International Finance

Chapter 18:
Multinational Cash Management

Cash Management for a Global

Firm
A global firms cash management is actually part
of the larger issue of working capital
management.
Working capital = current assets current liabilities.
Current assets:
Cash, accounts receivable, inventories, short term
investments.

Current liabilities:
Accounts payable, bank loans and notes payable, current
taxes payable.

Working Capital Management

Broader issue than cash.
Global firm needs to manage the:
Individual components in its working capital
structure.
Ensure that funds are available when needed
to meet current liabilities as they come due.
If internal funds are not available, need to enter
short term money markets to cover.

Focus on Cash Management

Issues for Global Firms:
Size of cash balances
Currency denominations of cash balances
Where cash balances are located among the global
firms foreign affiliates.

Goal of Global Firms:

Minimize the size of cash balances.
Non-interest earning assets!

Reduce foreign exchange transaction expenses and

exposure.

Additional Objectives of Cash

Management
When sourcing short term funds to cover cash
flow needs:
Do so at the lowest possible borrowing cost.

When investing short term (excess cash)

funds:
Do so where the greatest returns can be earned.

Both objectives need to consider:

Risk
Foreign exchange expsoure

Operational Consideration
Global firm must decide whether its cash
management shall be done:
Centrally (e.g., at headquarters), or
Centralized organizational structure.

Locally (e.g., at the affiliate level).

Decentralized organizational structure.

Cash Management Techniques

The following are the two major techniques
which are used by global firms in managing their
cash positions:
Netting Systems
Bilateral and Multilateral
Netting the cash positions of the various affiliates. Transferring
the net amounts (not the gross amounts).

Transfer Pricing
Establishing prices among affiliates for the intra-global firm
selling of produces and services.
Means of moving (repositioning) cash within the global firm.

Netting Systems
Begins with an analysis of the global firms internal cash
flows (i.e., among affiliates and the parent).
What are the amount of the payments that each entity expects to
pay and expects to receive.

Netting the above amounts is a way of reducing the

amount of cash flow (and its associated cost) within the
organization.
Netting is an efficient and cost-effective mechanism for settling
interaffiliate foreign exchange transactions.

However, not all countries allow MNCs to net payments

If this is the case, larger foreign exchange transactions flow
through the local (host country) banking system.

Exposure Netting: an Example

Consider a U.S. MNC with three subsidiaries and
the following foreign exchange transactions:
$20
$30
$40
$10 $35

$10
$25
$20
$30

$60

$30 $40

Bilateral Netting: an Example

Bilateral Netting would reduce the number of foreign exchange
transactions as follows; Examine U.S and Canadian affiliate

$20
$30
$40
$10 $35

$10
$25
$20
$30

$60

$30 $40

Bilateral Netting: an Example

Bilateral Netting: U.S. and Canada net out at $10

$10
$40
$10 $35

$10
$25
$20
$30

$60

$30 $40

Bilateral Netting: an Example

Bilateral Netting: Canadian and U.K. affiliates.

$10
$40
$10 $35

$10
$25
$20
$30

$60

$30 $40

Bilateral Netting: an Example

Bilateral Netting: Canadian and U.K. affiliates net
out at $10
$10
$40
$10 $35

$10
$25
$20
$30

$60

$10

Bilateral Netting: an Example

Bilateral Netting: U.K. and German affiliates.

$10
$40
$10 $35

$10
$25
$20
$30

$60

$10

Bilateral Netting: an Example

Bilateral Netting: U.K. and German affiliates net
out at $10
$10
$40
$10 $35

$10
$25
$60
$10

$10

Bilateral Netting: an Example

Bilateral Netting: U.S. and German affiliate.

$10
$40
$10 $35

$10
$25
$60
$10

$10

Bilateral Netting: an Example

Bilateral Netting: U.S. and German affiliate net out
at $25.
$10
$40
$25

$10
$25
$60
$10

$10

Bilateral Netting: an Example

Bilateral Netting: U.S. and U.K. affiliate.

$10
$40
$25

$10
$25
$60
$10

$10

Bilateral Netting: an Example

Bilateral Netting: U.S. and U.K. affiliate net out at
$20.
$10

$25

$20

$10

$25
$10

$10

Bilateral Netting: an Example

Bilateral Netting: German and Canadian affiliates.

$10

$25

$20

$10

$25
$10

$10

Bilateral Netting: an Example

Bilateral Netting: German and Canadian affiliates
net out at $15
$10

$25

$20

$15

$10

$10

Bilateral Netting
Before bilateral netting:
Total funds (gross) to be moved: $350

With bilateral netting:

Total funds (net( to be moved: $90

This is a reduction of $260 in foreign

exchange transactions.

Multilateral Netting: an Example

Consider simplifying the bilateral netting with multilateral
netting: Start with the bilateral amounts.

$10

$25

$20

$15

$10

$10

Multilateral Netting: an Example

U.K. affiliate owes the German affiliate $10; the
German affiliate owes U.S. $10.
$10

$15 $10

$20

$15

$10

$10

Multilateral Netting: an Example

Thus, the U.K. affiliate nets its payment to the U.S.
of $10.
$10

$15

$20

$15
$10

$10

Multilateral Netting: an Example

U.K. net payment of $10 to U.S. is combined with
the $20 it owes.
$10

$15

$20

$15
$10

$10

Multilateral Netting: an Example

U.K. affiliates owes $30 to U.S.

$10

$15

$30

$15

$10

Multilateral Netting: an Example

Consider Canadian and German affiliates.

$10

$15

$30

$15

$10

Multilateral Netting: an Example

Canadian affiliate owes German affiliate $15 and
the German affiliate owes the U.S. $15.
$10

$15

$30

$15

$10

Multilateral Netting: an Example

Canadian affiliate nets its payment to the U.S. of $15;
total Canadian affiliate payment to U.S. $25.

$10
$15
$30

$10

Multilateral Netting: an Example

Consider Canadian and U.K. affiliate

$10
$15
$30

$10

Multilateral Netting: an Example

U.K. affiliate owes Canadian affiliate $10;
Canadian affiliate owes U.S. $10.
$10
$15
$30

$10

Multilateral Netting: an Example

U.K. affiliate nets its payment to the U.S. of $10.

$15
$30
$10

Multilateral Netting: an Example

Combine this $10 with the $30 the U.K. affiliate
owes the U.S.

$15
$30
$10

Multilateral Netting: an Example

U.K. affiliate owes the U.S. $40.

$15
$40

Multilateral Netting: an Example

Total funds to be moved under multilateral netting
is $55.

$15
$40

Summary of Netting
Compare this (before netting).

$20
$30
$40
$10 $35

$10
$25
$20
$30

$60

$30 $40

Bilateral Netting
To this.
Bilateral Netting: Total funds moved = $90
$10

$25

$20

$15

$10

$10

Multilateral Netting
With this.
Multilateral netting: Total funds moved = $55

$15
$40

Government Policies and Netting

As noted, not all governments permit global
firms to net their account:
Who does without request:
United States, U.K., Canada, Germany, Switzerland, Hong
Kong.

Who does upon request and approval:

Italy, the Netherlands, Belgium.

Who doesnt:
Spain. Austria, the Philippines.
Why: Want transactions to flow through local banking
system (generate fees for local banks).

Benefits of Netting
Studies have shown the following:
Decrease in the expenses associated with
moving funds internationally.
Decrease in the number of foreign exchange
transactions (also reduces costs).
Reduction in intra-company float (wire
transfers can take up to 5 days).
Savings in administrative time.

Transfer Pricing
Refers to the prices being assigned to
goods and/or services transferred among
the affiliates (including the parent) within a
global organization.
The transfer price will reposition funds (cash)
within the organization.
High transfer price transfers to selling entity!

Reasons for Transfer Pricing

Reposition funds.
Out of high risk areas
Concerns about exchange rate changes, host
government policy changes affecting funds
transfers, political risk

Move funds (profits) into low tax rate

countries.
Minimize the consolidated tax liability of the global
firm.

Government Involvement in
Transfer Pricing
Most governments monitor the use of
transfer pricing by firms within their political
boundaries.
Concerned with companies attempting to
escape their appropriate tax liabilities.

Most governments insist that the transfer

price be:
An arms-length price, or what the selling
affiliate would charge an unrelated customer.

Calculating the Arms-Length

Price
United States (IRS) government uses the
following procedures for calculating an
arms-length price:
Comparable uncontrolled price.
Between affiliate and unrelated parties

Third party price

Similar goods/services sold in the market place.

Cost-plus price
Appropriate profit added to the cost of production