Description
This is a presentation about meaning of centralized cash management.
International Cash Management
Group 5
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
Cash Flow Analysis: Subsidiary Perspective
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 demands.
Cash Flow Analysis: Subsidiary Perspective
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
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
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.
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.
Cash Flow of the Overall MNC
Interest &/or Principal Loans or Investment Fees & Earnings Subsidiary Excess Cash Purchase Sale Long-Term Investment Return on
Investment
Short-Term Securities
Long-Term Projects
Funds for Supplies
Parent Loans Sources of Debt
Subsidiary
Excess Cash Fees & Earnings
Repayment New Issues Cash Dividends Stockholders
Loans or Investment Interest &/or Principal
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.
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
Techniques to Optimize Cash Flows
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.
Netting
$20 $30 $40 $10 $35 $10 $25 $20 $30 $60 $30 $40
Bilateral Netting
$10 $20 $15
$25
$10
$10
Multilateral Netting
$15 $40
Intersubsidiary Payments Matrix
Payments Matrix Canada France Japan Switzerland U.S. Netting Schedule Canada France Japan Switzerland U.S. Thousands of US$ Owed to Subsidiary in: Canada France Japan Switzerland U.S. –– 40 90 20 40 60 –– 30 60 50 100 30 –– 20 30 10 50 10 –– 50 10 60 20 20 –– Net Thousands of US$ Owed: Canada France Japan Switzerland U.S. –– 0 0 10 30 20 –– 0 10 0 10 0 –– 10 10 0 0 0 –– 30 0 10 0 0 ––
Techniques to Optimize Cash Flows
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
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.
Complications 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.
Complications in Optimizing Cash Flows
Characteristics of Banking Systems
– The abilities of banks to facilitate cash transfers for MNCs may vary among countries. – The banking systems in different countries usually differ too.
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.
Short-Term Interest Rates
25 25
20 20 15 15
Canada
U.K. Japan
10 10 5 5 0 0 1978 1978
Germany
1986 1986
U.S.
1990 1990 1994 1994 1998 1998 2002 2002
1982 1982
Investing Excess Cash
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
Determining the Effective Yield • The effective rate for foreign investments r f = ( 1 + i f ) ( 1 + ef ) – 1 whereif =the quoted interest rate on the investment ef =the % ? in the spot rate • If the foreign currency depreciates over the investment period, the effective yield will be less than the
Tallahassee Co. has $2 million in excess cash that it has invested in Mexico at an annual interest rate of 60 percent. The U.S. interest rate is 9 percent. By how much would the Mexican peso have to depreciate to cause such a strategy to backfire?
If the peso depreciates by more than 31.875 percent, the effective yield on the Mexican deposit will be less than the domestic yield.
Investing Excess Cash
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
Investing Excess Cash
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.
Use of the Forward Rate as a Forecast
IRP holds? Yes Yes Yes Yes Yes Forward rate accurately predicts future spot rate Forward rate forecasts future spot rate with no bias Forward rate overestimates future spot rate Forward rate underestimates future spot rate Scenario Type of Investment Investment yield* Covered Uncovered Similar Similar
Uncovered Similar on average Uncovered Uncovered Lower Higher
Use of the Forward Rate as a Forecast
IRP holds? No Scenario Forward premium(discount) exceeds (is less than) interest rate differential Forward premium (discount) is less than (exceeds) interest rate differential Type of Investment Investment yield* Covered Higher
No
Covered
Lower
Investing Excess Cash
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 breakeven exchange rate that will equate foreign and local yields.
Investing Excess Cash
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
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
Impact of International Cash Management on an MNC’s Value
Returns on International Cash Management
?m E ( CFj , t ) × E (ER j , t ) n ?? ? j =1 Value = ? ? t (1 + k ) t =1 ? ? ?
[
]
? ? ? ? ? ? ?
E (CFj,t ) = expected cash flows in currency j to be received by the U.S. parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the
Thank You
doc_137204935.ppt
This is a presentation about meaning of centralized cash management.
International Cash Management
Group 5
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
Cash Flow Analysis: Subsidiary Perspective
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 demands.
Cash Flow Analysis: Subsidiary Perspective
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
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
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.
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.
Cash Flow of the Overall MNC
Interest &/or Principal Loans or Investment Fees & Earnings Subsidiary Excess Cash Purchase Sale Long-Term Investment Return on
Investment
Short-Term Securities
Long-Term Projects
Funds for Supplies
Parent Loans Sources of Debt
Subsidiary
Excess Cash Fees & Earnings
Repayment New Issues Cash Dividends Stockholders
Loans or Investment Interest &/or Principal
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.
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
Techniques to Optimize Cash Flows
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.
Netting
$20 $30 $40 $10 $35 $10 $25 $20 $30 $60 $30 $40
Bilateral Netting
$10 $20 $15
$25
$10
$10
Multilateral Netting
$15 $40
Intersubsidiary Payments Matrix
Payments Matrix Canada France Japan Switzerland U.S. Netting Schedule Canada France Japan Switzerland U.S. Thousands of US$ Owed to Subsidiary in: Canada France Japan Switzerland U.S. –– 40 90 20 40 60 –– 30 60 50 100 30 –– 20 30 10 50 10 –– 50 10 60 20 20 –– Net Thousands of US$ Owed: Canada France Japan Switzerland U.S. –– 0 0 10 30 20 –– 0 10 0 10 0 –– 10 10 0 0 0 –– 30 0 10 0 0 ––
Techniques to Optimize Cash Flows
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
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.
Complications 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.
Complications in Optimizing Cash Flows
Characteristics of Banking Systems
– The abilities of banks to facilitate cash transfers for MNCs may vary among countries. – The banking systems in different countries usually differ too.
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.
Short-Term Interest Rates
25 25
20 20 15 15
Canada
U.K. Japan
10 10 5 5 0 0 1978 1978
Germany
1986 1986
U.S.
1990 1990 1994 1994 1998 1998 2002 2002
1982 1982
Investing Excess Cash
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
Determining the Effective Yield • The effective rate for foreign investments r f = ( 1 + i f ) ( 1 + ef ) – 1 whereif =the quoted interest rate on the investment ef =the % ? in the spot rate • If the foreign currency depreciates over the investment period, the effective yield will be less than the
Tallahassee Co. has $2 million in excess cash that it has invested in Mexico at an annual interest rate of 60 percent. The U.S. interest rate is 9 percent. By how much would the Mexican peso have to depreciate to cause such a strategy to backfire?
If the peso depreciates by more than 31.875 percent, the effective yield on the Mexican deposit will be less than the domestic yield.
Investing Excess Cash
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
Investing Excess Cash
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.
Use of the Forward Rate as a Forecast
IRP holds? Yes Yes Yes Yes Yes Forward rate accurately predicts future spot rate Forward rate forecasts future spot rate with no bias Forward rate overestimates future spot rate Forward rate underestimates future spot rate Scenario Type of Investment Investment yield* Covered Uncovered Similar Similar
Uncovered Similar on average Uncovered Uncovered Lower Higher
Use of the Forward Rate as a Forecast
IRP holds? No Scenario Forward premium(discount) exceeds (is less than) interest rate differential Forward premium (discount) is less than (exceeds) interest rate differential Type of Investment Investment yield* Covered Higher
No
Covered
Lower
Investing Excess Cash
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 breakeven exchange rate that will equate foreign and local yields.
Investing Excess Cash
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
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
Impact of International Cash Management on an MNC’s Value
Returns on International Cash Management
?m E ( CFj , t ) × E (ER j , t ) n ?? ? j =1 Value = ? ? t (1 + k ) t =1 ? ? ?
[
]
? ? ? ? ? ? ?
E (CFj,t ) = expected cash flows in currency j to be received by the U.S. parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the
Thank You
doc_137204935.ppt