of its other projects and with that of others available  Unique aspects of capital budgeting for foreign projects • Parent cash flows must be distinguished from project cash flows • Remittance of funds to the parent affected by differing tax systems, and legal and political constraints on movement of funds • Differing rates of inflation must be anticipated • Parent must consider possible changes in exchange rates • Must evaluate political risk in foreign market • Terminal value is difficult to estimate
  30. 30. Taxation of Foreign Source Income  International Tax Practices  Taxing Branches and Subsidies  Transfer Prices  Double Taxation and Tax Credit
  31. 31. International Tax Practices INTERNATIONAL TAX PRACTISES Difference in Tax Practices Differences in Types of Taxes Differences in GAAP Differences in Tax Rates Approaches to Corporate Taxation Separate Entity Approach Integrated System Approach
  32. 32. Taxing Branches and Subsidies FOREIGN BRANCH • Foreign Branch Income (or loss) is directly included in the parent’s taxable income • If the branch suffers a loss, the parent is allowed to deduct that loss from its taxable income, reducing it overall tax liability FOREIGN SUBSIDIARY • A foreign corporation is an independent legal entity set up in a country according to the laws of incorporation of that country. • When an MNE purchases or establishes such an entity, it is called a subsidiary. Subsidiary income is either taxable to the parent or tax deferred (not taxed until it is submitted as a dividend to the parent). CONTROLLED FOREIGN CORPORATION • The tax status of a subsidiary depends on whether the subsidiary is a controlled foreign corporation (CFC) and whether the income is active or passive. • Active income is derived from the direct conduct of a trade or business. Passive, or subpart F income, comes from sources other than those connected with the direct conduct of a trade or business (generally in tax haven countries).
  33. 33. Determining Subsidiary Income
  34. 34.  A price on goods and services one member of a corporate family sells to another.  Transfer pricing applies to transactions between related entities and is not usually an arm’s length price (price between two unrelated entities).  Transfer Prices and Taxation • Companies establish arbitrary transfer prices because of differences in taxation between countries. • The OECD is concerned about how companies manipulate transfer prices to minimize their tax liability worldwide. Transfer Prices
  35. 35. Double Taxation and Tax Credit  Value-added tax (VAT) has been in existence since 1967 in most Western European countries. Under a VAT, each company pays a percentage of the value added to a product at each stage of the business process. The EU has worked hard to reduce and standardize VAT rates among its members.  The purpose of tax treaties is to prevent double taxation or to provide remedies when it occurs. When agreeing to a treaty, countries generally grant reciprocal reduction on dividend withholding and exempt royalties, and sometimes interest payments, from any withholding tax.  Tax Treaties Eliminating Double Taxation • The purpose of tax treaties is to prevent double taxation or to provide remedies when it occurs.
  36. 36. Future: Technology and Cash Flows • Greater emphasis on moving corporate cash worldwide to take advantage of differing rates of return and minimize tax bills. • OECD countries are trying to break barriers to bank secrecy. • Technological innovation will allow companies to transfer funds more quickly worldwide.