Managing Accounting in Multinational Finance - Research Paper Example

 I . Introduction The reason businesses grow into larger corporate entities is for the clear purpose of capitalizing on economic opportunities. Within this context the role of the financial manager and the treasurer are to manage potential risk, and develop and consider emerging opportunities. The multinational corporations that capitalize the most on these elements within the international community are those that enjoy the most growth and financial prosperity. It follows that this report considers the essential role of the treasurer in term of their role in the measurement, recognition, and management within the multinational company. II. Treasurer Within the multinational company the treasurer is regarded as one of the highest financial offices. While the role of the treasurer is diverse and many varied, their overarching role is that of the acquisition and custody of funds. In addition to these elements the cashier regularly reports on elements related to cash-flow within the firm, develops financial budgets, and considers means of cash conservation. With the multinational company context, the treasurer must maintain relationships with banks, as well as insurance and pension fund entities (Weaver and Weston, 2001). While within the company, all the committee members share some monetary responsibility, the treasurer can be regarded as the locus of financial responsibility. In this role, they prepare financial reports to be understood and presented to other committee members. In considering this role they act as a 'trustee'. This term refers to an individual who is entrusted with charitable financial resources. In fulfilling this responsibility the trustee must be able to manage the budgetary reports, analyzing expenditures, and forecasting future financial positions. Still, this is ultimately a committee activity (cahs online, 2010). Considered from a more specific context, the treasurer is responsible for developing strategic decision making in terms of the organization's risk management strategy when the financial risk does not directly deal with a commodity. For instance, it was indicated that 90% of the instances wherein the company deals with foreign exchange risks the treasury department assumes control of instituting the risk management initiatives (Corporate treasurers, 2006). One can compare this to cases where the major areas of risk exposure is from energy or non-agricultural commodities, as in these instances the treasury is responsible only thirty-percent of the time; in agricultural instances, the treasurer is responsible 14 percent of the time. In other situations, business units within the company assume responsibility for strategic actions; these generally occurs in instances of commodity acquisition. This is also true in instances when the decision is deemed to be highly relevant in terms of strategic decisions that substantially effect organizational earnings. For instance, it's been indicated the treasury is primarily responsible for management in situations deemed of substantial financial only 35% of the time (Corporate treasurers, 2006). For organizations that have an integrated risk management structure, the treasury is indicated to manage credit risk thirty-one percent of the time, in terms of energy risk twenty-percent of the time, and in non-agricultural situations seventeen percent of the time (Corporate treasurers, 2006). III. Treasurer's Role Jeffery (2009) indicates that the treasurer is generally given the power to oversee company financial risk. This is articulated in the following sections. 3.1 Liquidity Risk Liquidity risk is understood as company risk in regards to financial reserves and capital. Indicated earlier, risk on unhedged exposure potentially effects cash volatility, reducing the company's potential opportunities, credit facilities, and cash flow. Within this context, there are risk to cash balances that the treasurer manages (Jeffery, 2009). 3.2 Credit Risk In terms of credit risk, Jeffrey (2009) indicates that the treasurer's main role is not simply to remain concerned with risk in terms of company's profits and risk in regards to credit, but also to attend to risk in regards to customers, suppliers, and other entities wherein risk may effect ability to complete payment. 3.3 Interest Rate Risk In terms of interest rate risk, generally floating debt rate exposure is a highly relevant factor. Floating debt rate exposure aside, there are also a number of other relevant factors that must be considered within this context. Jeffery (2009) indicates that one such issue is the risk to interest expense that is related to potential needs for refinancing debt or rate exposure; this is related to the essential nature of accessing capital markets at times because of unforeseen financial needs. 3.4 Commodity/Energy Prices Direct exposures are high concern elements among company management. Within this context, management is primarily concerned with the cost of raw materials as they can be effect by market fluctuations. In addition to this concern, management is concerned with energy consumption, both in terms of electricity and fuel, for instances in regards to transportation. On this last point Jeffery (2009) indicates that many managers are unconcerned with risk management as related to costs related to energy consumption and prices. Still, it's clear the fuel prices are an important element to consider; for instance, imagine energy costs for the shipment of large scale product items, such as metal or electronic circuit boards, which can quickly reach substantial levels. In these regards, managing energy risks are is an essential element of financial management. 3.5 Enterprise Risk While a treasure's locus of responsibility seems highly involved considering the previous examination, in terms of enterprise risk Jeffery (2009) notes that there are further elements that must be considered. In these regards, the treasurer's implement a variety of strategic management skills including analytical strengths and experience in managing enterprise risk. 3.6 Foreign Exchange Rates Another important management consideration is in terms of foreign exchange risk management. Foreign exchange risk management has been indicated to increasingly become a major element of treasurer responsibility (Treasury Solutions, 2010). As the current economic climate has witnessed considerable levels of fluctuations for the Euro in regards to international currency, multinational corporations have had to consider foreign risk management on a more highly integrated level. In terms of foreign currency, it's noted that this involves the effect cash flow has on sales and commodities, as well as investment potential (Jeffery, 2009). In considering the importance of foreign exchange, Buckley (2004) advances a four-way equivalence model. This model identifies foreign exchange risk in terms of transaction, translation, economic exposures, and management techniques. 3.6.1 Transaction Exposure and Risk As Homaifar (2004) explains that, as can been see in figure-1 Transaction exposure is defined as the impact of the unexpected change rate on the cash flow arising from all the contractual relationships entered prior to the change in exchange rate at time (t1) to be settled after the change in exchange rate at time (t2). The contractual relationship is entered at time (t1) between two parties for exchange rate of goods or services at a price denominated in foreign currency for delivery and settlement at time (t2). The exchange rate is likely to change between (t1) and (t2) producing exposure to the party that is expected to make or receive cash flow denominated in foreign currency. It refers to the variability in the home currency values of cash flows arising from transaction already completed and whose foreign currency values are contractually fixed. For example, in Indian firm, which has imported goods from the USA needs US dollars to make payment. It knows how many US dollars are requires because the amount is contractually fixed. However, it does not know how many rupees would be needed to buy the specified amount of US dollars because of fluctuations in exchange rates. Similarly, an Indian firm which expects to receive some foreign currency on account of cross border transactions would be certain about the amount of foreign currency to be received, but would be uncertain about the amount of rupees it will fetch when converted into rupees (Kevin, 2009). Perhaps it is fair to conclude that, were the four-way equivalence model to hold in the real world immutable and with no time lags, and if tax is ignored, then transaction exposure should not matter. That the real world is not so convenient as the theoretical one, that the four-way equivalence model dose involve time lags, and very big ones, and that tax treatment of interest and currency gain s and losses are not entirely symmetrical mean that transaction exposure is very important to international financial executives. In short, it needs to be managed (Buckley, 2004). IV. Measurement Exposure and Risk Madura (2004) considers measurement and exposure and risk in terms of multinational corporations. In these regards, it's argued that corporations with minimal risk are able to procure funds with less overhead. As these corporate entities have been indicated to experience more exchange rate movements as a result of market fluctuations, risk in the exchange rates can effect financing. It follows that hedging exchange rate risk my benefit these corporate entities. In these regards, it's necessary to consider the transaction exposure concept. Transaction exposure is when the corporation exposes their corporate entities to exchange rate movements. This can be determined through measuring transaction exposure as related to future payables and receivables along a variety of currency options; within this context it's also necessary to consider variability levels as well as the nature of these currencies. It follows then that multinational corporations must take their revenue into account and alter their response a variety of exchange rate situations. In these regards, translation exposure is an important concept; translation exposure is understood as the exposure of the multinational corporation's financial statements to exchange rate fluctuations. In measuring translation exposure multinational corporations can foretell their earnings in each within the foreign currency and examine how these earnings could be altered by fluctuations within the foreign exchange rates, as well as future potential movements. From a more overarching perspective, economic exposure is understood as the multinational corporation's cash flow exposure to fluctuations of the exchange rate. In determining the extent that currency will be affected by these foreign exchange rate currencies corporations are able to measure potential economic exposure. One such example, as demonstrated in appendix-4, considers measuring exposure by examining how sales and expense categories are affected by exchange rates. V. Management Exposure and Risk Buckley (2004, pg. 112) indicates that, “management of foreign exchange exposure is an integral part of the treasury function in the multinational company. Rational decision taking presupposes that relevant information pertinent to the decision is available. This generalization is no less true of treasury management than it is of any other aspect of business. To make logical decisions on foreign exchange exposure, relevant information is required.” Within this context it's notable to consider the means by which companies minimize foreign exchange risk using both internal and external techniques. In terms of internal techniques it's necessary to consider means of exposure management to minimize risky positions. Within this context strategies of liability management, netting, pricing policies, and matching are utilized. Regarding external techniques, multinational corporations develop contracts with outside entities to guard against foreign exchange risk. Within this context, the various methods utilized include short term borrowing, discounting, factoring, and forward contracts. Finally, some of the above methods are unbelievable to the multinational company, which are illegal in some countries and restricted in others (Buckley, 2004). As demonstrated in Figure-2, Madura (2008) contends that the various functions involved in managing exposure to exchange risk. Furthermore, it clarifies various methods used to forecast exchange rate, how to assess forecasting performance and how to measure exposure to exchange rate movements. 5.1 Exchange Rate In terms of exchange rates it's necessary to consider both forecasting and measuring elements. Figure-3 demonstrates motives for forecasting exchange rates. In these regards, intentions are distinguished in regards to the means by which multinational corporate entities increase value by effecting capital and cash flow. Madura (2008) argues that four categories of forecasting exist: technical, fundamental, market based and mixed. When considering measuring exposure to exchange rate volatility, it's noted that financial managers must examine exposure to these exchange elements to protect company interests. VI. Political Exposure and Risk Risk within the political dimensions can be understood as the changes in a company's financial situation based on changes in the government's financial policies. Oftentimes government intervention in economic policy has a significant impact on the political risk faced by the multinational corporate entity. In terms of specific political risk, this can be understood in regards to factors related to changes in tax legislation that impact financing operations. It follows that multinational companies must manage political risk. Buckley (2004) indicates that one major way is going ahead and investing, even in uncertain political and economic climates. VII. Conclusion Multinational corporate strategy is also carried out in relation to political risk and exchange rates. This specifically means returns related to changes in the relative value of domestic and foreign currency. Generally, cost inflation is an effect experienced by a great amount of corporate entities. These inflations are different from general inflation. In this situation, economic exposure does matter. Ultimately, minimizing this sort of exposure is accomplished through financing an appropriate currency into group financial statements of items in the parent company. The ultimate importance of this act is an empirical consideration. References Buckley, A. (2004) Multinational Finance. 5th edition. London: FT Prentice-Hall. Cash online (2008) Financial advice and training for small charities and voluntary groups: Community Accountancy Self Help. Available at: http://www.cash-online.org.uk/content/1/59/1/ [Accessed: 28th November 2010]. Ghassem A. Homaifar (2004) Managing global financial and foreign exchange rate risk. Canada: John Wiley & Sons, Inc. [Online] Available at: http://www.dawsonera.com/depp/reader/protected/direct/AbstractView,readerButtons.eBookView.sdirect?state:reader/protected/AbstractView=BrO0ABXcMAAAAAQAABWVpc2JudAANOTc4MDQ3MTU1NzMzMw%3D%3D [Accessed: 1st December 2010]. Jeffery, Craig A. (2009) The strategic Treasure: A Partnership for Corporate Growth. New Jersey: John Wilery & Sons, Inc. Kevin, S. (2009) Fundamentals of international financial management. New Delhi: PHI Learning Privet Limited. Madura, J. (2008) International Finance Management. 9th edition. USA: Thomson south-western. Treasury strategies (2010) Consulting services: Finding the right solution. Available at: http://www.treasurystrategies.com/content/corporations-public-sector-non-profit?mlid=750 [Accessed: 25th November 2010]. Treasury solutions (2010) Foreign Exchange. Available at: http://treasurysolutions.ie/?page_id=35 [Accessed: 24th November 2010]. Treasurers (2010) FX Risk. Available at: http://www.treasurers.org/FX+Risk [Accessed: 20th November 2010]. Weaver, S. and Weston, J. (2001) Finance and Accounting for non-financial managers. USA: The McGraw- Hill companies. Appendices Appendix-1: Transaction exposure and risk. Source: Managing global financial and foreign exchange rate risk (2004) Appedix-2: Managing exposure to exchange rate. Source: International finance management (2008). Appedix-3: Corporate motives for forecast exchange rates. Source: International finance management (2008). Appendix-4: Example: Using sensitivity analysis to measure economic exposure. Madison Co. is a U.S. based MNC that purchases most of its materials from Canada and generates a small portion of its sales from exporting to Canada. Its U.S. sales are denominated in U.S. dollars, while its Canadian sales are denominated in Canadian dollars (C$). The estimates of its cash flows are shown in Exhibit 1.0, separated y country. Assume that Madison Co. expects three possible exchange rates for the Canadian dollar over the period of concern: (1) $0.75, (2) $0.80, (3) $0.85. Three scenarios are separately analyzed in the second, third, and fourth colums of Exhibit 1.1, Row 1 is constant aross scenarios since the U.S. business sales are not affected by exchange rate movements. In row 2, the estimated U.S. dollar sales due to the Canadian business are determined by coverating the estimated Canadian dollar sales into U.S. dollars. Row 3 is the sum of the U.S. dollar sales in row 1 and 2. Row 4 is constant across scenarios since the cost of materials in the U.S. is not affected by exchange rate movements. In row 5, the estimated U.S. dollar cost of materials due to the Canadian business is determined by converting the estimated Canadian cost of materials into U.S. dollars. Row 6 is the sum of the U.S. dollar cost of materials in rows 4 and 5. Row 7 is constant across scenarios since the U.S. operating expenses are not affected by exchange rate movements. Row 8 is constant across scenarios since the interest expense on U.S. debt is not affected by exchange rate movements. In row 9, the estimated U.S. dollar interest expenses into U.S. dollars. Row 10 is the sum of the U.S. dollar interest expeses in row 8 and 9. The effect of exchange rates on Madison’s revenues and costs can now be reviewed. Exhibit 1.1 illustrates how the dollar value of Canadian sales ad Canadian cost of materials would increase as a result of a stronger Canadian dollar. Because Medison’s Canadian Exhibit 1.0 : Estimated sales and expenses for Madison’s U.S. and Canadian Business segments (In Millions) Exhibit 1.1: Impact of possible exchange rates on Cash Flows of Madison Co. (In Millions). Cost of materials exposure (C$200 million) is much greater than its Canadian sales exposure (C$4 million), a strong Canadian dollar has a negative overall impact on its cash flow. The total amount in U.S. dollars needed to make interest payment is also higher when the Canadian dollar is stronger. In general, Madison Co. would be adversely affected by a stronger Canadian dollar. It would be favorable affected by a weaker Canadian dollar because the reduced value of total sales would be more than offset by the reduced cost of materials and interest expenses. Read More