The typical multinational firm possesses cash flows between the parent and its subsidiaries, the subsidiaries and their suppliers, the subsidiaries and their customers, and between subsidiaries themselves, all of which are generally processed through banking institutions. As part of the “Multinational Treasury and Cash Management” post series, this post describes a detail overview of Multinational Cash management. Enjoy!
International Cash Management Goals
The theory of international cash management is the same as that of domestic cash management: the maximization of the firm’s financial resources is achieved by effectively receiving payments as fast as possible while taking advantage of all liability provisions, payable periods, which are low in cost.
Simply put, the business would prefer to conduct the same level of business activity with an ever-decreasing balance sheet. The complex part is not the theory, but the practice!.
There are two primary reasons why cash is transferred across national boundaries:
- First, for the payment for resources used such as materials, technology (fees), property rights (royalties), financing and debt service (principal and interest), or invested capital (dividends).
- The second reason is for the effective deployment or repositioning of funds in order to obtain higher rates of return, assure accessibility to funds, minimize currency risk, minimize total capital invested in working capital forms, and to minimize the global tax bill of the firm.
Mechanics of International Cash Management
The international cash management techniques employed for the payments depend on whether the payment is to be associated with a related or unrelated third party. The primary distinction arises from the ability of the parent to dictate or coordinate cash flow payment methods and timing between internal units, often without true market incentives (such as discounts), as opposed to third-party payments which are obviously less controllable.
Subsidiaries in France and Spain, for instance, are each individually faced with the common cash management and working capital management all firms everywhere face—traditional domestic treasury. The primary conduit for cash management in each country is the utilization of local banking and cash management services.
International treasury, either through a regional treasurer or through a representative of the parent company, would typically consider and evaluate any of the following potential techniques for the management of payments with unrelated parties:
- Timing of billing
- Use of lockboxes or intercept points
- Negotiated value dates
- DI and EFT avenues
- Same-day value basis transfers
The parent firm, its treasury staff, and bank representatives would in turn also be responsible for gaining whatever scale and scope benefits which may be derived from managing the related-party payments, the cash flows that are intrafirm:
- Leading and lagging of payments
- In-house factoring
- Bilateral or multilateral netting of payments
- EDI and EFT avenues
- In-house banking/reinvoicing
The last item on the list requires additional discussion. The multinational framework illustrated includes the potential creation of an in-house bank, a unit that could borrow and lend between units of the firm, offering competitive market rates for credit/investment that could be managed more effectively given proper cash planning throughout the multinational.
Each of the two cash management goals could be more effectively achieved with this type of structure, more effective cash management by either using excess cash flow from some units to supplement cash needs in other units (in-house banking), and to reposition funds for tax and foreign exchange management through repricing and invoicing (reinvoicing center). This comes at varying degrees of cost; in-house banking can often be achieved with acceptable separable costs, the savings often easily justifying the independent structure. The reinvoicing center, however, is not for everyone, given its separate incorporation needs and staffing if it is going to be effective in the repricing and taking title to intrafirm goods flows.
Payments by customers to the subsidiaries are typically processed through a local bank. Payments between the subsidiary and the parent, however, are frequently processed through branches, correspondents, or affiliates of the parent’s primary bank back in the United States [If the parent company is in the U.S.]. The U.S. bank affiliate structure serves as the primary conduit for real-time information regarding the cash flows and balances within the foreign markets. Typically, the U.S.-based parent will monitor cash balances in its foreign local banks (French and Spanish, for instance) through the electronic reporting systems of its U.S.-parent bank. There is at present a highly competitive marketplace for cash management system sales by many banks in New York and London to provide these services to the corporate public. Unfortunately, the systems are still years away from providing the technological and realtime accuracy, access, and comprehensiveness which the ideal multinational treasury system would require.
Techniques for Effective Deployment of Funds [Cash Concentration or Pooling]
A Firm would depending on the magnitude of cash flow differences between the two foreign [or more] subsidiaries and the operational and financial linkages between subsidiaries and parent, make varying levels of effort to reduce the total cash stock and cost within the system.
This international cash management/banking activity might take one of two forms, cash concentration or cash pooling:
- “Cash pooling“ is exactly what it sounds like, a commingling of cash flows or balances between affiliate operations. Pooling is often readily available in-country, but can be quite complex to establish and run cross-country. Cash pooling can take a variety of forms, including notional pooling and zero balancing, each of which requires the establishment of a master account in each country over the individual affiliate accounts. Notional pooling (also commonly referred to as interest compensation) is when interest charges are calculated on a notional pool of cash—the master account, although the individual balances are not intermixed. Individual balances are mathematically pooled for the calculation of master account interest expense/charges. Zero balancing refers to a structure in which funds are transferred from the subsidiary accounts each day to the master account in order to maintain an end-of-day zero-balance on the affiliate level. Although many treasurers prefer a structure in which no physical transfer is made, the notional pooling approach, both techniques are financially equivalent.
- “Cash concentration“ is the establishment of a cross-border master account to which all individual foreign affiliates have access. Essentially the creation of an internal bank, the cash concentration account can be constructed to allow access to funds, and accept payment of funds, in a variety of currencies. It may be constructed within the framework of a cash pooling structure, or independently formed so that multiple currencies are accessible to multiple units in multiple markets. Although beyond the scope of this chapter on international treasury management, the complexity of establishing a truly cost-effective cross-border cash concentration system would require a combination of tax management, cash management, and foreign exchange management. At the heart of such a system would be the minimization of cross-border cash payments, by currency, achieved through either bilateral or multilateral netting of obligations. Aside from the complexity of terminology involved, the complexity of gaining real-time access to the information necessary for the attainment of true efficiencies is frequently prohibitive.
The reporting and monitoring system for global cash management should be designed to ensure that the firm, on a global basis, can hold overall cash balances to a minimum, avoid political and foreign exchange risk, minimize net interest expense, and minimize costs associated with transactions, bank float, and the general movement of funds.
Transaction costs associated with global cash management are generally minimized by minimizing the number of transactions. The reports should include the following from the overseas operations: daily bank account records, activity schedules and fees, disbursements and collections, deposits and payments, negotiated bank arrangements (value dates), intragroup receivables and payables, and a cash budget for the appropriate time period ahead (including anticipated use of overdraft facilities). From the overseas banks, ledger balances and value balances should be available.
Barriers to Effective International Cash Management
What are the factors that make a comprehensive and effective international cash management system difficult to implement and manage? A partial list would include the following:
- Differences and discrepancies in national bank rules, regulations, and practices
- National restrictions on netting, leads and lags, and hedging practices
- Limited local banking services
- Few standards for pricing of banking services
- Chronic informational failures such as confirmation delays
- National differences in corporate payment practices and customs
- Local credit restrictions, rationing of access to local borrowing or investing alternatives
This formidable list is the playing field of the international cash manager. Although new and sophisticated electronic services are introduced daily by banks, the firm with multinational operations in far-flung parts of the globe faces a difficult and often time-consuming task of efficiently managing the firm’s source of value—cash flow.
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