International Business Strategy, Management

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International BusinessStrategy, Management the
New RealitiesCavusgil, Knight Riesenberger

• Chapter 19
• Financial Management and Accounting in the Global
  Firm

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International Financial Management

• The acquisition, management, and use of funds
  for
• cross-national trade, investment, and other
• commercial activities. It involves
• Conducting transactions in various currencies
• Operating in environments characterized by
  significant risk, capital flow restrictions, and
  varying accounting and tax systems
• Seeking and accessing funds from banks, bond
  markets, stock exchanges, venture capital firms,
  and intra-corporate sources, located worldwide.

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International Financial Management Tasks

1. Decide on the Capital Structure. Determine the
   ideal long-term mix of debt versus equity
   financing.
2. Raise funds for the firm. Acquire equity, debt,
   or intra-corporate financing for funding
   activities and investments.
3. Working Capital and Cash Flow Management. Manage
   funds passing in and out of the firms
   value-adding activities.
4. Capital Budgeting. Assess financial
   attractiveness of major investment projects
   (e.g., foreign market expansion).
5. Currency Risk Management. Manage
   multiple-currency transactions and exposure to
   exchange-rate fluctuations.
6. Manage the Diversity of international Accounting
   and Tax Practices. Operate in a global
   environment with diverse accounting practices and
   international tax regimes.

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Task One Decide on the Capital Structure

• Capital structure the mix of long-term equity
  financing and debt financing firms use to support
  their international activities.
• Firm obtains equity financing by selling shares
  of stock to investors or by retaining earnings.
• Shares of stock provide an investor with an
  ownership interest, that is, equity, in the firm.
  
• Debt financing comes from either loans from banks
  and other financial intermediaries or money
  raised from the sale of corporate bonds.

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Task Two Raising Funds

• Global money market financial markets where
  firms
• and governments raise short-term financing.
• Global capital market financial markets where
  firms
• and governments raise intermediate-term and
  long-term
• financing.
• Most funding is longer term. The global capital
  market is the meeting point of those who want to
  invest money and those who want to raise funds.
• Main advantage of the global capital market
  ability to access funds from a wider range of
  sources at lower cost.

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The Global Capital Market is Huge and Growing
(as of 2006)

• International issues of equity in world
  securities markets were about 380 billion, up
  from 83b in 1996 and just 14b in 1986.
• Stock of cross-national bank loans and deposits
  was 18,916b, up from 7,205b ten years earlier.
• There were 17,574b in outstanding international
  bonds and notes, up from 3,081b in 1996.
• This is the globalization of finance.
• Main facilitating factors Deregulation of global
  finance advanced ICTs globalization of business

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Sources of Funding 1 Equity Financing

• The firm obtains capital by selling shares of
  stock. In exchange, the shareholders obtain a
  percentage of ownership in the firm and, often, a
  stream of dividends.
• Global equity market the worldwide market for
  equity financing -- stock exchanges worldwide
  where investors and firms meet to buy and sell
  shares of stock.

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Sources of Funding 2 Debt Financing

• In debt financing, a firm borrows money from a
  creditor in exchange for repayment of principal
  and an agreed upon interest amount in the future.
  
• Debt financing is obtained from loans and bonds.
  
• International Loans. The firm may borrow money
  from banks in its home market or abroad.
• Eurocurrency Market is money deposited in banks
  outside its country of origin, mainly U.S.
  dollars, eurodollars. Other eurocurrencies
  include euros, yen, and pounds, banked outside
  the home country

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Bonds A Major Source of Debt Financing

• A bond enables the issuer (borrower) to raise
  capital by promising to repay the principal along
  with interest at a specified date.
• Global bond market is the international
  marketplace where bonds are bought and sold,
  primarily via banks and stockbrokers.
• Foreign bonds are sold outside the bond issuers
  country and denominated in the currency of the
  country in which they are issued.
• Eurobonds are sold outside the bond issuers home
  country and denominated in its own currency
  (e.g., when Toyota sells yen-denominated bonds in
  Europe)

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Sources of Funding 3
Intra-Corporate Financing

• Funds provided from sources inside the firm in
  the form of equity, loans, and trade credits.
  Trade credit arises when a supplier of goods and
  services grants the customer the option to pay
  later.
• Advantages Often the lowest-cost capital
  minimizes the transactions costs typical of
  obtaining funds from other sources has little
  effect on the parent firms balance sheet avoids
  risk of debt financing avoids ownership-diluting
  effects of equity financing.

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Task Three Working Capital and Cash Flow
Management

• Working capital the current assets of the firm.
• Working capital management aims to ensure cash is
  available where and when it is needed.
• Cash flow needs arise from everyday business
  activities, such as paying for labor or
  materials.
• Cash is generated from various sources and must
  be transferred from one part of the MNE to
  another.
• International financial managers devise various
  strategies for transferring funds within the
  firms worldwide operations, to optimize global
  operations.

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Methods for Transferring Funds within the MNE

• Through trade credit, a subsidiary defers payment
  for goods and services received from the parent.
• Royalty payments remuneration paid to the owners
  of intellectual property, as parents often
  license the use of assets to subsidiaries.
• Fronting loan a loan between the parent and its
  subsidiary, channeled through a bank. The parent
  deposits a sum in a foreign bank, which then
  transfers the funds to the subsidiary as a loan.
• Transfer pricing the prices that subsidiaries
  and affiliates charge one another for transferred
  goods and services within the same MNE.

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Multilateral Netting

• Strategic reduction of cash transfers within the
  MNE family via elimination of offsetting cash
  flows.
• Involves three or more subsidiaries that hold
  accounts payable or accounts receivable with each
  other. MNEs with many subsidiaries may establish
  a netting center.
• The center advises each subsidiary of the amounts
  to pay and receive from other subsidiaries on a
  specified date.
• Firms like Philips saves millions each year in
  transaction costs due to multilateral netting.

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Task Four Capital Budgeting

• Helps managers decide which international
  expansion projects are economically desirable.
• The decision to accept or reject an investment
  project depends on the projects initial
  investment requirement, its cost of capital, and
  the benefits the project is expected to provide.
  
• Involves net present value analysis.
• Can be very complex, because there are many
  variables to consider.
• Facilitated by spreadsheet analysis

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Task Five Currency Risk Management

• Currency risk the peril resulting from adverse
  unexpected fluctuations in exchange rates.
• Exporters and licensors face currency risk
  because foreign buyers pay in their own
  currencies.
• Foreign direct investors face currency risk
  because they receive both payments and incur
  obligations in foreign currencies.
• Managers of foreign investment portfolios face
  currency risk as the value of stocks fluctuate.

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Three Types of Currency Risk

• Transaction exposure. Arises when outstanding
  accounts receivable or payable are denominated in
  foreign currencies.
• Translation exposure. Results financial
  statements denominated in a foreign currency are
  translated into the functional currency of the
  parent, as part of consolidating international
  financial results.
• Economic exposure. Results from exchange rate
  fluctuations affecting the pricing of products,
  the cost of inputs, and the value of foreign
  investments.

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Foreign Exchange Trading

• A small number of currencies facilitate
  international trade and investment. Some 2/3 of
  foreign reserves are in U.S. dollars, 25 in
  euros, 7 in yen and British pounds, and only 2
  in the worlds 150 other currencies.
• Volume of currencies exchanged is huge. As of
  2007, some 3 trillion worth of currency was
  traded everyday, 10 times the value of daily
  stock and bond turnover, and 100 times the value
  of daily merchandise trade. One-third of all
  currency trading, about 1 trillion per day,
  takes place in London.

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Specialized Terminology for Currency Trading

• Spot rate the exchange rate applicable to the
  trading of foreign currencies in which the
  current rate of exchange is used and delivery is
  considered immediate.
• Forward rate the exchange rate applicable to the
  collection or delivery of foreign currencies at
  some future date, but a rate specified at the
  time of the transaction.

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Exchange Rate Forecasting and Hedging

• Firms attempt to forecast exchange rate
  fluctuations.
• Firms attempt to proactively manage exchange rate
  exposure via hedging.
• Forecasts are available from banks and business
  news sources.
• Online sources include the Bank for International
  Settlements (www.bis.org), the World Bank
  (www.worldbank.org), and the European Central
  Bank (www.ecb.int).

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Task Six Manage the Diversity of International
Accounting and Tax Practices

• The firms accounting systems must identify,
  measure, and communicate financial information,
  often in complex multi-country operations, with
  much variation in national accounting systems.
• For example, there are dozens of approaches for
  determining RD expenditures, cost of goods sold,
  asset valuation, net profits, etc.
• Financial statements prepared according to the
  rules of one country may be difficult to compare
  with those prepared in another country.

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Transparency in Financial Reporting

• Transparency is the degree to which firms
  regularly and comprehensively reveal substantial
  information about their financial condition and
  accounting practices.
• In order to increase transparency in the United
  States, the federal government passed the
  Sarbanes-Oxley Act in 2002, making CEOs and CFOs
  personally responsible for the accuracy of annual
  reports and other financial data.
• In general, accounting standards are becoming
  more standardized worldwide.

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Consolidating Financial Statements of
Subsidiaries

• Involves translating data denominated in
  foreign currencies into the firms functional
  currency on headquarters financial statements.
• Current rate method -- all foreign currency
  balance-sheet and income statement items are
  translated at the current exchange rate -- the
  spot exchange rate in effect on the day the
  statements are prepared.
• Temporal method -- the choice of exchange rate
  depends on the underlying method of valuation. If
  assets and liabilities are normally valued at
  historical cost, then they are translated at the
  historical rates. If assets and liabilities are
  normally valued at market cost, they are
  translated at the current rate of exchange.

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International Taxation

• A direct tax is imposed on income derived from
  the firms business activities.
• An indirect tax applies to firms that license or
  franchise products and services, or who charge
  interest. In effect, the local government
  withholds some percentage of payments as tax.
• A sales tax is a flat percentage tax on the value
  of goods or services sold, and paid by the
  ultimate user.
• A value-added tax (VAT) is payable at each stage
  of processing in the value chain of a product or
  service. It is common in Canada, Europe, and
  Latin America.

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Tax Havens

• A country hospitable to business and inward
  investment because of its low corporate income
  tax.
• Examples Bahamas, Luxembourg, Monaco, Singapore,
  Switzerland
• They exist partly because MNEs want to structure
  their global activities in ways that minimize
  taxes.
• MNEs take advantage of tax havens either by
  establishing operations in them or by funneling
  business transactions through them.