Contents of the course

1
International Finance
Part 2 International Corporate Finance
- Lecture n 8 Repositioning funds and working
capital management
2
Repositioning Funds

• As an MNE aims at maximizing the shareholder
  value, one of its tasks is to reposition the
  profits as legally and as practically as
  possible, in low tax environments.
• Repositioning profits is also useful to redeploy
  cash-flows or fund in more value-creating
  activities, or to minimize exposure to a currency
  collapse, or political crisis.
• To this end, it can use a variety of techniques
  
• Unbundling fund transfers
• Dividend remittances
• Payment of fees
• Home overhead charges
• Example Trident has operations in Brazil, China
  and Europe, each with their own constraints and
  opportunities for Trident to reposition funds

3
Repositioning Funds
4
Repositioning Funds

• The strategy for each subsidiary will be
• Trident Europe reposition profits from Germany
  to the US while maintaining the value of the
  European markets maturity
• Trident Brazil reposition or in some way manage
  the capital at risk subject to foreign exchange
  risk while still providing adequate capital for
  growth
• Trident China reposition the quantity of funds
  in and out of China to protect against transfer
  risk while balancing the needs of the joint
  venture partner

5
Repositioning Funds

• Constraints on Positioning funds
• Political constraints governments can block the
  movement of funds (transfer risk).
• Tax constraints tax liabilities may prohibit
  fund transfer tax structures may be complex and
  possibly contradictory.
• Transaction costs foreign exchange conversion
  and fees for money transfers. Become significant
  for large or frequent transfers. MNE avoid then
  unnecessary back-and-forth transfers.
• Liquidity needs each subsidiary needs to
  maintain adequate working capital.

6
Conduits for Moving Funds
Payment to Parent Company
7
Transfer Pricing

• Transfer pricing pricing of goods and services
  transferred to a foreign subsidiary from an
  affiliated company.
• A parent wishing to reposition funds out of or
  into a particular country can charge higher or
  lower prices on goods sold among subsidiaries
• This will affect the income statement of the
  subsidiary and effectively raise or lower taxes,
  with an opposite effect on the selling
  subsidiary.
• Efficient conduit to avoid high taxation
  environments, but subject to abuses and,
  therefore, controls by the fiscal authorities.
  (see examples)

8
Transfer Pricing

• Methods of determining transfer prices
• Comparable Uncontrolled Price Method
• Regarded as the best evidence of arms length
  pricing
• A market determined price
• Resale Price Method
• Subtracts appropriate markup for the distribution
  subsidiary from the final selling price to an
  independent purchaser
• Cost-Plus Method
• Sets price by adding a appropriate profit markup
  to the sellers full cost
• Often used where semi-finished products are sold
  between subsidiaries
• Other Pricing Methods
• Some tax authorities allow low pricing for
  establishment of new market so long as the cut
  price is passed on to final customer

9
License, Royalty Fees Shared Services

• License fees remuneration paid to the owners of
  the patents, technologies, trade names, etc.
• Usually based on a percentage of the value of the
  product or the volume of production
• Royalty fees similar compensation paid for the
  use of intellectual property
• Such fees are typically paid for identifiable
  services received by the subsidiary
• Shared services also referred to as distributed
  charges or overhead, are charges to compensate
  the parent for costs incurred in the general
  management of international operations and other
  corporate services provided to the subsidiary.

10
Dividend Remittances

• The classic way in which funds are transferred
  from subsidiary to parent
• Dividend payout policies have change over the
  years and now incorporate several variables in
  determining the payout strategy. These are
• Tax implications dividends are very
  tax-inefficient
• Political risk incite firms to remit all funds
  locally generated that are not necessary to
  locally.
• Foreign exchange risk if an FX loss is
  anticipated, the MNE will speed the transfer of
  funds.
• Distributions and cash flows growth is not
  always accompanied with liquidity, especially is
  working capital funding are high.
• Joint venture factors firms may be reluctant to
  vary the level of dividends paid, and tying its
  obligations toward the partner.

11
Leads and Lags

• Firms can reduce both operating and transaction
  exposure by accelerating or decelerating the
  timing of payments that must be made or received
  in foreign currencies
• To lead is to pay early
• A firm holding a soft currency or debts
  denominated in hard currency will lead by using
  the soft currency to pay off the debts before the
  soft currency loses value.
• To lag is to pay late
• A firm holding a hard currency and debts
  denominated in soft currency will lag by using
  the hard currency to pay off the debts in hopes
  of having to use less of the hard currency
• Leading and lagging is more feasible within a
  related firm

12
Reinvoicing Centers

• A reinvoicing center is a separate corporate
  subsidiary that serves as an intermediary between
  the parent and all foreign subsidiaries. Title of
  ownership and invoices pass through the center
  but the physical movement of goods is direct.
• Advantages
• Managing foreign exchange exposure is centrally
  located for all subsidiaries allowing center to
  attain specialized expertise
• Guaranteeing the exchange rate for future orders
  can be done through the center by setting firm
  local currency costs in advance
• Managing intra-subsidiary cash flows, including
  leads and lags of payments is better managed and
  allows center to hedge only the net exposure of
  cash flows
• Disadvantage that the cost of center may be
  greater than the benefits attained.

13
Working Capital Management

• The operating cycle of a business generates
  funding needs, cash inflows and outflows the
  cash conversion cycle and foreign exchange rate
  and credit risks.
• The funding needs generated by operations of the
  firm constitute working capital.
• The cash conversion cycle is the period of time
  extending between cash outflows for purchased
  inputs and cash inflow from cash settlement.
• The entire process from stage t0 to t5 is the
  companys operating cycle.

14
The Operating Cycle
15
Working Capital Funding

• Net Working Capital (NWC) is the net investment
  required of the firm to support on-going sales.
  NWC components typically grow as the firm buys
  inputs, produces product, and sells finished
  goods.
• Days working capital is a common method used to
  calculate the NWC of a firm
• This method is based on using a days sales
  basis if the value of A/R, inventories and A/P
  are divided by the annual daily sales
• The firms NWC can be summarized in the number of
  days sales of NWC. These results vary among
  industries and countries.

16
Working Capital Financing

• Managing Receivables
• A firms operating cash inflow is derived
  primarily from the collection of receivables
• There are several factors that go into the
  management of receivables
• Independent customers requires decisions about
  currency of denomination and payments terms
• Payment terms
• Self-liquidating bills secured by physical
  inventory that has been sold and the funds are
  lent based on the securitization
• Other terms
• Inventory Management
• Anticipating devaluation management must decide
  whether to build inventory of items that carry
  foreign exchange exposure
• Anticipating price freezes

17
International Cash Management

• International cash management is the set of
  activities determining the levels of cash
  balances held throughout the MNE, cash
  management, and the facilitation of its movement
  cross border, settlements and processing
• Cash levels are determined independently of
  working capital management decisions
• Cash balances, including marketable securities,
  are held partly for day-to-day transactions
  (transaction motive) and to protect against
  unanticipated variations from budgeted cash flows
  (precautionary motive)
• Cash disbursed for operations is replenished from
  two sources
• Internal working capital turnover
• External sourcing, traditionally short-term
  borrowing

18
International Cash Management

• All firms engage in some sort form of the
  following steps
• Planning a financial manager anticipates cash
  flows over future days, weeks, or months.
• Collection controlled through time lags between
  the shipment date and the payment date.
• Disbursement steps included are avoiding
  unnecessary early payment, maximizing float and
  selecting a disbursement bank.
• Covering cash shortages anticipated cash
  shortages can be managed by borrowing locally.
• Investing surplus cash if a subsidiary of an
  MNE generates surplus cash, the MNE must decide
  whether to handle its own short-term liquidity or
  whether surplus funds should be controlled
  centrally.

19
International Cash Settlements

• Four techniques for simplifying and lowering the
  cost of settling cash flows between related and
  unrelated firms
• Wire transfers Variety of methods but two most
  popular for cash settlements are CHIPS and SWIFT
• Cash pooling
• Payment netting
• Electronic fund transfers

20
International Cash Settlements

• Cash Pooling and Centralized Depositories
• Businesses with widely dispersed operating
  subsidiaries can gain operational benefits by
  centralizing cash management.
• Subsidiaries hold minimum cash for their own
  transactions and no cash for precautionary
  purposes.
• All excess funds are remitted to a central cash
  depository.
• Information advantage is attained by central
  depository on currency movements and interest
  rate risk.
• Precautionary balance advantages as MNE can
  reduce pool without any loss in level of
  protection.

21
International Cash Settlements

• Multilateral Netting
• Defined as the process that cancels via offset
  all, or part, of the debt owed by one entity to
  another related entity.
• Netting of payments is useful primarily when a
  large number of separate foreign exchange
  transactions occur between subsidiaries.

22
Financing Working Capital

• All firms need to finance working capital and
  most of the short-term financing needs is done
  through the use of bank credit lines.
• Banking sources available to MNEs are
• In-house Banks set of functions performed by
  the existing treasury department, providing
  banking services to the various units of the
  firm.
• Commercial Banking Offices
• Correspondent Banks with local banks across the
  world
• Representative Offices established in a foreign
  country
• Branch Banks and Affiliates