International Cash Management

South-Western/Thomson Learning © 2003
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Chapter Objectives
• To explain the difference between a
subsidiary perspective and a parent
perspective in analyzing cash flows;
• To explain the various techniques used to
optimize cash flows;
• To explain common complications in
optimizing cash flows; and
• To explain the potential benefits and risks
of foreign investments.
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Cash Flow Analysis:
Subsidiary Perspective
• The management of working capital has a
direct influence on the amount and timing
of cash flow :
¤ inventory management
¤ accounts receivable management
¤ cash management
¤ liquidity management
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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
Cash Flow Analysis:
Subsidiary Perspective
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Subsidiary Revenue
• International sales are more likely to be
volatile because of exchange rate
fluctuations, business cycles, etc.
• Looser credit standards may increase
sales (accounts receivable), though often
at the expense of slower cash inflows.
Cash Flow Analysis:
Subsidiary Perspective
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Subsidiary Dividend Payments
• 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 and denominated in
the subsidiary’s currency.
Cash Flow Analysis:
Subsidiary Perspective
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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 balances.
Cash Flow Analysis:
Subsidiary Perspective
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Centralized Cash Management
• While each subsidiary is managing its own
working capital, a centralized cash
management group is needed to monitor,
and possibly manage, the parent-
subsidiary and intersubsidiary cash flows.
• International cash management can be
segmented into two functions:
¤ optimizing cash flow movements, and
¤ investing excess cash.
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Centralized Cash Management
• The centralized cash management division
of an MNC cannot always accurately
forecast the events that may affect parent-
subsidiary or intersubsidiary 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.
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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 around the
world (to reduce mail float) and
preauthorized payments (direct charging
of a customer’s bank account).
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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.
Techniques to Optimize
Cash Flows
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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.
Techniques to Optimize
Cash Flows
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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.
Techniques to Optimize
Cash Flows
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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.
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Characteristics of Banking Systems
¤ The abilities of banks to facilitate cash
transfers for MNCs may vary among
¤ The banking systems in different countries
usually differ too.
in Optimizing Cash Flows
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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.
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Centralized Cash Management
• 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.
Investing Excess Cash
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Determining the Effective Yield
• The effective rate for foreign investments
= ( 1 + i
) ( 1 + e
) – 1
where i
= the quoted interest rate on the
= the % A in the spot rate
• If the foreign currency depreciates over
the investment period, the effective yield
will be less than the quoted rate.
Investing Excess Cash
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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.
Investing Excess Cash
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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.
Investing Excess Cash
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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.
Investing Excess Cash
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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.
Investing Excess Cash
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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.
Investing Excess Cash
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Impact of International Cash Management
on an MNC’s Value
( ) ( ) | |
( )
t j t j
1 =
, ,
= Value
) = expected cash flows in currency j to be received
by the U.S. parent at the end of period 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
Returns on International
Cash Management
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• Cash Flow Analysis: Subsidiary
¤ Subsidiary Expenses
¤ Subsidiary Revenue
¤ Subsidiary Dividend Payments
¤ Subsidiary Liquidity Management
• Centralized Cash Management
Chapter Review
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Chapter Review
• Techniques to Optimize Cash Flows
¤ Accelerating Cash Inflows
¤ Minimizing Currency Conversion Costs
¤ Managing Blocked Funds
¤ Managing Intersubsidiary Cash Transfers
• Complications in Optimizing Cash Flows
¤ Company-Related Characteristics
¤ Government Restrictions
¤ Characteristics of Banking Systems
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Chapter Review
• Investing Excess Cash
¤ How to Invest Excess Cash
¤ Centralized Cash Management
¤ Determining the Effective Yield
¤ Implications of Interest Rate Parity
¤ Use of the Forward Rate as a Forecast
¤ Use of Exchange Rate Forecasts
¤ Diversifying Cash Across Currencies
¤ Use of Dynamic Hedging to Manage Cash
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Chapter Review
• Impact of International Cash Management
on an MNC’s Value