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The concept of globalization, which is characterized, with free movement of people, goods and services and capital between and among countries made possible by the advent in technology information, has revolutionalized how mankind does his things. As a result, the world has no doubt turned into a global village fashioned by interconnectedness and interdependence. The globalization of trade and finance is changing international relationships at several levels of interaction. It is also the case when examining international identity, community, knowledge and the environment. There is very little that cannot be linked with globalization when studying international business (Adler & Gundersen, 2008). The task of this paper is to examine a situation where a firm engages in business with other countries. In order to be able to succinctly cover this issue the paper will describe what is meant by multinational corporation and give clear reasons why companies expand their operations to other countries. A section of the paper will also distinguish multinational financial management from financial management as practiced by purely domestic firm, the issue of currency prices will also be tackled and some calculation performed based on a set of data provided.
On top of this, the paper will also address the issue of convertible currency and point out the problems that can arise when a multinational company operates in a country whose currency is not convertible, between difference between spot rates and forward rates are and influence of relative inflation on interest rates and exchange rates. Lastly, a section of this paper covers concepts international capital markets and the impact of multinational operations on cash management, capita; budgeting decisions, credit management and inventory management.
With the concept of globalization, it is essential for managers and business people to understand it in order to be able to contribute sustainably to their organizations in this competitive business world. Christian, J. et al (2006) research indicates that most businesses are today going globally to seek for more profit. Multinational Corporation has been thought as a corporation or business enterprise that is duly registered having facilities and assets in at least one country other its home country. It is worth mentioning that multinational corporations have offices, factories and stores in different nations. In multinational businesses, most companies have mother organizations that give rise to sub-branch companies that may be placed in different geographical world regions. The born company branches however are more likely to take after the mother company’s mode of management system (Claire, 2008). Nonetheless, the operations are coordinated from the head office, which is usually located in the home country. The corporation engages in global transactions, which are in the nature of goods, services, technology, managerial knowledge, and capital. Therefore, multinational corporations are involved in both importations and exportation of the above mentioned business transactions.
It will be rational to expound on how Multinational Corporation come about. From literature, scholars have established that one way Multinational Corporation come into existence is through the efforts of a company to open new companies with one headquarters in one country probably the country of origin. With this, the firm is able to produce goods and services with the facilities located in the different geographical locations. This is a rigorous activity since the company must go through certain legal requirement before being given a node to establish its roots in the host countries.
Another common approach that gives birth to multinational corporations is through mergers. This is when at least two companies based in different countries come together in most cases to deal with the issue of competition through gaining competitive advantage either by dealing with war prices, reduce costs associated with advertisements and promotions among others. Lastly, they come about because of acquisition as well as hostile takeovers. Acquisition is where one firm buys another firm from a different country.
The desire for companies to go global rests on the notion that by operating in a global environment it is possible for the company to shade off economic as well as political shifts compared to corporations that operate in one country. Other benefits include opening the doors for diversifications, access to resources and labor. Even during financial crisis well established multinational corporation have the possibilities of remaining solvent this is true if particularly if one of the subsidiaries is not doing so well and it is recording losses (Adler & Gundersen, 2008).
Questions have been raised concerning businesses expanding their wings into other countries. To answer this paper will succinctly discuss reasons why businesses have taken the advantage brought about by globalization.
One of the reasons that make companies to expand into the global business environment is to expand its market base and share which ultimately leads to increased revenue and profit. Ideally, when a firm introduces a new product or service into a new market, it offers such a firm the opportunity to grow and expand. A typical example of such a firm that took advantage of globalization is Coca-Cola. After its establishment in the United States, it grew to a point that it was not possible to increase its market share with the U.S. The desire to expand its operations other continents such as Africa, Europe, North America and Asia has seen to it that it is a multibillion corporation having the largest customer base (Christos & Sugden, 2000). Another example of a firm that has realized the advantages of going global in its business operations is MAC cosmetics. Being a small company that deals with cosmetic, the firm ventured into international business environment, the firm ended up selling their products in over 120 countries hence controlling approximately 45.0% of cosmetic sales in the world.
It has been shown that companies decide to go global setting up other subsidiary branches in other countries to take advantage of human resource. Although some might argue that it would be cheaper to employ some as expatriates, these group of people will be paid salaries based on the laws of the country. However, to avoid this and take advantage of cheaper cost of labor, the only way is to open business operation in other countries where the cost of labor is manageable and cheaper. For instance, in the United States of America labor is much expensive and the same applies to major developed countries (Christos & Sugden, 2000). However, in most developing countries, the cost of labor is cheaper and this can explain why a company such as Coca-Cola has specialized in expanding in developing countries such as Brazil, Kenya among others. It is worth noting the idea of cutting costs helps a multinational corporation gain competitive advantage that has pushed more firms to expand their operations in a global environment.
In addition to this fact, major corporation desire to operate in other countries is driven by the quest to minimize costs. When organizations search outside their borders, there is, hope that they will eventually finds more economical solutions to how they produce and manufacture goods and services. This can be attained through a number of ways such as looking for cheaper labor which has been discussed in the previous section, moving the manufacturing processes closer to the locations of natural resources, take advantage of new technologies as well as enjoy benefits of different tax structures. To illustrate this, a corporation situated in the United States and gets a bigger percentage of resources from India might wish to consider moving its operation closer to India or even in India. This will ensure that the transportation costs are minimized to a larger extent. If Kahawa Ltd takes the initiative to operate in Asia, it will then be able to enjoy the benefits of lower labor cost compared to when operating in Europe.
Another reason that corporations consent to operating in a global environment rests on the ideas of seeking raw materials. It is worth mentioning that this was the major reason for earlier multinational corporations to expand their wings to other countries. This can be illustrated particularly in the past centauries where firms from Britain, France and other colonizers expanded and started setting up their businesses in their colonies. The primary reason for this was to take advantage of the natural resources and other costs of productions such as land and labor. The major reason for going international was to exploit the raw material that was found in other countries. Typical examples of modern day firm include petroleum and mining firms such as the British Petroleum Standard Oil, International Nickel as well as Kennecott Copper are among forms that took advantage of the idea of exploiting raw materials found overseas. Expanding operations to Asia will give Kahawa Ltd an opportunity to utilize raw materials that are in given countries in that region helping it avoid the costs associated with transporting the raw materials to its headquarters.
In the previous section, it was indicated that one way that led to existence of multinational companies is as a results of mergers and acquisition. Due to globalization, the world of business has been characterized with very stiff competition. The competitive advantages firms had and believed that no other firm could imitate them proved to be wrong since new firms’ derived better ways of doing business. Similarly larger firms conquered markets across the world making it very difficult for smaller firms to be competitive and remain relevant in the market. In order to protect their existence businesses go international by forming mergers with other bigger or smaller businesses. The advantage this brings is reduced wars in terms of price, reduced costs of advertisements among others. Similarly, when firms come together, the synergy in terms of resources makes it possible to remain relevant and meet the demands and aspirations of the customers. On the same note even without forming mergers or acquiring other firms, when businesses expand globally, they get opportunity to protect themselves from competitors or potential competitors since they expand their market base and share.
Interestingly some businesses have gone global in order to avoid political as well as regulatory hurdles. Despite the fact that a business may be domestic, there are some countries, which have very strict laws and regulations on how businesses should operate; this is after factoring in the initial hurdles that should be met by the owners before establishing such businesses. Additionally there are some countries, which are politically unstable. On the other hand, since every country has its own laws and regulations, a firm might find it favorable to set up a new subsidiary in another country since the legal aspects are less complex and the business is guaranteed of carrying out its operations smoothly without political interferences. For Kahawa Ltd it might be difficult for it to continue opening up new subsidiaries in Europe or even in the U.S compared to countries in Asia. This will give it an opportunity to open its business within shorter time span and meet less or equally straightforward legal requirements. On the same note, the issue to do with tax benefit can be a motivation for a firm to go global. Tax benefits will help a business to offer its products at a lower price leading the firm to accumulate huge profits. Typical examples of going international to avoid political and regulatory handles is when firms such as Toyota, Mazda as well as Honda shifted their operations to the United States in order to avoid import quotas.
Lastly, the issue of diversity comes in as another important reason that makes corporations expand their operations to other countries. Although it has been shown that financial crisis if it hits developed countries, it is possible that most of the countries will be negatively affected. However, if recession is regional, then those firms that have invested in one country might be forced to close down if financial crisis is to hit that country. With such realization, businesses have taken the advantage of globalization and resorted to investing in hospitable countries. This has ensured that large corporations such as Coca-Cola continue recording profits even if one of its subsidiaries is negatively impacted with financial crisis. In the case of Kahawa Ltd, expanding its operation in Asia will most likely cushion it from the negative impacts of financial crisis for instance the one experienced recently in the Eurozone
Financial management in domestic and international firm
As noted in the previous sections there are a varied reason that makes businesses to operate in more than one country. Among these reasons include cutting down cost, avoid political and regulatory handles, increase market share, and utilize raw materials from other countries to mention but a few. With this comes the issue of financial management. Financial management has been thought of as the process to plan, direct, monitor, organize, and control a firm’s monetary resources. It is worth to note that the popular financial goals of multinational corporation include the following; maximizing growth in terms of corporate earnings, maximizing return on equity as well as guaranteeing that financial resources will be always available if need be. With this in mind, it has been observed that the issue of financial management in domestic and international environment is purely different. For this reason, it is important to bring to light these differences so that those businesses that are planning to expand their operations to other countries get to know what they expect and adequately prepare themselves so that the effort will yield positive results.
The first difference is about currency denominations. In case of a multinational corporation, it is no doubt that cash flow will be in form of different currency denomination. For instance if a firm operates in the United States, Japan, Kenya, South Africa and the Great Britain, financial managers have to brace themselves to have a full understanding on how the issue of exchange rates, inflation, interest rates play and impact on their business activities. On the other hand a domestic firm will not need to worry a lot about studying and analyzing the impact of foreign financial characteristics such as interest rates, inflation or even exchange rates since it does business locally and cash flows is in one currency although of different denominations. For the case of Kahawa Ltd it has to employ well-qualified financial experts or take the initiative of taking the existing financial experts for further training so that they will help the firm to handle financial issues in a global environment.
It is also a fact that businesses at one time of their operations will need to raise more capital to increase or expand their operations. For multinational corporations there are varied options to raise capital required. It is thus understood that with much more option of raising capital, the firm should have the necessary personnel with needed and relevant skills to advice the firm on which of the option of raising capital is less costly to the business. This is attributed to the fact that a variety of options brings with it a variety of challenges with respect to choosing the right and better source of capital. With this in mind, Kahawa Ltd should brace itself to have at its disposal the right finance human resource to handle the challenges anticipated. This will call for training as well as educating their existing officers so that they will be at par with the varied requirements that will help it secure capital at affordable cost.
More importantly, for those firms that operate in different countries, there is the challenge for the financial manager to handle the differences brought about by the economic and legal structure. An ancient saying states that when one goes to Rome, there is need for that person to do as Romans do. This is more pronounced when a firm documents its financial records. While a domestic corporation will only worry to abide by the financial recording laws stated by the host country, those firms that operate in various countries have no option but to adhere to two financial structure of reporting their records. A typical example is when a firm in the UK operates in US. Such a firm will be compelled to adhere to the GAAP accounting standards as well as UK accounting standards. Recently, with the introduction of International Financial Reporting Standards multinational corporations should fully understand how the basic principles of IFRS apply. Various standards contained in the IFRS affect the tax report. It is therefore important that enterprises should put into consideration all the IFRS related adjustments before adopting the standards or when adopting them on an ongoing basis. Clients should make sure that they understand the tax issues that could arise from adopting IFRS affecting their enterprises (Hay. et al., 2006). It is worth mentioning that IFRS is made up of a set of principals established by the IASB dictating specific treatments of the accounting procedures. They comprise of the International Financial Reporting standards (IFRS) issued after the year 2001, International Accounting Standards (LAS) issued after 2001, Standing Interpretations Committee (SIC) issued before 2001, and Conceptual Frame Work for Financial Reporting (Wu, 2007). In such a situation Kahawa Ltd in order to be seen to comply with such standards, they have no other option other than adopting them. This is contrary to what a domestic firm is expected to behave.
Another major difference between financial management in domestic and international environment lies in the twin concept of language and cultural differences. Although it is a fact that even within a given country, there exists some differences in culture and to some extent the language, these are more pronounced when one considers different countries in which multinational corporations operate. Culture refers to a set of believes, values, and behaviors practiced in a particular society (Brickson, 2000). In business organizations however, culture is defined as a system in which the staffs share values and believes that are connected to the organization’s people, structure, and control system to produce behavioral norms (Gonzales, 2009). There are four organizational culture types namely market, clan, adhocracy and bureaucratic hierarchy. Each of this four culture types is characterized by a certain set of shared believes. Taking a global approach, studies indicate that national and ethnic cultures have influence on organizations and employees well being.
Based on this fact, there is need for the firm to fully understand how culture impact on how for instance culture of a given region impact on how to market and promote a given product in terms of the media used, slogan used among others. The finance managers should understand these concepts so that they can be able to allocate funds on projects that will continue generating revenue and profit for the firm. For instance McDonald has mastered this concept by ensuring that the menus they have in different locations reflects the way the host population believe in terms of food. Similarly, there is also the issue of conflict management, which is affected directly by culture. There are societies that like confronting the conflicts in a formal way while other like the Chinese like approaching conflict in an informal manner. Kahawa limited should indulge her managers to familiarize themselves with the various cultures so that they will be able to help the firm attain its goals of going global.
Similarly, the issue of language is critical for international firms while managing financial aspects. There is no doubt that the ability to effectively communicate is very important in ensuring smooth operation in business. Despite the fact that English is becoming a global language used in conducting business, the ability of a business to have employees who understand local language finds it easy to conquer such markets. For instance doing business in Spain calls for one to fully understand Spanish, this not being enough there are some locations where one is to use Catalan, Galician or Basque language to appeal to a wide range of customers. For this reason, multinational companies including Kahawa Ltd should brace itself to foot extra costs related to educating and training its staff, translating company laws among other issues related to culture and language.
The issue of political risk and the role of government give another base to differentiate between financial management for a domestic firm and for one that operates in a global scale. With the concept of sovereignty, it has been argued that a nation can decide to exercise its mandate by protecting its citizen especially if it emergences that a given firm is exploiting her citizens. This can be done by seizing a firm’s property or blocking it from repatriating the accrued earning. This will make the affected firm to lack funds to continue with its daily operations. It is thus mandatory for the firm to strictly adhere with the laws of the host country so that it finds itself in good books with the government.
More importantly, it is worth noting that the way one government engages with foreign firms varies. For instance, most developed countries such as U.S play less direct role about how foreign companies conduct business provided they have met the initial requirements of registration. Similarly, some government has in place regulation and tariffs aimed at protecting domestic firms while others provide incentive in exchange for jobs for its citizens. There are also issue related to corruption, efficiency and bureaucracy. It is upon the firm to familiarize itself with all these aspects, as it will help it operate in new environment with ease.
Exchange rates decisions in multinational corporations
Exchange rates with the concept of globalization which has pushed organizations to open businesses in other countries, there is need to have a full understanding about the rate at which the currency of one given country will be exchanged for the currency of another country. This also gives business organizations operating in other countries to understand the value of one country’s currency in relation to another. This concept is what has been termed as exchange rate or forex rate. There are basic terms and concepts related to exchange rate that should be mastered. From the table below (table 1) it is worth noting that the currency prices are direct quotations. This can be explained by the fact that the values represent the value of a domestic currency in terms of a unit of foreign currencies, for instance to buy in order for one to buy one Japanese yen, Ksh. 89.43 is required. On the other hand, indirect quotation refers to the number of units of a foreign currency that are required to purchase one dollar or a local currency. From the same table one can easily calculate the indirect quotations for the currency of any given country. In order to arrive at indirect quotation values, one needs to just find the reciprocal of the direct quotations for the respective country’s currency in this case Yen and Hong Kong dollar.
For the Japanese Yen, the direct quotation=1/89.43
For the Hong Kong Dollar, the direct quotation=1/10.28
All these are illustrated in table 2.
Table 1 Direct quotation
KSH required to buy one unit of foreign currency
Japanese Yen (000)
Hong Kong Dollar
Table 2 direct quotation and indirect quotation
Hong Kong Dollar
With regards to cross rate, this refers to the exchange rate between any two non-dollar currencies. A relatively large number of cross rates would be required to trade every currency directly against every other currency. For example, N currencies would require N x (N-1)/2 separate cross rates. For this reason, most exchange rates are quoted in terms of dollars and by far the greatest volume of trading directly involves the dollar. This reduces the number of cross-currency quotes that dealers must keep track of and reduces the potential losses associated with mispricing currencies relative to one another. In order to calculate the cross rates between Yen and Singaporean Dollar, it is important to note that there are two options; one is to either divide the direct and indirect quotations or perform a reciprocal operation of each of the currency under investigation. For the purposes of this assignment I chose to divide the indirect quotations, the justification for doing this is that the approach is easy and straight forward characterized with less complicated computations.
The two cross rates between Japanese Yen and Singaporean Dollar are,
=0.0565 Yen per Singaporean Dollar
=1.6785 Singaporean Dollar per Yen
It is a fact that businesses are in operations in order to make profits. The value that a firm adds to the total cost they encountered while producing given good or product for sole reason of generating profit is termed at mark up. It is the profit generated through sale of goods and services that helps an organization to continue running by paying bills, salaries among others. Different organizations have various rules on how to generate profit, for instance, one may state that for every good or services, a 50% mark up should be imposed.
In the case of Kahawa Ltd which intends to ship one ton of coffee to Hong Kong costing Ksh. 30 million, if the company wishes to make 50% mark up, then the coffee will be at how much in Singapore?
To succinctly respond to this question there is need to first calculate the cross rates between Hong Kong and Singaporean Dollars.
=5.1755 Hong Kong Dollar per Singaporean Dollar
=0.1932 Singaporean dollar per Hong Kong Dollar
The total sell in Singaporean Dollars that the coffee will be sold for the company to realize a 50% mark will then be; 30,000,000(0.1932)*53.13
The one ton coffee should be sold at 307,941,480 Singaporean dollars in order for the firm to realize a 50% mark up.
Spot rate has been defined as the current value of a given currency. It is worth noting that the value varies accordingly as a result of trading on the currency exchange. In other words, spot rates refer to the value paid to buy currency for immediate delivery usually within a two-day after the day the transaction took place. On the other hand, forward rate has been thought as a given exchange rate or value at which two countries or parties agree to trade currencies. Mostly the involved parties enter into a forward contract, which clearly stipulates that, a given exchange rate or value will be used during transaction for specific period. In simpler words, forward rate is the rate paid to purchase currency for delivery at some agreed future date for instance 3 months, 6 months and so on.
Forward rate is deemed to be at discount if and only if the forward currency is less valuable compared to the spot currency. On the other hand, in situation where the forward currency holds more value compared to the spot currency, then the forward currency is deemed to be at premium.
It is important to mention the benefits of such an arrangement. In most cases, the value of currencies fluctuates everyday and even within hours. For this reason, after entering a business deal with another corporation or business, it is important for the organization or business buying a product or a service to cushion itself from value uncertainty of currencies. To do this businesses have managed to use currency forward markets to hedge against fluctuation in the values of currencies before the transaction is finalized.
For instance, if Kahawa Ltd has established its subsidiary in Japan and wishes to buy some products from Hong Kong, and the payment should be made within 2 months. There is need for the firm to enter into an agreement with the partner in Hong Kong with regards to the value of currency that will be used to make payment within 2 months. This will help the firm not to use more Japanese Yen in case the value of Yen depreciates. In order to protect itself from such happening, Kahawa can engage in buying Hong Kong Dollar for delivery within 2 month, hence locking in the current forward rate.
With globalization, countries were forced to adopt an open door policy thereby encouraging foreign direct investment. The notion to doing this rests on the ability of globalization to help nations grow economically, fight poverty, reduce lower rate employment, ensure that human resource are educated and trained in a wide variety of filed among others. However, with all these it emerged that there was need for foreign companies and even domestics firms to have the freedom of buying goods and services in whatever currency they wish. This brought to light the concept of convertible currency.
Ideally, convertible currency refers to currencies that one can quickly buy or sale without necessarily having the permission to do so from the central bank. It is import to mention that in the recent past only a few currencies are convertible; however, over time many countries have made their currency convertible in order to encourage investors both of the international and domestic origin. Any currency easily traded in the FOREX market easily and exchanged in a private situation base on stipulation of the law is a convertible currency. In order for a country to realize full currency convertibility, there is need for the authorities to allow everyone, residents as well as non-residents to buy and sell home currency for other currencies freely with n restrictions. However as noted in the literature, it is important for the government to be keen in ensuring that some transactions such as residents buying a foreign asset.
It would be rational to give some reasons why the issue of currency convertibility has gained popularity. To illustrate this, I will examine what the Soviet Union believed about currency convertibility. One such reason was the belief that currency convertibility will bring about a market-oriented economy. Simply market-oriented economy is a situation where the markets plays the role f invisible hand sharing how production and distribution of resources are accomplished bringing the highest efficiency in terms of production. Usually the market dictates what should be produced and for who. Additionally demands and supply the forces of the markets are responsible for sharing production and consumption.
Another push for currency convertibility was due to its ability to bring competitiveness in the market. This was because new information concerning new patterns of demands, development of new technologies would help customers make decisions on what they want hence compelling markets to provide better and high quality services and products. The issue of currency convertibility was fronted since monopolies responded poorly to market signals and the only way to reverse this was to have in plac
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