Why should a company hold cash or short term deposits when the return is often quite low?

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1.1 A) Why should a company hold sums of money in cash or short term deposits when the return is often quite low?

Cash and Cash Equivalents is also called Cash and Cash Equivalents and listed on the Balance Sheet, the cash is simply the actual cash the company has on hand. It is widely agreed that the amount of cash and cash equivalents a company holds is very important and is a large component of a company’s overall operating strategy. For instance, companies with high amounts of cash and cash equivalents are better able to get through hard times when sales are low or expenses are particularly high. High cash reserves can also signal that the company is “saving up” to make some significant acquisition (investinganswers.com 2010). Therefore the fact that a company holds sums of money in cash or short term deposits when the return is often quite low is understandable and widely adopted by many companies.

1.2 B) What techniques are available to an MNC with operating subsidiaries in many countries to economize on these short term assets?

1.2.1 Cash pooling

Cash pooling is a financial management strategy that allows companies to maximize both the current credit and debit positions so that the corporation receives the most benefit from those positions. In addition, cash pooling can help the company to avoid a number of costly bank fees, as well as help reduce the opportunity of damaging the reputation of the corporation because of negative balances on a bank account. (wisegeek.com 2008) In effect, cash pooling helps the make the most of the resources that are available. One basic approach to cash pooling involves the application of a cash management technique known as notional cash pooling.

1.2.2 Bilateral and multilateral netting

With bilateral netting, two counterparties agree to net with one another. They sign a master agreement specifying the types of netting to be performed as well as the existing and future contracts which will be affected. Bilateral netting is common in the OTC derivatives markets. Multilateral netting occurs between multiple counterparties. Multilateral netting has the advantage that it reduces credit exposure even more than does bilateral netting. It has the disadvantage that it tends to “mutualize” credit risk. Because credit exposure to each party is spread across all participants, there is less incentive for each participant to scrutinize the credit worthiness of each other counterparty (riskglossary.com 2012). Anyhow, it is still considered as a major method to economize on the short term assets.

1.2.3 Accelerating collections via direct deposit and lockboxes

Direct deposit allows a company to electronically deposit the employee payroll check into their bank account. It can also be used for expense reimbursements, tax refunds, pensions, dividends and bonuses. Best of all, a company can control the process when it uses the direct deposit service. And lockbox service helps accelerate the accounts receivable collection process. The clients direct their paper-based payments to the post office and the bank will pick up these payments and process them according to the given instructions, and credit the account that day (bankcherokee.com 2011). These are the usual function of the direct deposit and lockboxes which assists to accelerate the collection of cash.

1.2.4 Treasury workstations to track the firm’s cash position on a real-time basis.

A treasury workstation is a combination of hardware and software that will manage cash, investments, debt issuance and tracking, as well as provide some risk analysis functions. A treasury workstation automates so much of the rote finance tasks. For example, if an employee enters an investment into the system, it will create a transaction for the settlement, one for the maturity and another for the interest. It will then alter the cash forecast with this information, as well as create a wire transfer to send the money to an investing entity (accountingtools.com 2012). The role of the treasury workstation such as Bank reconciliation, Cash forecasting, Cash movement, Debt tracking and Financial exposure will assist the MNCs to better economize on these short term assets.

1.3 C) What advantages and disadvantages might SKB realize from centralizing international cash management and foreign exchange management?

1.3.1 Case background

SmithKline Beckman is the health caser products MNC with 105 affiliates worldwide. It is now part of GlaxoSmithKline plc (GSK) which is a British multinational pharmaceutical, biologics, vaccines and consumer healthcare company headquartered in London, United Kingdom (reuters.com 2010). And there has always been a great deal of intercompany sale, dividend flows and fee and royalty payments while each unit makes its intercompany credit, payments and hedging decision independently.

1.3.2 Advantages from centralizing international cash management and foreign exchange management

1.3.2.1 Better manage liquidity

As mentioned, in SmithKline Beckman there has always been a great deal of intercompany sale, dividend flows and fee and royalty payments while each unit makes its intercompany credit, payments and hedging decision independently. By centralizing international cash management and foreign exchange management the individual affiliate will save a lot of liquidity spent in the intra company transactions and thus the pools of excess liquidity will be minimized and reduce to a large extent.

1.3.2.2 Centralized control in the company

With each subsidiary is managing its own working capital, a centralized cash management group is needed to monitor, and possibly manage, the parent-subsidiary and intersubsidiary cash flows. And theoretically by centralizing international cash management and foreign exchange management, it assists to ensure centralized control in the company from the perspective of corporate governance.

1.3.2.3 Enhanced profitability

With the reduction and elimination of the intra company finance transactions, it is expected that the finance cost will the eliminated and thus the profitability will see further enhancement.

1.3.2.4 Higher level of skills in handling company finance

After centralizing international cash management and foreign exchange management, it is expected that only one group will be handling the company finance transactions frequently, and based on the labor division theory, no doubt that this group of people will get higher level of skills and professionalism in handling the company finance through actual working experience and more exposure to the finance activities.

1.3.2.5 Exhibition of big picture in cash management activities

Because of the centralizing international cash management and foreign exchange management, the company would now be able to make decisions in respect of the cash management activities in a strategic perspective which consider the overall company needs rather than the divisional needs and therefore it will exhibit big picture in cash management activities.

1.3.2.6 Enhanced headquarter bargaining power

By increasing the volume of foreign exchange and other transactions done through headquarters, banks provide better FX quotes and better service. In another word, by integrating international cash management and foreign exchange management, the headquarter would have more bargaining power because of the increased volume of foreign exchange and other finance activities.

1.3.3 Disadvantages from centralizing international cash management and foreign exchange management

1.3.3.1 Lack of accuracy in predicting intra cash flows

The centralized cash management division of an MNC cannot always accurately forecast the events that affect parent- subsidiary or intersubsidiary cash flows. And therefore lack of preparing can happen and it could cause liquidity crisis within the company because the company is not geared up for it in advance.

1.3.3.2 Increased cost with complex hierarchy and central management

Central management has its own advantages such as better control to the subsidiaries, but it also has its own costs and risks. Such costs could take a number of forms. For instance, a central management would require more senior and middle end management positions to support the running of the central management. What is more, the more complex company hierarchy will result in higher cost of communication because of the more complex company structure setting.
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