A multinational corporation (MNC) is any business that has its headquarters in one country, with operations in several other locations. In recent years, the global economy has experienced rapid growth in the number of multinational organizations. Today, these large companies greatly influence the factor movements and trade patterns across the world. MNCs may not have the political power to control the state. Still, their impact on the economies where they operate is often so significant that even local governments may only regulate them to a certain extent. When a country’s economic well-being and prosperity depend on these giant corporations’ presence, the local governments have no choice but to encourage these corporations’ investment. States avoid driving them away through strict legislation.
Following the rise of MNCs in the global markets, one question to ask is: why are so many businesses choosing to locate abroad? Why do they prefer operating from multiple locations instead of remaining in their country of origin? There are many reasons for this. Firstly, working within their target markets gives the business access to local knowledge and resources, allowing them to take advantage of the lower production cost in developing countries. Secondly, they can avoid many trade barriers and high transportation costs by having their operations in the country instead of exporting them.
While there are clear benefits to having a global presence, MNCs also face plenty of challenges. Before launching operations in another market, the company must consider the local market variables, such as the laws and regulations, availability of resources, the differences in customer requirements, and the country’s standard business practices. Moreover, the management of every business function is far more challenging for an MNC than a local organization, including the running of its finance function.
HOW DO MULTINATIONAL CORPORATIONS MANAGE THEIR FINANCES?
Managing the finances of an MNC is far from being simple or easy. While aiming to make sound financial and investment decisions, the CFO of an MNC must understand international financial management insights to see the bigger picture. First, the company must abide by the varying financial reporting and tax regulations in each county. Next, investment and financing decisions are often more complicated for an MNC, given the broader range of options available. An MNC also encounters a high level of foreign exchange and political risk, and the CFO must manage it effectively.
In this article, we look at how multinational corporations ensure smooth management of their financial affairs.
EXCHANGE RATE FLUCTUATIONS
As a result of operating in multiple countries, financial managers of MNCs must deal with numerous currencies. Any changes in the exchange rate of these currencies can significantly impact the company’s net cash flows. Financial management for an MNC involves eliminating any significant negative impact of exchange rate fluctuations on its financial performance.
Many MNCs minimize their foreign exchange risk using various hedging strategies. For instance, if the company has a significant foreign currency transaction due to a specific future date. It may enter into a forward contract or futures currency contract to reduce risk. Such contracts fix the amount of money that is payable or receivable in the future, converting uncertain future currency values into fixed currency values for the company. Similarly, MNCs make use of currency options. These are contracts with an upfront fee that gives the holder the right to exchange a set amount of currency at an agreed rate over a specific time.
MNCs must prepare and report their financial statements in each of the locations they operate according to the country’s laws and regulations. Political risk refers to the risk of a government policy change, harming the company’s financial statements. Political risk could arise due to several factors such as war, civil unrest, fiscal policy changes, price controls, contract cancellations, and restrictions on transferring profits back to the home country.
MNCs must manage political risk by coming up with appropriate risk management strategies for each country. One way to do this is to partner with local firms in areas where it is advantageous to do so. The involvement of local businesses reduces the risk of any harmful political intervention. MNCs should also offer developmental assistance in their host countries so that their presence is considered beneficial for the local economy instead of detrimental to it.
Investment decisions for an MNC involve considering many of the same factors as those for a domestic organization. The finance manager must calculate the project’s capital requirements and compare it with the future cash flows over the project to determine if it will be a profitable venture.
However, MNCs must take into account some additional considerations when making investment decisions. The financial markets and institutions operate differently in every country, resulting in different legal and political constraints affecting the investment. Moreover, the regulations on remittances of profits and the local tax system will determine the amount of profit available to the parent company after the necessary deductions.
To generate value for shareholders, MNCs must ensure that they only invest in foreign ventures. It happens when sufficient evidence that the risk-adjusted return will be greater than the firm’s return can earn from local projects. If the risk on a foreign assignment is too high, it is much more viable to invest in a safer, locally-based project.
The process of raising capital is significantly more complicated for an MNC than a local firm. Financial managers must decide whether it is more beneficial to do so in their domestic markets or the international markets. MNCs have significantly more options available to them to raise finance, but this makes the decision more complicated and time-consuming.
MNCs must consider the difference in interest rates, collateral types, and repayment terms in each country before deciding on the best financing option for their needs. Shareholder rights also vary among states. In some countries, shareholders have greater rights, which can increase capital costs for the company.
Unlike local organizations, a multinational corporation’s exposure to financial risks and challenges is more significant due to its foreign operations. Therefore, these organizations need a more qualified team of professionals with international financial management experience to run their finance function. These individuals can implement stringent financial management strategies to reduce the risks of operating in various markets. With the right team and systems in place, an MNC can ensure its finance function’s smooth running, regardless of the risks it faces.