M18 MOFF8079 04 SE C18 - Pearson Education

1 LEARNING OBJECTIVES Demonstrate the operation of working capital management in a multinational enter-prise and its various foreign subsidiaries. Analyze how multinational companies reposition their profits, cash flows, and capitalwithin their multinational structures to maximize profitability, minimize global tax lia-bility, and optimize their use of capital . Describe the role that royalties and license fees play in the repositioning strategiesemployed by MNEs. Learn how international dividend remittances are determined. Apply management guidelines to minimize the costs of funding working capitalrequirements. Identify devices used to manage cross-border cash settlement processes. Describe the different internal and external banking and financial services which maybe used by MNEs in the conduct of global capital managementin an MNE requires managing the repositioning of cash flows,as well as managing current assets and liabilities, when faced with political, foreign exchange,tax and liquidity constraints.

2 The overall goal is to reduce funds tied up in working capitalwhile simultaneously providing sufficient funding and liquidity for the conduct of global busi-ness. This should enhance return on assets and return on equity. It also should improve effi-ciency ratios and other evaluation of performance first section of this chapter describes Trident s operating cycle. The second sectionanalyzes Trident s fund repositioning decisions. The third section examines the constraintsthat affect the repositioning of Trident s funds. The fourth section identifies alternative con-duits for moving funds. The fifth section introduces the management of net working capital ,including accounts receivable, inventory, and cash. The sixth and final section examines howworking capital is financed, including the various types of banking services available.

3 Thechapter concludes with the Mini-Case,Honeywell and Pakistan International Airways,which demonstrates the complexity of working capital management for multinational firmsoperating in emerging is all right, but what about dividends? Kaiser Wilhelm 7/1/11 2:34 PM Page W-22W-23 CHAPTER 18 working capital ManagementOperating CycleTimeAccountsPayablePeriod AccountsReceivablePeriodPaymentReceivedC ashInflowCashOutflowCash Settlement ReceivedCashConversion CycleCash Payment for InputsPriceQuoteOrderPlacedInputsReceive dOrderShippedQuotationPeriodInputSourcin gPeriodInventoryPeriodt0t1t2t3t4t5 Trident Brazil s Operating CycleThe operatingand cash conversion cycles for Trident Brazil are illustrated in Exhibit operating cycle can be decomposed into five different periods, each with business,accounting, and potential cash flow implications.

4 Quotation noted in Chapter 10 when we explored transaction exposure, thequotation period extends from the time of price quotation,to the point when the cus-tomer places an order,If the customer is requesting a price quote in foreign currencyterms, say Chilean pesos, Trident Brazil would now have a potential but uncertain foreignexchange transaction exposure during this period. The quotation itself is not listed on anyof the traditional financial statements of the firm, although a firm like Trident Brazil wouldkeep a worksheet of quotations extended and their time periods. Input sourcing a quotation has been accepted by the customer, the order isplaced at time At this point, a contract is signed between the buyer and seller, describ-ing the product to be delivered, likely timing of delivery, conditions of delivery, and priceand financing terms.

5 At this time, Trident Brazil would order those material inputs that itrequires for the manufacture of the product which it does not currently hold in on the individual sale, a cash deposit or down payment from the buyer is madeat this point. If so, this would constitute the first actual cash flow associated with the order,a cash inflow to Trident Brazil, and that would initiate the cash conversion cyclefor thistransaction. Inventory inputs are received, Trident Brazil assembles and manufactures thegoods. The length of time during this inventory-manufacturing period, from to depends on the type of product (off-the-shelf versus custom built-to-specification), thet2, ,EXHIBIT and Cash Cycles for Trident 7/1/11 2:34 PM Page W-23W-24 PART 6 Topics in International Financesupply-chain integration of Trident Brazil with its various internal and external suppliers,and the technologyemployed by Trident itself.

6 Accounts payable inputs arrive during this period they are listed as materialand component inventories on the left-hand side of Trident Brazil s balance sheet, withcorresponding accounts payable entries on the right-hand side of the balance sheet. Ifthe inputs are invoiced in foreign currencies, either from Trident USA, a sister sub-sidiary, or from external suppliers, they constituteforeign currency transaction expo-sures to Trident that the accounts payable period shown in Exhibit begins at the same timeas the inventory period,but may extend in time to after the inventory period ends. IfTrident Brazil s suppliers extend trade credit, Trident Brazil would have the ability to post-pone paying for the inventory for an extended period of time. Of course, if Trident Brazilchooses not to accept trade credit, it may pay for the inputs as delivered.

7 In this case, theaccounts payable period would end before the inventory period the manufacturingperiod ends at time At whatever point in time Trident Brazil chooses to settle its out-standing accounts payables, it incurs a cash outflow. Accounts receivable the goods are finished and shipped, Trident Brazilrecords the transaction as a sale on its income statement, and books the transaction on itsbalance sheet as an account receivable. If it is a foreign currency-denominated invoice,the spot exchange rate on that date,is used to record the sale value in local exchange rate in effect on the date of cash settlement,would then be used in thecalculation of any foreign exchange gains and losses associated with the transaction thetransaction length of the accounts receivable period depends on the credit terms offered byTridentBrazil, the choice made by the buyer to either accept trade credit or pay in cash,and country-specific and industry-specific payments practices.

8 At cash settlement, TridentBrazil receives a cash inflow (finally) in payment for goods delivered. At time the trans-action is concluded and all accounting entries inventory items, accounts payable, andaccounts receivable are s Repositioning DecisionsNext, we describe the variety of goals and constraints on the repositioning of funds withinTridentCorporation. Exhibit depicts Trident, its wholly owned subsidiaries, the currencyand tax rates applicable to each unit, and management s present conclusions regarding eachsubsidiary s growth prospects. Trident s three foreign subsidiaries each present a unique setof concerns. Trident Europe, the oldest of the three, is operating in a relatively high-tax environment(compared in principle to the tax rate in the parent country, the United States). It is oper-ating in a relatively stable currency the euro, and is free to move capital in and out of thecountry with few restrictions.

9 The business itself is mature, with few significant growthprospects in the near future. Trident Brazil, the result of a recent acquisition, is operating in a low-tax environment,but historically a volatile currency environment. It is subject to only a few current capitalrestrictions. Trident believes the business has very good growth prospects in the short- tomedium-term if it is able to inject additional capital and managerial expertise into ,t5,t4, , 7/1/11 2:34 PM Page W-24W-25 CHAPTER 18 working capital ManagementTrident Europe(Hamburg, Germany)Trident China(Shanghai, China)Trident Brazil(S o Paulo, Brazil)Country:Currency: The Dollar (US$)Tax rate: 35% capital restrictions: NoneCountry:Currency: The euro ( )Tax rate: 45% capital restrictions: NoneSubsidiary Status:Business: MatureTrident Corporation(Los Angeles, USA)GreenfieldInvestmentCountry:Currency : The real (R$)Tax rate: 25% capital restrictions: SomeSubsidiary Status:Business: Immediate growth potentialAcquisitionInvestmentCountry:Cu rrency: The renminbi (Rmb)Tax rate: 30% capital restrictions: ManySubsidiary Status.

10 Business: Long-term growth potentialJoint VentureInvestment Trident China, a new joint venture with a local partner that is a former unit of the Chinesegovernment, is operating in a relatively low-tax environment, with a fixed exchange rate(the renminbi is managed within a very narrow band relative to the dollar). It is sub-ject to a number of restrictions on capital . The business is believed to have the greatestpotential in the long practice, Trident s senior management in the parent company (corporate) will firstdetermine its strategic objectives regarding the business developments in each subsidiary,and then design a financial management plan for the repositioning of profits, cash flows, andcapital for each subsidiary. As a result of this process, Trident will now attempt to pursue thefollowing repositioning objectives by subsidiary: Trident Europe:reposition profits from Germany to the United States while maintainingthe value of the European market s maturity to Trident Corporation Trident Brazil:reposition or in some way manage the capital at risk in Brazil subject to for-eign exchange rate risk while providing adequate capital for immediate growth prospects Trident China:reposition the quantity of funds in and out of China to protect againstblocked funds (transfer risk), while balancing the needs of the joint venture partnerConstraints on Repositioning FundsFund flows between units of a domestic business are generally unimpeded, but that is not thecase in a multinational business.