INTERNATIONAL FINANCE VERSUS DOMESTIC FINANCE

International finance is to a great extent, similar to domestic corporate finance. A domesticcompany takes
up a project for investment only when the net present value of cash flows ispositive and it shapes the
working capital policy in a way that maximizes profitability andensures desired liquidity. It is not
different in case of MNCs. Again, the financing decisions, inrespect of whether a domestic or an
international company, aim at minimizing the overall cost of capital and providing optimum
liquidity.Domestic financial management is concerned with the costs of financing sources and the
payoffsfrom investment. In domestic arena, movements in exchange rates are substantially ignored.
Butwhen we move outside of this purely domestic field, there is no way that we can analyzeinternational
financing and investment opportunities without an understanding of the impact of foreign exchange rates
upon the basic model of financial management.

 
CPA REVIEWS NOTES- INTERNATIONAL FINANCE© kadenchimbi@yahoo.com
 
 , 0754 327487 
6
We still concerned with raising funds at minimum cost, but there is clearly a complication of analyzing if
United Republic of Tanzania-based Company is raising funds by way of a Swissfranc borrowing. We are
still concerned with investment opportunities chosen to createmaximum shareholder value, but what if the
income and cash flow of our URT-basedcompany’s investment arise from South Africa in Rands or, from
Mexico in pesos. Moreover,what if exchange controls place barriers on remittances of some proportion of
profit.
However, international finance has a wider scope than domestic corporate finance and it isdesigned to
cope with greater range of complexities than the domestic finance.The reasons are as follows:-(a)
 
The MNCs operate in different economic, political, legal, cultural and tax environments(b)
 
They operate across and within varied ranges of product and factor markets which vary inregard to
competition and efficiency.(c)
 
They trade in a large number of currencies as a result of which their dependence on theforeign exchange
market is quite substantial.(d)
 
They have easy access not only to varying domestic capital markets but also tounregulated international
capital markets which differ in terms of efficiency andcompetitiveness.The greater the degree of
involvement of the firm in the international economic environment orthe greater the degree of differences
among different segments of the international economicenvironment, the greater are the complexities.
Basically, when MNCs make internationalinvestments, they also need to consider the political relations
between the host government andhome government.The capital budgeting technique also considers the
intra-firm flows. A domestic firm does neednot have to bother with these complexities.Moreover,
working capital management for an MNC is more complex because it involves cashmovement and
movement of raw materials and finished goods from one political and tax jurisdiction to
another.Obviously multinational finance possesses a dimension that makes it far more complicated
thandomestic financial management. Indeed, multinational finance is a complex area of studycompared to
domestic finance.
International finance is different from domestic finance in many aspects and first
and the most significant of them is foreign currency exposure. There are other
aspects such as the different political, cultural, legal, economical, and taxation
environment. International financial management involves into a lot of currency
derivatives whereas such derivatives are very less used in domestic financial
management.

The term ‘International Finance’ has not come from Mars. It is similar to the
domestic finance in many of the aspects. If we talk on a macro level, the most
important difference between international finance and domestic finance is of
foreign currency or to be more precise the exchange rates.

In domestic financial management, we aim at minimizing the cost of capital while

raising funds and try optimizing the returns from investments to create wealth for
shareholders.

We do not do any different in international finance. So, the objective of financial

management remains same for both domestic and international finance i.e. wealth
maximization of shareholders. Still, the analytics of international finance is different
from domestic finance. Following are the major differences:

Exposure to Foreign Exchange: The most significant difference is of foreign currency

exposure. Currency exposure impacts almost all the areas of an international
business starting from your purchase from suppliers, selling to customers, investing
in plant and machinery, fund raising etc. Wherever you need money, currency
exposure will come into play and as we know it well that there is no business
transaction without money.

Macro Business Environment: An international business is exposed to altogether a

different economic and political environment. All trade policies are different in
different countries. Financial manager has to critically analyze the policies to make
out the feasibility and profitability of their business propositions. One country may
have business friendly policies and other may not.

Legal and Tax Environment: The other important aspect to look at is the legal and
tax front of a country. Tax impacts directly to your product costs or net profits i.e.
‘the bottom line’ for which the whole story is written. International finance manager
will look at the taxation structure to find out whether the business which is feasible
in his home country is workable in the foreign country or not.

Different group of Stakeholders: It is not only the money which along matters, there
are other things which carry greater importance viz. the group of suppliers,
customers, lenders, shareholders etc. Why these group of people matter? It is
because they carry altogether a different culture, a different set of values and most
importantly the language also may be different. When you are dealing with those
stakeholders, you have no clue about their likes and dislikes. A business is driven by
these stakeholders and keeping them happy is all you need.

Foreign Exchange Derivatives: Since, it is inevitable to expose to the risk of foreign

exchange in a multinational business. Knowledge of forwards, futures, options and
swaps is invariably required. A financial manager has to be strong enough to
calculate the cost impact of hedging the risk with the help of different derivative
instruments while taking any financial decisions.

Different Standards of Reporting: If the business has presence in say US and India,
the books of accounts need to be maintained in US GAAP and IGAAP.

It is not surprising to know that the booking of assets has a different treatment in
one country compared to other. Managing the reporting task is another big
difference. The financial manager or his team needs to be familiar with accounting
standards of different countries.

Capital Management: In an MNC, the financial managers have ample options of

raising the capital. More number of options creates more challenge with respect to
selection of right source of capital to ensure the lowest possible cost of capital.

There may be such more points of difference between international and domestic
financial management. Mentioned above are list of major differences. We need to
consider each of them before taking any decision involving multinational financial
environment.