Multinational companies are companies that operate across international borders. The multinational company has overseas production units, marketing or service units. A MNC is a corporation that has a given proportion of its assets, personnel, sales or earnings originating from or set-up in a foreign country. Multinational companies (MNCs) play a significant role in the globalization of businesses. The emergence of MNCs was a result of differences in geographical endowments of factors of production and due to acute market failures. The fact that MNCs operate in the global arena means that they face unknown political, social-cultural, economic, technological and legal environments (Skim & Siegel, 2008). MNCs have faced foreign resistance in countries for which they are based. However, corporations have proved themselves as agents of change and economic development. For a MNC to survive, organizational capabilities, often based on knowledge, must be used to leverage the strategic capabilities held by the organization. MNCs have to strategically deal with cultural differences and legal differences. Cross-cultural competence is essential for the cross-cultural communication to take place. This is also to avoid cultural mistakes that may influence the business of the corporation (Skim & Siegel, 2008).
MNCs enter the global scene through various strategies available for the internalization of a Corporation. A single international corporation may choose to adopt more than one strategy in order to make it a multinational Corporation. Strategies are foreign direct investment, export trade, franchising, licensing, joint ventures and by having foreign subsidiaries. The choice of strategy to be used is pegged on business riskiness, control, organizational and management demands. Exportation would be considered less risky, as compared to foreign direct in investment. This is probably because the FDI involves a supply of funds in a foreign country in buying a new firm (green field investment). Organizations choose to operate as international companies for various reasons, such as the exploitation of new markets, search for raw materials and technology to be used in the production processes. Corporations also venture in the international arena for production efficiency, diversification or to avoid legalities and political interferences in the home country (Skim & Siegel, 2008).
MNCs derive a large percentage of their income from the foreign operations. Thus, the chief finance officers must understand the density of dealing with international finance, in order to make prudent financial and investment decisions. The financial aspect of MNC deals with management of working capital, sourcing of international financing and hedging against exchange rate risks and political risks. Exchange rate risks are particularly pertinent, as it can materially affect the corporation’s payables and receivables. There are various ways in which an organization can hedge or avoid exchange risks. These include forward contracts, swaps and futures (Skim & Siegel, 2008).
The financial management of MNCs is characterized by:
1. Numerous currency difficulties. Different currencies may be used to value the sales revenue, assets and profits of the organization.
2. There are numerous legal, economic and institutional challenges. The fact that corporations operate in foreign countries means that they experience varied tax and labor laws, policies of balance of payment, issues of government control of the organization, as well as the repatriation of profits.
3. Internal control problems. These problems emanate from the simple fact that MNCs are located in different countries; thus, internal control difficulties and conflicts are bound to occur.
4. Interest rate parities
In the summary, financial decisions that have to be made by the organization’s CFO include decisions of expansion of business operations in a particular country and the discontinuation of operations. Financial decision made by the finance officer may create agency problems. This is a situation whereby the decision reached conflicts that of maximizing shareholder wealth. For example, decisions to establish subsidiary companies may be informed on the location advantages as opposed to the potential benefits such a project is likely to bring to stakeholders.
Madura Exchange Rates
Exchange rates are quoted in two ways, namely, direct quotations and indirect quotations. A direct quotation is where the dollar is quoted against the foreign currency while, for an indirect quotation, the foreign currency is quoted against the dollar. A spot rate is the prevailing exchange rate while a forward rate is one that has been predetermined at an earlier date. For forward rates, parties to an agreement agree on the exchange rate for a transaction that is to be held at a future date. The forward rate varies from the spot rate and the difference can be ascertained as a premium or as a discount. A cross rate refers to an indirect calculation of exchange rates of one country’s currency in terms of the US dollar. An exchange risk is the risk of having the cash flows of the organization decline because of changes in exchange rates (Madura & Madura, 2011).
MNC’s face numerous financial risks because they operate in an unpredictable foreign scene. Futures and options are devices used by corporations in management of financial risks that they face. Futures are contracts traded on future / standardized contracts. A plan is currently established for sale and purchase of a given commodity/consignment at a predetermined future date. Options are similar to the future, but the bearer of options has the option of fulfilling or forfeiting the contract (Madura & Madura, 2011).
Interest Rate and Inflation
The interest rates and inflation levels of the foreign country has serious implications on the financial performance of multinational companies. The inflation rate influences the future production of the company. It also influences the exchange and interest rates, which have effects on the MNCs profitability. Foreign countries with greater inflation rates in relation to that of the United States are at risk of experiencing depreciation of the local currency. The CFO can predict the direction of the exchange rate by looking at differences in the interest rates. Relative inflation rates also have an influence on interest rates. Interest rates are crucial as they influence the financing of the MNCs. A country with a high inflation rate is likely to experience increased interest rates. Decisions for international investment are largely influenced by inflation and interest rates. This is likely to influence the financial position of the MNC (Skim & Siegel, 2008).
Cash Management and Capital Budgeting
The move towards globalization has been accelerated by the trend that companies are operating internationally. There are various financial implications for MNCs. The cash management function is made complex due to the geographical distance. As firms need to source for finance from many markets and the fact that cash is denominated in foreign currencies, makes cash management function of the CFO complex, as compared to when it involves local companies. Capital budgeting decisions for MNCs is made complex by the fact that the firm has foreign operations that are taxed in the foreign country. The same funds are also subjected to taxation when repatriated to the home country (Ehrhardt & Brigham, 2010). MNCs face political and exchange rate risks. It is the function of the finance department to leverage the organization against this risk through government lobbying and by using appropriate financial devices to enable the company operate profitably. There are more financial considerations for MNCs as compared to those of local companies.