MNC Cash Management

The Management of
International Cash Balances

• Decision Variables:
– Size of Cash Balances
– Currency of Cash Balances
– Location of Cash Balances
 Size of Cash Balances
• The Liquidity Trade-Off
– The cost of keeping “too much” cash on hand, i.e.
the opportunity costs of holding cash (lower return).
– The cost of not keeping enough cash on hand, i.e.
the trading costs associated with having too little
cash (transaction costs, short-term debt costs, etc.)
• The variability of cash flows.
 Size of Cash Balances
Trading costs increase when the
firm must sell securities to meet
cash needs.
Costs of holding cash

Total cost of holding

cash
Opportunity
Costs
The investment income
foregone when holding
cash. Trading
costs
C* ▪ Size of cash balance
▪
 Currency of Cash Balances
• By maintaining cash balances in a particular
currency, the MNC is essentially speculating in
that currency.
• Strategies:
– Pooling
– Netting
 Location of Cash Balances
• Should the firm have centralized cash
management in the home country?
• Or should the firm let each affiliate handle it
locally?
• Where are borrowing costs lowest and
investment returns highest?
 Challenges
• Cash Flow Complexity
• Political Risk
• Legal and Ethical Issues
• Tax Issues
• Foreign Exchange (FX) Exposure
 Cash Management Techniques
• Pooling
• Netting
• Multicurrency Accounts
• Hedging
 Pooling
• Company and all its subsidiaries must maintain
accounts at the same bank
• Notional pooling: Positive and negative balances are
aggregated each day to calculate interest earned or
due; funds are not actually transferred but merely
totaled
• Some type of credit facilities are usually required to
support negative balances in the pool
• Most pooling is currently single-currency/one country
 Exposure Netting
• Bilateral Netting
– Purchases between two subsidiaries are periodically
netted against each other.
– Payments netted in different currencies are converted to
a common reference currency.
• Multilateral Netting
– Purchases between multiple subsidiaries are periodically
netted against each other.
– Payments are combined ina common, reference currency.
.
 Exposure Netting
MNC has the following foreign exchange transactions:
Disbursements
Receipts US Canada Germany UK Total R. Net
US — 30 35 60
Canada 20 — 10 40
Germany 10 25 — 30
UK 40 30 20 —
Total Dis.
 Exposure Netting
Receipts:
Disbursements
Receipts US Canada Germany UK Total R. Net
US — 30 35 60 125
Canada 20 — 10 40 70
Germany 10 25 — 30 65
UK 40 30 20 — 90
Total Dis. 70 85 65 130 350
 Exposure Netting
Complete Table :
Disbursements
Receipts US Canada Germany UK Total R. Net
US — 30 35 60 125 55
Canada 20 — 10 40 70 (15)
Germany 10 25 — 30 65 0
UK 40 30 20 — 90 (40)
Total Dis. 70 85 65 130 350 0
 Exposure Netting
• NOTES
1. Total disbursements must equal total
receipts.
70 + 85 + 65 + 130
= 125 + 70 + 65 + 90 = 350
2. Total net must equal zero.
55 – 15 – 40 = 0
 Bilateral Netting

Bilateral Netting reduces transactions by half:

$20
US $10
$30 CANADA
$40
$20 $15
$10$25$35 $10 $30$10$40
$25
$60
$20
GERMANY $10 UK
$30

Transactions: 6 Value: $90

 Bilateral Netting

Receipts:
Disbursements
Receipts US Canada Germany UK Total R. Net
US — 10 25 20 55
Canada 0 — 0 10 10
Germany 0 15 — 10 25
UK 0 0 0 — 0
Total Dis. 0 25 25 40 90
 Key Idea

• Expose netting never changes…

– Net Cash Flows
• Expose netting does change disbursements
and receipts.
• Expose netting decreases transactions and
total value of cash flows.
 Multilateral Netting
• Two Suggestions:
– Use the one set of values you know…
• Net cash flows to each unit.
– Start the calculations with the subsidiaries and
end with the parent.
 Multilateral Netting

Net Cash Flows:

Disbursements
Receipts US Canada Germany UK Total R. Net
US — 55
Canada — (15)
Germany — 0
UK — (40)
Total Dis. 0
 Multilateral Netting

Receipts:
Disbursements
Receipts US Canada Germany UK Total R. Net
US — 15 0 40 55 55
Canada 0 — 0 0 0 (15)
Germany 0 0 — 0 0 0
UK 0 0 0 — 0 (40)
Total Dis. 0 15 0 40 55 0
 Multilateral Netting with Central
Depository
Consider the net cash flows of the affiliates with
the rest of the world:
Affiliate Net Receipts Net Excess Cash from Net Flow
from Multilateral Transactions with
Netting Third Parties
U.S. $55,000 $20,000 $35,000
Canada ($15,000) ($30,000) $15,000
Germany 0 $75,000 ($75,000)
U.K. ($40,000) ($25,000) ($15,000)
Total ($40,000)
 Transfer Pricing
• The Transfer Price is the price that for
accounting purposes, is assigned to goods and
services flowing from one division of a firm to
another division.
• Controversial even for a domestic firm.
– Consider the example of a firm that has one division
that mills lumber and another that makes furniture.
– The transfer price of the lumber is a political as well
as economic and accounting issue.
 International Transfer Pricing
• Added complications :
– Differences in tax rates
– Exchange rate restrictions on the part of the host
country.
• Most countries have regulations controlling
transfer pricing.
– In the U.S., the tax code requires transfer prices to be
arms length prices.
 Blocked Funds

• Restrictions on the movement of funds in a

specific currency.
• A form of political risk is the risk that the
foreign government may impose exchange
restrictions on its own currency.
 Blocked Funds Strategies
• Additional strategies for unblocking funds:
• Direct negotiation
• Export creation
• Using the blocked funds to buy goods and services
for the MNC.
– Transfer local expatriates from home payroll to the local
subsidiaries payroll.
• Transfer pricing
• Swaps