International Financial Management

The Islamian Business Executives 1


Group Introduction

“The Islamian Business Executives”

• M.Khalid Aslam 16

• Shahid Amin 38

• Hassan Raza 10

• Tariq Aziz 44


International financial management

• International business operations very complex .• The financial decision in one locale can affect

operation of subsidiaries in other locale.• Subsidiaries are faced with number of financial

decision wether to, lower price, increase or decrease imports the inventory, speed up or slow down A/R collection.

• So we need to know how MNE’s make financial strategies and techniques to mange their business world wide.


Key Elements of IFM

• Management of global cash flows

• Foreign exchange risk management

• Capital expenditure analysis

• Capital budgeting


Objectives of IFM

• Provide assistance to all geographic operations

• Limit financial losses through the use of cash flow guidelines

• Timely execution of FERM strategies

• Prudent capital expenditure

• Careful capital budgeting


Decision making in MNE’s

• Types of decision– Day to day (operational)– Strategic (long term)


Who will make decisions?


Parent-Subsidiary Relationships

• Important area of operations

Finance• Parent company-planning and control

authority

• Subsidiary –Planning and control authority

• Central control to co-ordinate overall operations


PSR Approaches

• Polycentric

• Ethnocentric

• Geocentric


Polycentric Approach

• Treating the MNE as a holding company and decentralizing decision making to subsidiary level– Financial statements preparation– Performance evaluation

• Example…..


Polycentric Approach• Advantages

– On spot decisions– Flexibility– Motivation– Efficiency– Competitiveness

• Disadvantages– Reduces home office authority– Lower overall profit


Ethnocentric Approach

• Treating all foreign operations as if they were extensions of domestic operations– Integrated planning and control on each units

• Example.....


Ethnocentric Approach

• Advantages– Co-ordination– Cash management

• Disadvantages– Problems for individual subsidiary


Geocentric Approach

• Handling financial planning and controlling decisions on a global basis.

• Decisions are influenced by:– Nature and location of subsidiary– Gains

• Examples….


Geocentric Approach

• Advantages:– Maximum profit – Efficiency

• Disadvantages:


Managing Global Cash Flows

• Techniques to managing the global cash flows:– Internal funds flows– Funds positioning– Multilateral netting


Internal funds flows

• MNE’s need funds to expand operations

• Internal sources of funds– Working capital– Borrowing

• Local banks• Parent company• Other subsidiary

– Equity capital investment


Unilever

Unilever Pakistan

Unilever India

Loan

Interest Payments

Loan

Interest Payments

Dividends, royalties, and fees

Equity capital Investments


Which method is most likely to be used?

• It depends upon government regulations regarding – Intercompany lending– Licensing or royalty fee


Funds positioning techniques

• Strategies used to move funds from one multinational operation to another.

• Most common approaches:– Transfer pricing– Tax havens– Fronting loans


Transfer Pricing

• An internal price set by a company in intrafirm trade– Objective is to maximize profits in low tax rate

country and minimize them in high tax rate country


Shifting profits by transfer pricing

Arm's length price Transfer price

Country A Country B Country A Country B

Sales $10,000 $12,000 $12,000 $12,000

Cost of Sales 8000 10000 8000 12000

Profit 2000 2000 4000 Nil

Tax rate 800 1000 1600 Nil

Net Profit 1200 1000 2400 Nil


Transfer Pricing

• Benefits:– Allows to reduce taxes– Allow to concentrate cash in specific locale

• Problems– Inaccurate reflection of subsidiary

performance– Strategy does not encourage efficient

performance by the seller


Tax havens• Low-tax countries that are hospitable to

business• Characteristics:

– No or nominal taxes– Does not exchange information regarding tax

payers to other countries– Lacks transparency– Does not require substantial productive

operations


Transfer pricing through tax havens

Country ACountry B (tax

haven)Country C

Sales $8,000 $12,000 $12,000

Cost of Sales 8,000 8,000 12000

Profit ---- ---- ----

Tax rate ---- ---- ----

Net Profit 0 4000 0


Fronting Loans

• A funds positioning strategy that involves having a third party manage loan.

• Benefits:– Protection of investment from political and

legal roadblocks


Multilateral Netting

• An internally operated netting process that controls the flow of funds and ensure that bills are paid promptly.

• Clearing account manger is responsible for seeing that this process occurs quickly and correctly.


German Subsidiary Chilean Subsidiary

Mexican SubsidiaryJapanese Subsidiary

$100,000

$100,000

$100,000

$25,000

$25,000

$25,000

$50,000

$50,000

$150,000

$125,000

$50,000

$50,000


Net Cash Positions of Subsidiaries

Subsidiary Receivables Payables Net Positions

German $300,000 $225,000 $75,000

Chilean $125,000 $150,000 ($25,000)

Japanese $200,000 $275,000 ($75,000)

Mexican $225,000 $50,000 $25,000


German Subsidiary Chilean Subsidiary

Japanese Subsidiary Mexican Subsidiary

Central Clearing

Account

$75,000

$75,000

$25,000

$25,000



• Advantages:– Quick financial interactions b/w the units– Units owed money have faster access to their

funds– Effective cash management– Cost of converting foreign exchange is

minimize



• Disadvantages:– Government restriction

• Only for trade transactions • Payment delayed until customs clearance

– Less co-operation on the part of manger whose cash outflows are larger than inflows

Besides of these problems, netting process ensures

that inter-subsidiary accounts are balanced.


Real Case Study

• Motorola’s Global Cash management System


Q & A

International Financial Management

Documents

business characteristics

business world wide

tax havens country

country b country

low tax rate country

transfer pricing tax

high tax rate country

internal funds