Importance Of International Financial Management Finance Essay
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Published: Mon, 5 Dec 2016
The rapid globalization, economic crises and continuously changing business environment together to make present financial management challenges more critical than ever. And the same forces make successful financial controls very important because international financial management (IFM) operates, with the decisions financial in nature taken, in the era of international business. The development in international business is apparent in the mode of extremely inflated volume of international trade. The history of international trade can be traced back to World War II. When after the war years immediately, the common type of contracts on the Trade and Tariffs were established in order to increase trade. This arrangement eliminates the trade restrictions extensively over the years and as a consequence multinational trade grew largely. Moreover, the trader’s financial contribution in respect of exports and imports surged widely across the countries. Since then this situation persist and increase over the years that compel companies of all types and sizes to think how to utilize resources when dealing in international markets. This expansion gives rise to significant variation in the position of market stability. As a result, today major financial decisions entail cross-border complications. Preferences in respect of raising capital, management of risk, investment decisions, mergers, restructuring, and all other features of financial strategy generally involve international complexities and these complications increase the need of international financial management. When financial managers take these decisions they must examine currency exchange rates, risk factors of specific country, tax rule’s differences and deviation in legal systems. In short, the finance managers of multinational corporations need appropriate management of international flow of funds for which the international financial management came to be very important and this has been discussed in detail below.
The purpose of this research paper is to discuss the importance of international financial management to know that the role that financial management is playing in a modern international business environment.
Importance of International Financial Management
International financial management (IMF) significance cannot be exaggerated. It is, however, the core factor to successful business operations. In the absence of finance in local even in international market, no entity can achieve its full strengths for success and growth. We all know that money is a worldwide lubricant that keeps the local and multinational enterprise dynamic in developing product, keeping machines and men in working, motivating management to create values and progress. As I have discussed above that globalization open the market for major corporations to business into international markets, but it also brings corporations to a variety of risks that they can face while operating in international era and in this regard international financial management is the only solution to mitigate these risks and expose corporations to the whole world to operate in. Below is the details of risk that multinational companies face and the role international financial management play to control these risk that increase the importance of international financial management.
Currency Exchange Risk and International Financial Management
Operating business in international markets may result in a foreign currency exchange risk that is known as exposure of transaction. Currency exchange risk arises when an entity has receivables or payables major portion in foreign currency (FC). The risk persists in the variation of the foreign currency exchange rate. For instance, if the foreign currency increases in value before paying liability, the business has to pay extra amount to purchase the foreign currency required to clear this liability. As a consequence, the business will face a loss of foreign exchange. And when the currency value decreases the business will have foreign currency gain. On the other hand net assets will have the reverse relationships that are denominated in a foreign currency.
In managing the risk of currency exchange, IFM approaches have gained prominence in recent years. IFM provides a variety of hedging techniques to control foreign currency transaction risks.
Pricing. The basic technique offers by international financial management to manage risk or to control billing currency, is called pricing. Exchange risk currency can be controlled if the businesses invoice their clients in the company’s reporting currency or functional currency. For instance, a business can settle a price of receivable in the currency in which they are reporting and thus transfer the risk of exchange to their customer.
Settlement. This technique is used where the business cannot price their customer in reporting currency, it can exercise the settlement technique to eliminate FC exchange risk. This technique needs that management continuously offer early settlement discounts for receivables or payables dealt in a foreign currency. In short, this technique of IFM pushes a business to renounce the advantage of the money time value with the intention to evade the risks of foreign currency exchange variations.
Forward Contracts. The business should use the other techniques to control the cash flows if it doesn’t want to make early settlement or cannot price in reporting currency. Almost certainly in this situation the renowned hedging methods is selling and buying forward contracts in foreign currency. These are agreements between parties to sell or buy foreign currency in future time at pre-decided fixed exchange rate. It reduces the company’s exposures to variation in exchange rates, whatever the rate in future is, the transactions occur at fixed rate. This transaction involves the cost of currency exchange and the cost of purchasing a forward contract.
Leading and logging. IFM also provides additional technique to mitigate the risks for centralized and large business, called leading and logging. This technique requires leading (prepaying) due amount when the currency of payer is decreasing against the payment currency and lagging (covering) those payments if the currency of payer is increasing. From business perspectives, the international financial manager can ask for leading and lagging technique so as to take benefit of the constructive consequences of exchange rate variation. Moreover, leading and lagging strategies may be exercised to move funds to cash-poor from cash-rich partners, thus enhancing liquidity in short-term.
Working Capital Management and International Financial Management
International financial management plays very important role in working capital management. Working capital management means taking decisions relating to short-term liquidity, and capital financing. These decisions comprises on managing the rapport between short-term asset and short liabilities of the firm. In this regard international financial management plays very important role in maximizing the worth of the firm by spending in such projects which produce a positive net present value (NPV) by discounting with appropriate discount rate. These investments, as a result, have complexities in relation to cost of capital pf cash flow. The purpose of IFM is to make sure that the business is capable of operating, and that it has positive flow of cash to support debt in long-term, and to assure both upcoming operational expenses and short-term debt. In this way the firm value is appreciated in case the return on capital investment surpass the capital cost.
International Financial Management also guides companies in taking financing decions. And accomplishing the business financial objectives IFM need that any corporate investment be financed properly. As discussed above since both un-stable rate and cash flows will be influenced, the mix of the financing can influence the valuation. In this way financial manager must highlight the capital structures and optimal mix of financing that should result in maximum value. The sources to generate finance generally involve the combination of debt and equity financing. If a business decides to finance through debt, it will increase the liability that must be paid, therefore involving cash flow complications independent of the project target of success. The second option is equity financing. Equity financing is, however, less risky in relation to cash flow payment promises, but results in a reduction of control, ownership and earnings. The equity financing cost is also more than the cost incurred in debt financing, and in this way equity financing method may result in an appreciated hurdle rate that may compensate any reduction in risk of cash flow. International financial management helps management to keep balance between both options to avoid the risk of cost burden.
IFM Co-ordinates Various Functional Activities
International financial management offers comprehensive harmonization between varieties of functional areas such as production, marketing, etc. to accomplish the goals of organizations. If financial management is imperfect in multinational companies, the effectiveness of other business units can be maintained. For instance, it is very essential for the finance department to make available required finance for the raw material procurement and for other expense for the successful running of business. If financial department does not work properly and fails to meet obligations, the sale and production units will suffer and as a result profit and income will undergo. In short, proper financial management occupies a significant place in any business concern.
Determinant of Business Success
International financial management is necessary for the business success. It has been identified that the financial manger plays a very imperative role in the business success by suggesting the higher level management the effective solutions of a range of financial problems as professional. They provide considerable figures and facts in relation to financial position and company various functions performance in specific period before the higher management in such means that make it easier for the higher management to assess the company’s progress to adjust policies and the principles of the company properly. The international financial managers help the higher management in the process of decision making by recommending the best possible solutions out of the number of alternatives options available. Hence, international financial management assists the management at various stages in taking national and international financial decisions.
IFM as Measure of Performance
International financial management helps to measure the performance of business through its financial results by applying the techniques of ratio analysis. These analyses provide the position that where the firm is going over the years. Such financial decisions that appreciate risks become cause to decrease the worth of the firm and on the other the hand, such international financial decisions that boost the profitability enhance the firm value. Profitability and risk are two necessary part of any business that can be managed effectively through financial management.
The challenges that management is facing today is the effective and efficient working such that is internationally oriented. The major difficulties that a business faces in international markets are, fluctuation in currency exchange rate, investing decisions, financing decision, coordination of different business unit in different geographic places, etc. These problems can be managed through proper adaptation of international financial management methodologies. The effectiveness of these methodologies based on management’s understanding to the foreign markets and the requirements of its subsidiaries. In short, managing business accounts and finance is crucial to the success of every multinational business because the increase in complication and importance of financial management in international business environment poses challenges for management in international corporations.
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