Working Capital

Managing

Working Capital

 In doing business, financial officers also need to manage working capital, or cash, balances, and this task is more complicated for multinational corporations compare to domestic firms. Besides, financial officers must consider about firm’s working capital in each of its foreign subsidiaries and each currency which subsidiaries do business. There are three corporate financial goals that must be balance. Its include;-

Minimizing working capital balances

Domestic and international firms must hold working capital for two reasons, which is: first is to facilitate day-to-day transactions and second is to cover against unexpected demands for cash. Any firms should not run out of cash on hand. It will cause failure to have sufficient cash to pay workers or suppliers. It can lead at a minimum, to expensive emergency borrowing or in the worst case, to an embarrassing loss of reputation that may cause suppliers and lenders to cut off future lines of credit.

 Financial officers usually need to balance the firm’s need for cash against the opportunity cost of holding the firm’s financial asset in such low yielding forms. One technique that been use by multinational corporations to minimize their company-wide cash holdings is centralized cash management. Each of the subsidiaries send to the centralized cash managers a daily cash report and an analysis of subsidiary’s expected cash balances and needs over the short run These report then are assembled by the centralized cash manager’s staff, who uses them to reduce the precautionary balances held by the corporations as a whole and to plan short-term investment and borrowing strategies. Instead of each subsidiary holding precautionary, “just in case” cash balances, the staff may direct each subsidiaries to send cash in excess of its operational needs to a central corporate bank then they will pool these funds, funneling it to subsidiaries when and if emergency arise. Thus the centralized cash manager ia able to reduce the precautionary held as whole and thereby reduce the amount of the firm’s assets tied up in such a low-yielding form. It is more efficient and cost effective to concentrate such financial information gathering and decision making in one unit of the corporation, rather than compelling each subsidiary to develop such expertise-in-house by reducing number of high-salaried financial specialists.

Minimizing currency conversion costs

Multinational corporations face another complication in doing international businesses, which involved their foreign subsidiaries, for example they buy and sell parts and finished goods among themselves. The constant transfer of parts and finished goods among subsidiaries generates blizzard of invoices and a constant need to transfer funds among the subsidiaries’ bank account. Cumulative bank charges for transferring these funds and converting the currencies involve can be high. In large transactions it involved two major currencies,   conversion fees and expenses may average 0.3 percent of the value of the transaction.

For smaller-sized transactions or for involving minor currencies with narrow markets, such fees and expenses can easily be 3 or 4 times higher. The conversion cost can be cut considerably, however if the subsidiaries engage in bilateral netting, in which two subsidiaries net out their mutual invoices. Currency conversion costs can be reduced further if the company engages in multilateral netting, which is done among three or more business units. However, some countries impose restrictions on netting operations to support their local banking industries, which benefit from fees charged for currency exchange.

Minimizing foreign-exchange risk

In minimizing foreign- exchange risk , financial officers typically adjust the mix of currencies that make up the firm’s working capital. Often firms use a leads and lags strategy to try to increase their net holdings of currencies that are expected to rise in value and to decrease their net holdings of currencies that are expected to fall in value. Financial officers in multinational face a complex task to ensure each subsidiary maintains sufficient cash balances to meet expected ordinary day-to-day cash outflows, as well as an appropriate level of precautionary balances to respond quickly to sudden, unexpected increase in cash outflow. They also balance each subsidiary’s expected and unexpected demands for cash against the opportunity cost of holding the firm’s financial assets in such low-yielding forms, while simultaneously controlling working capital-related currency conversion costs and foreign-exchange risk.