16 International Financial Management Flashcards
Trade risk
Risks & (mitigations) associated with selling overseas include:
Goods lost / damaged in transit (insurance)
Goods not compliant with local laws (legal research)
Bad debt risk (export factoring, export credit insurance etc)
FX risk (hedging)
Lack of demand in foreign market (market research)
Political risk, quotas, tariffs etc (Research before selecting target country)
Financing trade credit
When making decisions about financing international trade transactions, companies should consider:
The need to offer credit to make a sale
The length of time credit will need to be offered
The cost of different methods of financing
The risks associated with financing the transaction
Overseas investment - 4 types
Acquisition of foreign company
Foreign subsidiary
Foreign branch
Joint venture with foreign partner
Overseas investment
Acquisition of foreign company
pros & cons
Pros
Existing market knowledge
Established brand / reputation
Synergies
Removal of competitor
Removal of barriers to entry
Cons
Cultural clashes
Large capital outlay
Duplication of resources
Overseas investment
Foreign subsidiary
pros & cons
Pros
Access to local grants
Better profile than foreign-owned
branch
Cons
Need to consolidate financial
statements
Need to file financial statements
overseas
Complex to dissolve
Overseas investment
Foreign branch
pros & cons
Pros
Automatic loss relief for tax
Simple to close down
Cons
Parent is fully liable for activities
of branch
Not well received by customers
Overseas investment
Joint Venture
pros & cons
Pros
Shared costs
Access to local knowledge
Access to partner’s core competencies
Less risky
Cons
Shared profits
Disputes over profit share,
remuneration, transfer prices
Reduced managerial freedom
Time taken to find a reliable
partner
Overseas investment
Accounting for foreign investments
A reporting entity with foreign operations needs to translate the financial statements of those operations into its own reporting currency before consolidation or inclusion through the equity method. This is dictated by IAS 21.
See chapter 21 for details
Overseas investment
Financing overseas investments
Factors affecting the capital structure of a Multi National Company
When deciding whether to fund foreign operations with debt or equity, and in which currency this finance should be arranged, businesses should consider:
Taxation – higher rate makes debt more attractive
Exchange rate risk – consider matching currency of financing and investment
Business risk – more volatile earnings make debt less attractive
Finance risk – financial gearing
Costs
Overseas investment
Assurance
The assurance adviser will be concerned with the issues of changing exchange and interest rates,
where material, in the relevant accounting period, also issues over regulatory and tax compliance.
The assurance adviser will carry out the following work:
Examination of the loan capital terms and contractual liabilities of the company.
Checking the remittance of proceeds between the country of origin and the parent company by reference to bank and cash records.
Reviewing the movement of exchange and interest rates, and discussing their possible impact
with the directors.
Obtaining details of any hedging transaction and ensuring that exchange rate movements on
the finance has been offset.
Examining the financial statements to determine accurate disclosure of accounting policy and
accounting treatment conforming to UK requirements
Global treasury management
Important issues which the treasury department of a large company with significant international trading and operations will have to consider include:
Management of cash flows from and to suppliers, customers and subsidiaries.
Dealing with political constraints affecting the flow of funds.
Compliance with multiple legal and taxation requirements.
Dealing with foreign exchange exposure.
Maintaining relations with banks in different countries.
Impact of exchange controls on investment decisions
Foreign governments may not allow funds to be repatriated to a UK company until a project is completed or a certain amount of time has passed.
Assuming that no repatriation is possible until period N, when the life of the project will have been completed, then the NPV will be calculated as follows:
Step 1 Convert all foreign net cash flows to terminal value, using the reinvestment rate
Step 2 Sum the terminal values and deduct withholding tax
Step 3 Translate the net terminal value into £s at the anticipated spot rate at the end of the
project
Step 4 Discount the net terminal value, using a discount factor for the year of repatriation
(the end of the project)
Step 5 Deduct the initial investment at T0
Strategies for dealing with exchange controls
Multinational companies have used many different strategies to transfer funds to the UK when dividend payments to a UK parent are not permitted, the most common of which are listed below.
Transfer pricing
Royalty payments
Charging non-market rates of interest on intra-group loans
Management charges
Transfer pricing
What is it?
This is the price at which goods or services are transferred from one process or department to another or from one member of a Group to another.
Bases of transfer prices
The extent to which costs and profit are covered by the transfer price is a matter of company policy.
A transfer price may be based upon any of the following.
Standard cost
Marginal cost: at marginal cost or with a gross profit margin added
Opportunity cost
Full cost: at full cost, or at a full cost plus price
Market price
Market price less a discount
Negotiated price, which could be based on any of the other bases
