Financial Management in Nonprofit Organizations - Book Report/Review Example

International Financial Management Introduction When an organisation does business across international borders, it has to face the risk of currency exchange rates changes (Brigham, 2007). These risks come in various ways. First, there are transaction risks, which occur when the firm’s financial portfolio is reduced due to unfavorable changes in the values of the currencies. When a firm transacts using one currency and gets paid using another, there is always a risk of losing money and making prefects. For instance, when a firm buys stock in dollars and sells the same in pounds, it incurs the risk of losing money if the pound loses its value against the dollar. Sometimes, firms sell their products before they have met the cost of production. For instance, an airline can sell its tickets while the cost of buying fuel is at a certain point, yet due to change in dollar exchange rates, this can increase the cost of fuel, which would lead to losses or minimized profits. If the change is significant enough, the results will be a loss. Slow Nourish plc faces the same kind of problem. This is because the firm buys its merchandise using one type of currency and sells the same using another currency. What makes the risk of currency for the firm even more serious is the fact that the profit margin is so low (3%) that if a small change in currency was to happen in unfavorable way, the firm would lose its profits and maybe even make losses. The other issue is the fact that most of the goods that the firm buys are highly perishable. This means that if the currency rates were to be changed, the firm would not be able to hold its stock until such a time when the currency rates are fair. This exposes the business to currency risks in two major ways. Issue I: Managing currency rates risk Mr. Brick, the Estates Director argued that the IMF should be able to help in making sure that the exchange rates did not change too much as to affect the global payment systems. His argument was that IMF, in accordance with its mandate as stipulated in the Bretton Woods Conference of 1944, should be able to monitor and control the world payment system to avoid big changes in the exchange rates. While Mr. Brick’s argument was valid on principle, Mr. Cheap, the purchasing director argues that this was not possible in practice due to the fact that the American dollar, which has come to be a major currency pegging for world currency, is not in good condition due to poor balance of payment issues. However, Mrs. Innocent, the legal secretary said that, although the exchange rates were seen to shift greatly over short periods of time, this was nothing to worry about since the rates moved both unfavorably as well as favorably and so the effect on the firm was neutral. All these arguments have far reaching implications for a business like Slow Nourish plc. Mr. Brick’s argument, for instance, about the role of the IMF was actually valid. The IMF does have the mandate to manage the world payment system to avoid big changes in currency exchange rates as they affect the flow of economic activities around the globe. However, as Mr. Cheap said, this is not always possible since the pegging system of the world has changed from the gold system which was in place at the time the IMF was formed, to one that is dependent on the American dollar. The fact that America is in so many national debts and their economy is not doing well is also an issue to indicate that there is much to be done. However, legal secretary Mrs. Innocent had argued that on the average, the exchange rates are neutral since they move up and done. Despite the fact that this is the reality, it does not offer a business enough strategy to deal with currency exchange rates risks since some times the exchange rates can change badly thus pushing a firm in a very unpleasant financial position within a matter of short time (International Monetary Fund, 2006). Managing the risk There are a number of ways to manage currency rates risk. Businesses that face this kind of risk can use some of the methods available for managing currency rates risks. These are as follows; Hedging Many financial organizations offer a number of hedging products which helps firms like Slow Nourish plc to overcome the issue of currency rates risks (Madhumathi, 2009). When a firm buys a hedging insurance with a financial firms such as banks, the firm is able to get a stable exchange rate when they are buying or selling their currency (Johnston & Swinburne, 1999). Forwards As Hull (2009) argues, businesses can use forward contract to help in managing their finances. Forwards are private contracts between two parties (businesses) that determine future business transactions. A business can agree with another about the price of a product in the future (Janakiramanan, 2012). This protects one of the parties or both of the parties from future unexpected changes on prices caused by either demand/supply issues, or currency issues. Forwards contracts are flexible and any two business partners can define their own contract that works for them (Papaioannou, 2006). However, as Gastineau (1999) argues, due to the lack of an outside neutral regulator, any party of the forward contract can default and this happens often. Futures contracts These kinds of contracts are usually made between two businesses. They are just like the forward contracts, but have different settings in their details. Unlike forwards, the future of contract is highly regulated by a neutral regulator. This, as Brigham (2007) says, makes them quite rigid in nature. However, because of outside regulation, the rates of defaults are very low for this tool as compared to forwards contract. Future contracts are also a very good tool to help the people in this kind of situation to manage their risks. If a business is concerned that it might face a currency risk in the future, it can use this tool to manage this risk (Kennedy, 2003). They can have an agreement on a price for the produces which will be used in the future and this price will not be affected by market conditions in the future. Slow Nourish plc, for instance, can have a futures contract with its suppliers that they will sell their products to Slow Nourish plc at a pre-agreed price regardless of the change in currency rates. Alternatively, if Slow Nourish plc has many big buyers, it can enter into an agreement, which will determine the price at which Slow Nourish plc will sell its goods. There are a various issues which must be looked upon in order to help Slow Nourish plc not be exposed to this risk. Opportunity Cost All these hedging do not come without a cost. As much as these tools help in eliminating or mitigating the risk of currency change, there is a cost that comes with this. All these hedging tools come with an opportunity cost which would have benefitted the business. For instance, if the business was to have a futures contract with its suppliers to supplier them with goods at a standard pre-agreed exchange rate, it would mean that the potential advantage of the exchange rates changing in favor of Slow Nourish plc would be lost. So these risk management tools does help the firm, but at a cost. Issue II: Foreign investment With regard to the foreign investment, there are two major concerns which come up. The first one is the issue of the fact that the management of the firm is not efficient enough due to the fact that their managers do not know how to operate the business in this new environment. There are various strategies, which can be used to deal with this situation. Merging with the local firms in these new markets is a necessary action, which would help making sure that Slow Nourish plc is successful in the local market. While Slow Nourish plc has the experience and resources gained from operating business in its home country, the managers have little knowledge of the foreign market and in this case it would require some help from the local people. This can be achieved through two main ways. Hiring local managers Hiring experienced local managers can help a lot to make sure that Slow Nourish plc is able to operate efficiently in the local market. As Gaeta (2012) argues, the local people are able to understand the rules of doing business in the local market much better than the managers at Slow Nourish plc. By hiring these local people they would help Slow Nourish plc to be able to deal with the issues as follows; Understanding the institutional void and how to take advantage of it According to OECD (2012), one of the biggest problems that foreign firms in the developing economies face is the institutional void. In the countries where these firms come from, the availability of third party institutions such as certification bodies, professional institutions and other necessary institutions that help in understanding the economy is always a good asset for most of these businesses. However, in the developing economies such as India, there are no enough of these institutions and the businesses in these environments operate without the presence of these institutions (Hardie, 2012). This comes as a disadvantage to the foreign firms such as Slow Nourish plc. The local businesses are able to take advantage of the lack of these institutions. By hiring local managers, they can help in making sure that the firm will take advantage of the institutional void (International Monetary Fund: Research Dept, 2012). Understanding the informal rules of doing business in the local market Developing economies operate in an environment that is characterized by two main factors. First, there are formal rules and regulations which, when compared to the developed economies, are not well evolved. Secondly, while these rules and regulations are available, they are hardly ever observed by the local businesses. This leaves a room for an informal environment in which to operate. Most foreign businesses like Slow Nourish plc make the mistake of ignoring this informal environment and in most cases this leaves them at a weaker strategic position compared to the local businesses (Chattopadhyay, 2012). If Slow Nourish plc uses local manager, it will be easier to overcome this barrier and ensure that they are able to take advantage of the issue. Understanding the local market and how to make the best of the local market The other main hindrance to foreign firms trying to make an entry in the emerging markets is that they do not understand the local market (Cavusgil, 2012). By failing to understand the local market, they use the same strategy as in their home economies. The truth is that consumers in every economy behave in a different way and have expectations for businesses. In this regard, failing to have a business strategy that is purposely designed for the local market can be a big challenge for these business and can act as a barrier to success (Hoffmann, 2013). In fact, it happens to many businesses that have ventured into the foreign market. Having local people in the management team can help in understanding the local market and how it can be exploited economically (Temouri, 2014). As Delios (2012) identifies, only foreign businesses that take this issue of understanding the local markets seriously are able to succeed in these foreign markets. However, those who ignore the need to fine-tune their business and customer strategy to the local needs always face the risk of failing, regardless of how big they are (Poillon, 2001). Slow Nourish plc can choose to employ as many qualified local mangers as possible especially at the executive level in order to break this barrier. Local manager understand the local market better than anyone else and this helps in making sure that all needs of the local market will have been taken care off. This increases the chance of the business succeeding in this local market. Merging with local businesses The second issue is the issue of how this investment would affect the business. To deal with this issue, there are many issues, which must be considered. First, it is important for Slow Nourish plc to make sure that any negative financial results of the investment in India or any foreign country will not affect Slow Nourish plc. As Marinov and Marinova (2013) pointed out, this can be achieved by investing in these new markets as a separate entity. Merging with local business will have the same advantages as hiring local managers By merging or buying out local business, Slow Nourish plc will be able to break so many market barriers. It will have managed to know how to take advantage of the local market as well as take advantage of the institutional void in the local market. However, apart from having the same advantages as hiring local mangers, this will also have the advantage of having an already laid foundation. Merging with the local businesses can be useful because the local consumers are more likely to trust local brands than foreign ones (Pacek, 2007). Carrying out research to understand the local business environment Whether Slow Nourish plc will merge with local business or not, and whether it will hire local managers, there is definitely a need to carry out research in the local market (India) in order to make sure that the local market environment is well understood. Slow Nourish plc cannot assume that it can use the same business strategy in India as it is using in the UK. To be able to smoothly get into the Indian market, it may be necessary to make sure that the local market has been explored and any unique opportunities taken advantage of. As Cellich and Jain (2004) argued, failure to do this can be risky for the business. Issue II: Using historical financial data to predict the future This was another issue that came up in the market. From the graph data available, the two graphs indicate that both the dollar and the pound were declining. The argument that they should be selling less in pounds and buying more in dollars is worth studying. However, the purchasing director disagreed, arguing that these were just graphs and had nothing to do with how the currency exchange rates would behave in the future. This raises a very serious issue because both of the two officers were right and wrong at the same time. While Finance Director was right in arguing that the trend was a favorable one and actions should be taken to take advantage of the situation, it is also necessary to note that the graphs may not prevent a sudden change in either way. If Slow Nourish plc makes a huge investment in stock just because of the declining dollar, it runs an even bigger risk if the pound or the dollar plummets. However, the argument of the sales director that these were just graphs and did not have any bearing on how the rates will behave in the future is not entirely valid. Reference list: Brigham, E. (2007). Fundamentals of Financial Management. London, UK: Cengage Learning. Cavusgil, S. (2012). Doing Business in Emerging Markets. new York, NY: SAGE Publications. Cellich, C. & Jain, S.C. (2004). Global business negotiations: a practical guide. New York, NY: Thomson/South-Western,. Chattopadhyay, A. (2012). The New Emerging Market Multinationals: Four Strategies for Disrupting Markets and Building Brands. New York, NY: McGraw Hill Professional. Delios, A. (2012). Strategy for Success in Asia: Mastering Business in Asia. Hoboken, NJ: John Wiley & Sons. Gaeta, G. (2012). Opportunities in Emerging Markets: Investing in the Economies of Tomorrow. Hoboken, NJ: John Wiley & Sons. Gastineau, G. (1999). Dictionary of Financial Risk Management. Hoboken, NY: John Wiley & Sons. Hardie, I. (2012). Financialization and Government Borrowing Capacity in Emerging Markets. London, Uk: Palgrave Macmillan. Hoffmann, J. (2013). Global Luxury Trends: Innovative Strategies for Emerging Markets. London, UK: Palgrave Macmillan. Hull, J. (2009). Options, Futures and Other Derivatives. Mew York, NY: Pearson/Prentice Hall. International Monetary Fund. (2006). Annual Report 2006: Making the Global Economy Work for All. New York, NY: International Monetary Fund. International Monetary Fund. Research Dept. (2012). World Economic Outlook, April 2012: Growth Resuming, Dangers Remain. New York, NY: International Monetary Fund. Janakiramanan, S. (2012). Derivatives and Risk Management. Mumbi, IN: Pearson Education India. Johnston, R.B. & Swinburne, M. (1999). Exchange Rate Arrangements and Currency Convertibility: Developments and Issues. New York, NY: International Monetary Fund. Kennedy, G. (2003). Structure and Meaning in English: A Guide for Teachers. New York, NY: Pearson Longman. Madhumathi, R. (2009). Derivatives and Risk Management. New delhi, IN: Pearson Education India. Marinov, M. M. (2013). Successes and Challenges of Emerging Economy Multinationals. London, UK: Palgrave Macmillan. OECD. (2012). Knowledge Networks and Markets in the Life Sciences. Paris, FR: OECD Publishing. Pacek, N. (2007). Emerging Markets: Lessons for Business Success andthe Outlook for Different Markets. Hoboken, NJ: John Wiley & Sons. Papaioannou, M. (2006). Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms. New York, NY: International Monetary Fund. Poillon, C. (2001). Getting Started in Emerging Markets. Hoboken, NJ: John Wiley & Sons. Temouri, Y. (2014). International Business and Institutions After the Financial Crisis. London, UK: Palgrave Macmillan. Read More