Chapter 22

Working Capital
Management in the
MNE

Working Capital Management

in the MNE
Workingcapitalmanagementinamultinational
enterpriserequiresmanagingcurrentassets(cash
balances,accountsreceivable,andinventory)and
currentliabilities(accountspayableandshortterm
debt)whenfacedwithpolitical,foreignexchange,tax,
andliquidityconstraints.
Theoverallgoalistoreducefundstiedupinworking
capitalwhilesimultaneouslyprovidingsufficient
fundingandliquidityfortheconductofglobalbusiness.
Workingcapitalmanagementshouldenhancereturnon
assetsandreturnonequityandshouldalsoimprove
efficiencyratiosandotherperformancemeasures.

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Working Capital Management

Theoperatingcycleofabusinessgeneratesfunding
needs,cashinflowsandoutflows(thecashconversion
cycle)andforeignexchangerateandcreditrisks.
Thefundingneedsgeneratedbytheoperatingcycleof
thefirmconstituteworkingcapital.
Thecashconversioncycle,asubcomponentofthe
operatingcycle(workingcapitalcycle),isthatperiod
oftimeextendingbetweencashoutflowforpurchased
inputsandmaterialsandcashinflowfromcash
settlement.

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Working Capital Management

TheoperatingandcashconversioncyclesforCascade
Mexicoisillustratedinthefollowingexhibit.
Thisisdecomposedintofivedifferentperiods(each
withbusiness,accounting,andpotentialcashflow
implications):
Quotationperiod
Inputsourcingperiod
Inventoryperiod
Accountspayableperiod
Accountsreceivableperiod

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Exhibit 22.1 Operating and Cash Cycles

for Cascade Mexico
Operating Cycle
Accounts
Payable
Period
Input
Sourcing
Period

Quotation
Period
Price
Quote

Cascade
Mexico t
0

Order
Placed

t1

Accounts
Receivable
Period

Inventory
Period

Inputs
Received

t2

Order
Shipped

t3

Payment
Received

t4

t5

Cash
Outflow

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time
Cash
Intflow

Cash
Payment
for Inputs

Cash
Settlement
Received

Cash
Conversion Cycle

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Working Capital Management

IfCascadeMexicosbusinesscontinuesto
expand,itwillcontinuallyaddtoinventories
andaccountspayable(A/P)inordertofill
increasedsalesintheformofaccounts
receivable(A/R).
Thesecomponentsmakeupnetworking
capital(NWC):
NWC=(A/R+inventory)(A/P)

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Exhibit 22.2 Cascade Mexicos Net Working

Capital Requirements

Net Working Capital (NWC) is the net investment required of the firm
to support on-going sales. NWC components typically grow as the
firm buys inputs, produces product, and sells finished goods.
Cascade Mexicos Balance Sheet
Assets

Liabilities & Net Worth

Cash

Accounts payable (A/P)

Accounts receivable (A/R)

Short-term debt

Inventory

Current assets

Current liabilities

NWC = ( A/R + Inventory ) - A/P

Note that NWC is not the same as Current assets & Current liabilities.227

Working Capital Management

Thepreviousexhibitillustratesoneofthekeymanagerial
decisionsforanysubsidiary:
ShouldA/Pbepaidoffearly,takingdiscountsofferedbysuppliers?
ThealternateformoffinancingforNWCbalancesisshorttermdebt

Inourexample,CascadeMexicosCFOmustdecidewhichisthe
lowercost(shorttermMexicanpesoborrowingsortheeffective
annualinterestcostofsupplierfinancingcostofcarry).

Clearly,thereareissuessuchasaccesstolocalcurrencydebt,or
variousintracompanyfinancingalternativesthatcomplicatethe
decision.

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Working Capital Management

Acommonmethodofbenchmarkingfinancial
managementpracticeistocalculatetheNWCof
thefirmonadayssalesbasis.
Ananalysisofthismetricinaglobalcontext
showsthatUSfirmshaveatypicaldayssalesof
29,whiletheEuropeangrouphasadayssalesof
75.
Clearly,Europeanbased(technologyfirmsinthis
example)arecarryingasignificantlyhigherlevel
ofnetworkingcapitalintheirfinancialstructures.
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Working Capital Management

TheMNEitselfposessomeuniquechallengesinthe
managementofworkingcapital.
Manymultinationalsmanufacturegoodsinafewspecific
countriesandthenshiptheintermediateproductstoother
facilitiesgloballyforcompletionanddistribution.
Thepayables,receivables,andinventorylevelsofthe
variousunitsareacombinationofintrafirmandinter
firm.
Thevaryingbusinesspracticesobservedglobally
regardingpaymenttermsbothdaysanddiscounts
createseveremismatchesinsomecases.

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Exhibit 22.4 Cascades Multinational Working

Capital Sequence
Cash inflows to Cascade Mexico arise from local market sales.
These cash flows are used to repay both intra-firm payables
(to Cascade USA) and local suppliers.
Cascade Mexico
Balance Sheet
60 days
A/R
Inventory

A/P
A/P

Cascade USA
Balance Sheet

Intra-firm:
30 days

A/R
Inventory

A/P

30 days

Local-sourcing: 60 days
Mexican Business Practices

United States Business Practices

Payment terms in Mexico are longer than

those typical of the United States. Cascade
Mexico must offer 60-day terms to local
customers to be competitive with other firms
in the local market.

Payment terms used by Cascade USA are

typical of the United States, 30 days. Cascade
USAs local customers will expect to be paid in
30 days. Cascade USA may consider extending
longer terms to Mexico to reduce the squeeze.

Result: Cascade Mexico is squeezed in terms of cash flow. It receives inflows

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in 60 days but must pay Cascade USA in 30 days.

Working Capital Management

Afirmsoperatingcashinflowisderivedprimarily
fromthecollectionofaccountsreceivable.
Multinationalaccountsreceivablearecreatedbytwo
separatetypesoftransactions:
Salestorelatedsubsidiaries
Salestoindependentorunrelatedbuyers

Managementofaccountsreceivableformindependent
customersrequirestwotypesofdecisions:
Whatcurrencyshouldthetransactionbedenominated?
Whatshouldbethetermsofpayment?

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Working Capital Management

Operationsininflationary,devaluationprone
economiessometimesforcemanagementtomodifyits
normalapproachtoinventorymanagement.
Insomecases,managementmaychoosetomaintain
inventoryandreorderlevelsfarinexcessofwhat
wouldbecalledforinaneconomicorderquantity
model.
Itisimportanttoanticipate:
Devaluation
Pricefreezes
Theimplicationsofvariousformsoffreetradezones

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International Cash Management

Internationalcashmanagementisthesetof
activitiesdeterminingthelevelsofcash
balancesheldthroughouttheMNE(cash
management)andthefacilitationofits
movementcrossborder(settlementsand
processing).
Theseactivitiesaretypicallyhandledbythe
internationaltreasuryoftheMNE.

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International Cash Management

Thelevelofcashmaintainedbyanindividual
subsidiaryisdeterminedindependentoftheworking
capitalmanagementdecisionswehavediscussed.
Cashbalances,includingmarketablesecurities,are
heldpartlytoenablenormaldaytodaycash
disbursementsandpartlytoprotectagainst
unanticipatedvariationsfrombudgetedcashflows.
Thesetwomotivesarecalledthetransactionmotive
andtheprecautionarymotive.

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International Cash Management

Cashdisbursedforoperationsisreplenished
fromtwosources:
Internalworkingcapitalturnover
Externalsourcing,traditionallyshortterm
borrowing

Efficientcashmanagementaimstoreducecash
tiedupunnecessarilyinthesystem,without
diminishingprofitorincreasingrisk,soasto
increasetherateofreturnoninvestedassets.
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International Cash Management

Allfirms,bothdomesticandinternational,
engageinsomeformofthefollowing
fundamentalsteps:
Planning
Collection
Repositioning
Disbursement
Coveringcashshortages
Investingsurpluscash

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International Cash Management

Multinationalbusinessincreasesthecomplexityof
makingpaymentsandsettlingcashflowsbetween
relatedandunrelatedfirms.
Overtimeanumberoftechniquesandserviceshave
evolvedthatsimplifyandreducethecostsofmaking
thesecrossborderpayments.
Foursuchtechniquesinclude:

Wiretransfers(exhibit22.5)
Cashpooling
Paymentnetting(exhibit22.7)
Electronicfundtransfers

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Exhibit 22.5 Average Daily Dollar Amount Handled

by CHIPS (billions of US dollars)
1600

1400

1200

1000

800

600

400

200

0
70

72

74

76

78

80

82

84

86

88

90

92

94

96

Source: Clearing House Interbank Payment System, http://www.chips.org (April 2002).

98

2000

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Exhibit 22.7 Multilateral Matrix Before Netting

(thousands
of US dollars)
The Four European Affiliates of Quad Corporation
$4,000

Quad
United Kingdom

Quad de
France

$3,000
$3,000

$5,000

$5,000

$5,000

$6,000

$4,000

$3,000

$2,000

Quad
Belgium

$2,000
$1,000

Deutscheland
Quad

Prior to netting, the four sister affiliates of Quad Corporation have numerous
intra-firm payments between them. Each payment results in transfer charges.

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Financing Working Capital

Allfirmsneedtofinanceworkingcapital.

Thenormalsourcesoffundsforfinancingshorttermworking
capitalareaccountspayabletosuppliersandloansagainstbank
creditlines.

Insomecountries,suchastheUnitedStates,borrowingisdone
bythefirmissuingnotespayabletobanksandothercreditors.

Inmanyothercountries,shorttermborrowingisdoneonan
overdraftbasis.

Inallcases,permanentworkingcapitalrequirements,asopposed
toseasonalneeds,areatleastpartiallyfinancedwithlongterm
debtandequity.

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Exhibit 22.9 Multilateral Matrix After Netting

(thousands of US dollars)
The Four European Subsidiaries of Quad Corporation
Quad
United Kingdom

Pays $1,000

Quad
Belgium

Quad de
France

Pays $3,000

Pays $1,000

Deutscheland
Quad

After netting, the four sister subsidiaries of Quad Corporation have only three
net payments to make among themselves to settle all intra-firm obligations

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Financing Working Capital

SomeMNEshavefoundthattheirfinancialresources
andneedsareeithertoolargeortoosophisticatedfor
thefinancialservicesavailableinmaylocationswhere
theyoperate.
Onesolutiontothishasbeentheestablishmentofan
inhouseorinternalbankwithinthefirm.
Suchaninhousebankisnotaseparatecorporation;
rather,itisasetoffunctionsperformedbytheexisting
treasurydepartment.
Thefollowingexhibit,illustrateshowtheinhouse
bankofCascadePharmaceuticals,Inc.,couldwork.
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Financing Working Capital

CascadeMexicosellsallitsreceivablestotheinhouse
bankastheyarise,reducingsomeofthedomesticworking
capitalneeds.
Additionalworkingcapitalneedsaresuppliedbythein
housebankdirectlytoCascadeMexico.
Becausetheinhousebankispartofthesamecompany,
theinterestratesitchargesmaybesignificantlylowerthan
whatCascadeMexicocouldobtainonitsown.
Inadditiontoprovidingfinancingbenefits,inhousebanks
allowformoreeffectivecurrencyriskmanagement.
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Exhibit 22.10 Cascades In-House Bank

Cascade Europe deposits excess cash balances
with the in-house bank.
Cash flow

Cascades
In-House
Bank

Cascade Europe

Cascades in-house bank

reallocates cash and capital
within the MNE network.

Cascade Mexico
Cash flow

Cascade Mexico sells its receivables to the in-house bank,

receiving cash and receiving working capital financing.

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Financing Working Capital

MNEsdependontheircommercialbanksto
handlemostofthetradefinancingneeds,such
aslettersofcredit,andtoprovideadviceon
governmentsupport,countryriskassessment,
introductionstoforeignfirmsandbanks,and
generalfinancingavailability.
Themainpointsofbankcontactsare
correspondentbanks,representativeoffices,
branchbanks,subsidiaries,andaffiliates.
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