1. Working Capital Management in the MNE
Chapter 22
Working Capital Management in the MNE

2. Working Capital Management in the MNE
Working capital management in a multinational enterprise requires managing current assets (cash balances, accounts receivable, and inventory) and current liabilities (accounts payable and short-term debt) when faced with political, foreign exchange, tax, and liquidity constraints.
The overall goal is to reduce funds tied up in working capital while simultaneously providing sufficient funding and liquidity for the conduct of global business.
Working capital management should enhance return on assets and return on equity and should also improve efficiency ratios and other performance measures.
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3. Working Capital Management
The operating cycle of a business generates funding needs, cash inflows and outflows (the cash conversion cycle) and foreign exchange rate and credit risks.
The funding needs generated by the operating cycle of the firm constitute working capital.
The cash conversion cycle, a subcomponent of the operating cycle (working capital cycle), is that period of time extending between cash outflow for purchased inputs and materials and cash inflow from cash settlement.
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4. Working Capital Management
The operating and cash conversion cycles for Cascade Mexico is illustrated in the following exhibit.
This is decomposed into five different periods (each with business, accounting, and potential cash flow implications):
Quotation period
Input sourcing period
Inventory period
Accounts payable period
Accounts receivable period
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5. Exhibit 22.1 Operating and Cash Cycles for Cascade Mexico
Operating Cycle
Accounts
Payable
Period
Accounts
Receivable
Period
Input
Sourcing
Period
Quotation
Period
Inventory
Period
Price
Quote
Order
Placed
Inputs
Received
Order
Shipped
Payment
Received
Cascade
Mexico
time t0 t1 t2 t3 t4 t5
Cash
Outflow
Cash
Intflow
Cash
Payment
for Inputs
Cash
Settlement
Received
Cash
Conversion Cycle
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6. Working Capital Management
If Cascade Mexico’s business continues to expand, it will continually add to inventories and accounts payable (A/P) in order to fill increased sales in the form of accounts receivable (A/R).
These components make up net working capital (NWC):
NWC = (A/R + inventory) – (A/P)
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7. Exhibit 22.2 Cascade Mexico’s 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 Mexico’s 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.

8. Working Capital Management
The previous exhibit illustrates one of the key managerial decisions for any subsidiary:
Should A/P be paid off early, taking discounts offered by suppliers?
The alternate form of financing for NWC balances is short-term debt
In our example, Cascade Mexico’s CFO must decide which is the lower cost (short-term Mexican peso borrowings or the effective annual interest cost of supplier financing – cost of carry).
Clearly, there are issues such as access to local currency debt, or various intra-company financing alternatives that complicate the decision.
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9. Working Capital Management
A common method of benchmarking financial management practice is to calculate the NWC of the firm on a “days sales” basis.
An analysis of this metric in a global context shows that US firms have a typical days sales of 29, while the European group has a days sales of 75.
Clearly, European-based (technology firms in this example) are carrying a significantly higher level of net working capital in their financial structures.
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10. Working Capital Management
The MNE itself poses some unique challenges in the management of working capital.
Many multinationals manufacture goods in a few specific countries and then ship the intermediate products to other facilities globally for completion and distribution.
The payables, receivables, and inventory levels of the various units are a combination of intra-firm and inter-firm.
The varying business practices observed globally regarding payment terms – both days and discounts – create severe mismatches in some cases.
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11. Exhibit 22.4 Cascade’s 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
Cascade USA
Balance Sheet
Intra-firm:
30 days
60 days
30 days
A/R
Inventory
A/P
A/R
Inventory
A/P
A/P
Local-sourcing: 60 days
Mexican 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.
United States Business Practices
Payment terms used by Cascade USA are typical of the United States, 30 days. Cascade USA’s 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
in 60 days but must pay Cascade USA in 30 days.

12. Working Capital Management
A firm’s operating cash inflow is derived primarily from the collection of accounts receivable.
Multinational accounts receivable are created by two separate types of transactions:
Sales to related subsidiaries
Sales to independent or unrelated buyers
Management of accounts receivable form independent customers requires two types of decisions:
What currency should the transaction be denominated?
What should be the terms of payment?
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13. Working Capital Management
Operations in inflationary, devaluation-prone economies sometimes force management to modify its normal approach to inventory management.
In some cases, management may choose to maintain inventory and reorder levels far in excess of what would be called for in an economic order-quantity model.
It is important to anticipate:
Devaluation
Price freezes
The implications of various forms of free-trade zones
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14. International Cash Management
International cash management is the set of activities determining the levels of cash balances held throughout the MNE (cash management) and the facilitation of its movement cross-border (settlements and processing).
These activities are typically handled by the international treasury of the MNE.
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15. International Cash Management
The level of cash maintained by an individual subsidiary is determined independent of the working capital management decisions we have discussed.
Cash balances, including marketable securities, are held partly to enable normal day-to-day cash disbursements and partly to protect against unanticipated variations from budgeted cash flows.
These two motives are called the transaction motive and the precautionary motive.
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16. International Cash Management
Cash disbursed for operations is replenished from two sources:
Internal working capital turnover
External sourcing, traditionally short-term borrowing
Efficient cash management aims to reduce cash tied up unnecessarily in the system, without diminishing profit or increasing risk, so as to increase the rate of return on invested assets.
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17. International Cash Management
All firms, both domestic and international, engage in some form of the following fundamental steps:
Planning
Collection
Repositioning
Disbursement
Covering cash shortages
Investing surplus cash
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18. International Cash Management
Multinational business increases the complexity of making payments and settling cash flows between related and unrelated firms.
Over time a number of techniques and services have evolved that simplify and reduce the costs of making these cross-border payments.
Four such techniques include:
Wire transfers (exhibit 22.5)
Cash pooling
Payment netting (exhibit 22.7)
Electronic fund transfers
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19. Exhibit 22.5 Average Daily Dollar Amount Handled
by CHIPS (billions of US dollars)
Source: Clearing House Interbank Payment System, (April 2002).

20. The Four European Affiliates of Quad Corporation
Exhibit 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
$2,000
Quad
Belgium
Deutscheland
Quad
$1,000
Prior to netting, the four sister affiliates of Quad Corporation have numerous
intra-firm payments between them. Each payment results in transfer charges.

21. Financing Working Capital
All firms need to finance working capital.
The normal sources of funds for financing short-term working capital are accounts payable to suppliers and loans against bank credit lines.
In some countries, such as the United States, borrowing is done by the firm issuing notes payable to banks and other creditors.
In many other countries, short term borrowing is done on an “overdraft” basis.
In all cases, permanent working capital requirements, as opposed to seasonal needs, are at least partially financed with long-term debt and equity.
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22. The Four European Subsidiaries of Quad Corporation
Exhibit Multilateral Matrix After Netting (thousands of US dollars)
The Four European Subsidiaries of Quad Corporation
Quad
United Kingdom
Quad de
France
Pays $1,000
Pays $3,000
Pays $1,000
Quad
Belgium
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

23. Financing Working Capital
Some MNEs have found that their financial resources and needs are either too large or too sophisticated for the financial services available in may locations where they operate.
One solution to this has been the establishment of an in-house or internal bank within the firm.
Such an in-house bank is not a separate corporation; rather, it is a set of functions performed by the existing treasury department.
The following exhibit, illustrates how the in-house bank of Cascade Pharmaceuticals, Inc., could work.
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24. Financing Working Capital
Cascade Mexico sells all its receivables to the in-house bank as they arise, reducing some of the domestic working capital needs.
Additional working capital needs are supplied by the in-house bank directly to Cascade Mexico.
Because the in-house bank is part of the same company, the interest rates it charges may be significantly lower than what Cascade Mexico could obtain on its own.
In addition to providing financing benefits, in-house banks allow for more effective currency risk management.
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25. Exhibit 22.10 Cascade’s In-House Bank
Cascade Europe deposits excess cash balances
with the in-house bank.
Cash flow
Cascade Europe
Cascade’s
In-House
Bank
Cascade’s 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.

26. Financing Working Capital
MNEs depend on their commercial banks to handle most of the trade financing needs, such as letters of credit, and to provide advice on government support, country risk assessment, introductions to foreign firms and banks, and general financing availability.
The main points of bank contacts are correspondent banks, representative offices, branch banks, subsidiaries, and affiliates.
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