Table of contents
Drivers for WCM
International Cash Management
Who is responsible?
Netting of Payments
Investment of Excess Funds
Establishing the required Cash Level
The Scope of Working Capital
Account Receivables Management
Unsecured sources of short-term loans
Secured sources of short-term loans
Working Capital Management’s [hereafter abbreviated WCM] accepted purpose has been the management of a firm’s current assets and current liabilities in a way that achieves the optimum balance between liquidity and profitability. On the one hand, obviously, a high level of net working capital implies funds invested in current assets that increase a firm’s liquidity but reduces its returns, because current assets are less profitable than long-term assets. On the other hand, however, a low level of net working capital results in increased profitability, since funds are put to better use, but increases the firm’s risk of technical insolvency. The bottom line is that any suboptimal level of net working capital in the end reduces the return to shareholders by lowering the firm’s value (Gitman, 2000, p. 616).
However, “[t]he ‘collect early, push out the product and pay late’ attitude, familiar to many treasurers, squeezes both customers and suppliers and […] is increasingly recognized as short-term and potentially damaging to business” (Hall, 2002, p. 29). Therefore, it is of supreme importance to understand the complex and not openly visible ties of working capital and its components to a company’s strategy and operations, rather than treating WCM as an isolated task.
WCM for multinational corporations is in its core very similar to purely domestic WCM. However, in the international realm there exist a few essential differences that add complexity. Consider “the impact of currency fluctuations, potential exchange controls, and multiple tax jurisdictions […], in addition to the wider range of short-term financing and investment options available” (Shapiro, 2005, p. 516).
This paper will discuss the main components of WCM (international cash management, accounts receivables/payables, etc.) as well as the implications of managing working capital in the international sphere, while taking into consideration a more profound approach to WCM that goes beyond the superficial understanding of working capital as an isolated item solely under the control of the finance or treasury department.
Drivers for WCM
The reasons for efficient WCM are as manifold as they are persuading. Discussing each and every single business pressure in this context is clearly beyond the scope of this paper. Thus, we would like to direct the reader’s attention to the three main strategic drivers as identified by Hall:
1. ”Unlocking internal cash is the cheapest way to fund strategic projects.
2. Improving key ratios […] makes for a more favorable company valuation by equity analysts.
3. Robust working capital management can help secure access to the capital market and bolster your credit ranking” (Hall, 2002, p. 32).
One of the most striking examples for the benefits that superior WCM may generate for a firm is Dell Computer. Mainly by revolutionizing the WCM approach and firmly integrating it in the company strategy, Dell has become the world’s second largest computer manufacturer and increased its stock value by 72,000 percent during the last decade. Thus, sound working capital management is necessary if a company wants to compete in the information age, and the lessons taught by Dell extend to other industries (Brigham & Houston, 2001, p. 693).
International Cash Management
In international, just as domestic, cash management there is one fundamental reality that governs virtually all decisions in this area: “[S]ince cash […] earns no interest, the firm has a strong incentive to minimize its holdings of cash” (Melvin, 1989, p. 194).
Who is responsible?
Keeping this reality in mind, we first need to address the question of who in a multinational corporation should be responsible for the management of working capital in general and the management of cash in particular. Current assets and liabilities in foreign subsidiaries are in principle part of foreign operations and should, as a general rule, not be tempered with by the parent; except for ensuring alignment to the corporate WCM strategy. Cash, however, is an exception to this rule. Cash is not only the most liquid of all assets; it is also the most movable. Exploiting these characteristics can reduce total cash as well as total assets and makes centralized control of a corporation’s cash balances beneficial in several ways.
1. Centralized control facilitates intra-subsidiary netting of cash-balances.
2. Drastically reduced amounts of inter-subsidiary transactions reduce transaction fees and foreign exchange risk.
3. Subsidiaries need only hold those cash balances required for operations, eliminating the need for cash-cushions.
4. Reducing total assets boosts profitability and decreases the cost of financing.
5. All cash decisions are aligned to corporate strategy.
6. Centralizing transactions increases the parent’s bargaining power with respects to the banks involved.
7. Centralized control brings greater expertise (cash & portfolio management).
8. Assets at (political) risk can be reduced in foreign operations (Shapiro, 2005, p. 516f).
Despite these pressures for centralization, the corporation should keep in mind that local managers possess a more profound knowledge of local markets and might spot opportunities that are not visible to the parent. Also, centralizing cash management may maximize the corporate profitability, but not necessarily unit profitability, since it takes away decision power from local managers. Therefore, this needs to be considered upon evaluating the performance of local management.
Managing both collection float and disbursement float, meaning the time that payments from customers and to suppliers are in transit, is a major concern in national as well as international cash management. On the one hand, maximizing disbursement float increases the firm’s supply of spontaneous short-term financing which is free of interest charges. Minimizing collection float, on the other hand, helps “reduce the investment in accounts receivable and to lower banking fees and other transaction costs” (Shapiro, 2005, p. 517), thereby freeing cash for other purposes.
Managing float in the international sphere is more complex than managing it domestically. International operations require the manager to identify and evaluate all the different sales channels available and select the most appropriate one. Unfortunately, the optimal solution normally differs for various business models, countries, and customers. After establishing procedures for the operations of a business, the most suitable way to collect payments needs to be determined.
In general, wire transfers (cable remittances) are to be preferred over any kind of other payment method because it speeds up the reception of good funds by automating the transfer and clearing of the funds. The wide-spread availability of a common giro-system in most of Europe makes that relatively easy, even for many retail businesses. In the United States, where paying by check is much more common, other cash management techniques like concentration-banking or lock-boxes are worth considering (Gitman, 2000, p. 677). Payments within a corporation can then normally be executed very rapidly at same-day value. Globally operating banks provide treasury workstations to their larger customers that enable them to gather real-time information about company cash-balances worldwide and permit them to initiate transactions online (Shapiro, 2005, p. 519).
Managing disbursement float, however, tends to be an even more challenging task and differs even more from country to country. The general problem with managing disbursement float is the dilemma between retaining payments as long as possible without harming the firm’s credit rating.