Globalization and International Financial Management

This article focuses on international financial management. International financial management is a growing management practice with significant implications for the economic relationship between countries and the global economy as a whole. This article provides a description and analysis of the main international financial management practices including exposure management, capital financial management, international supply chain management, capital budgeting management, currency swap management, distribution management, futures, options, and derivatives management, investment management, and international accounting management. The issues associated with the use of international financial management software will be discussed.

Keywords Benchmark Return; Capital Budgeting; Currency Swap; Emerging Markets; Exceptional Return; Exposure Management; Financial Management; Futures; Global Economy; Global Markets; Globalization; Information Ratio; International Financial Management; Interpenetration; Investment Management; Liberalization; Objective Value; Opportunity Loss; Options; Organization; Securitization

International Business > Globalization & International Financial Management

Overview

International financial management is a growing field with significant implications for the economic relationship between countries, businesses, and the global economy as a whole. International financial activity requires active management practices and tools. International financial management combines the fields of international finance and financial management. International finance refers to the field of economics that involves exchange rates, foreign investment, and international trade. Financial management refers to a division of management responsible for both resource management and finance operations. International financial management concerns multinational corporations as whole entities and involves cross-disciplinary decision-making. International financial management is a holistic endeavor involving international financial planning, financial control, and financial decision-making.

Multinational corporations rely on international financial management to achieve the goals of creating a competitive advantage in the global marketplace and maximizing shareholder profits (Delk, 2000). Traditional models of corporate financial management are changing as a result of new technological, business, and market environments. International financial managers now manipulate and combine unbundled financial products, such as futures, swaps, collars, and floors, to meet the needs of individual clients (Levich, 1989). Common concerns for international financial managers include the following: Exchange rate fluctuations, forecasting efficiency, transactions exposure, long-term financing, direct foreign investment, futures and options, country risk, international working capital management, transfer pricing, and economic exposure (Madura & McCarty, 1989).

The Global Economy

International financial management is growing in importance as international financial activity and global markets become increasingly common. Global markets are characterized by an increasing mobility in capital, research and design processes, production facilities, customers, and regulators. Global markets, created through socio-economic changes, political revolutions, and new Internet and communication technology, have no national borders. The modern trend of globalization, and resulting shifts from centralized to market economies in much of the world, has created opportunities for increased trade, investment, business partnerships, and access to once closed global markets.

Economic environments around the world are changing due to the forces of globalization. Globalization is characterized by the permeability of traditional boundaries of nations, culture, and economic market. The fundamental economic forces and events influencing globalization around the world include the end of communism; the shift from an economy based on natural resources to one based on knowledge industries; demographic shifts; the development of a global economy; increased trade liberalization; and advances in communication technology (Thurow, 1995).

Business opportunities, including international investments and joint ventures, in the global economy are increasingly tied to trade pacts. In addition, business opportunities are resulting from privatization worldwide. Countries are privatizing many state-owned industries and allowing foreign investors to purchase pieces of them through joint ventures or local operations so that they can participate in these projects.

Emerging markets, often occurring in countries experiencing political upheaval, will continue to increase in the expanding global market. Businesses, participating in the new global economy, will continue to seek out new manufacturing and sales opportunities in foreign markets and countries (Sites, 1995).

The Financial Management Association

Multinational corporations in the global economy require new forms of financial management. Professional finance organizations have contributed to the development of international financial management tools and practices. For example, one of the most influential professional international financial management organizations, the Financial Management Association (FMA), was founded in 1970. The Financial Management Association, which brings together academic and business interests, is considered to be one of the global leaders in developing and disseminating knowledge about international financial decision making. The goals and objectives of the Financial Management Association include "broadening the common interests between academics and practitioners; providing opportunities for professional interaction between and among academics, practitioners and students; promoting the development and understanding of basic and applied research and of sound financial practices; and enhancing the quality of education in finance" (History, 2007, ¶2).

International Financial Innovation

In the twenty-first century, international financial innovation is impacting and directing corporate financial management practices. International financial innovation is associated with product innovation, securitization, liberalization, globalization, and interpenetration.

• Financial product innovation refers to the development of new risk management and funding vehicles.
• Securitization refers to a greater tendency toward marketable financial instruments rather than bank loans.
• Liberalization refers to the expansion of domestic financial market practices through deregulation.
• Globalization refers to the internationalization of financial markets.
• Interpenetration refers to the increased competition among financial institutions that result from reduced boundaries between types of banks and securities firms (Levich, 1989).

The following section provides a description and analysis of the main international financial management practices including international supply chain management, exposure management, capital financial management, capital budgeting management, currency swap management, distribution management, futures, options, and derivatives management, investment management, and international accounting management. This section serves as a foundation for later discussion of the growing trend in international financial management software use.

Applications

International Financial Management Practices

There are a common set of international financial management practices found across businesses and industries. Popular international financial management practices include:

• International supply chain management
• Exposure management
• Capital financial management
• Capital budgeting management
• Currency swap management
• Distribution management
• Futures, options, and derivatives management
• Investment management
• International accounting management.

These international financial management practices are described and analyzed below (Delk, 2000).

International Supply Chain Management

International financial managers oversee and engage in supply chain management in an effort to coordinate business operations across and between countries. Supply chain refers to the connections between trading partners extending from the supplier's supplier to the customer's customer. International supply chains are those that cross national boundaries. Issues related to logistics, taxes, quotas, regulations, and differences in currencies, languages, and cultures challenge and complicate international supply chains. International supply chains often involve multiple currency exchanges. International supply chain management is three stage process involving getting information to run the business, delivering products to customers, and getting the cash to generate profits. International supply chain management and international financial management intersect at numerous points including vendor selection, risk management, and asset management. In particular, supply chain management and financial management are equally effected by political, exchange rate, and lead-time risks. International financial managers may reduce costs for all parties involved in a supply chain or business transaction by combining transactions through one financial institution. Factors that affect these sorts of shared transactions include fund transfers, currency exchange, hedging, funding credit, and the sharing of financial information (Delk, 2000).

Exposure Management

International financial managers are responsible for exposure management. Exposures refer to categories of risks faced by a firm. International financial managers protect the firms from exchange rate exposure, transaction exposure, economic exposure, and translation exposure. International financial managers work to reduce exposures faced by their firms. Exchange rate exposure refers to the extent to which currency exchange and exchange rate fluctuations will affect firm activities and profits. Transaction exposure refers to the degree to which future cash transactions are affected by exchange rate fluctuations. International financial managers control transaction exposure by analyzing extent and range of exposure by country for all activities of the organization. International financial managers are responsible for developing inflows and outflows of cash in multiple currencies. In scenarios in which the transaction exposure is high, international financial managers may choose to use a hedging technique to reduce the risk (Delk, 2000).

Economic exposure refers to the amount a firm's present value of current cash flows is affected by exchange rate fluctuations. International financial managers control economic exposure through the application of techniques such as debt restructuring, modified sales activity, adjusted orders with suppliers, and adjusted production volumes by country. International financial managers adjust their orders with suppliers and their production volume in different countries in an effort to reduce their economic risks. Translation exposure, also known as accounting exposure, refers to the risk that a firm's equities, assets, liabilities, and income will change in response to exchange rate fluctuations. International financial managers control translation exposure through the use of consolidation techniques and carefully-chosen cost accounting evaluation procedures.

Capital Financial Management

International financial managers are responsible for capital financing decisions. International financial managers must procure the capital necessary for growth. International finance opportunities are plentiful. For example, numerous multinational corporations rely on international chain financing as a primary source of capital. Chain financing refers to the process of pooling loans to finance the activities of supply chain partners.

Capital Budgeting Management

International financial managers control capital budgeting decisions between countries. Financial mangers are generally directly involved in capital budgeting decisions. Capital budgeting refers to the strategic process used to ascertain a firm's future investments such as new machinery, replacement machinery, new plants, new products, and research and development projects. Computational methods for capital budgeting analysis include a conceptual options framework for capital budgeting; quantifying flexibility in capital budgeting; discrete and continuous time models; interactions among multiple real options; hybrid real options valuation of risky projects; and strategic analysis.

Currency Swap Management

International financial managers are responsible for currency swaps between national offices and accounts. Currency swaps refer to a swap that involves the exchange of principal and interest in one currency for the same in another currency. Currency swaps require special management due to their special reporting requirements. Most governments consider currency swaps to be foreign exchange transactions that do not require reporting on balance sheets.

Distribution Management

International financial managers oversee distribution between national offices, production facilities, and distribution centers. Distribution management is an integral part of international financial management. Distribution is a crucial concern for businesses that operate in global markets transformed by new information and communication technologies. Products and services are increasingly developed, produced, and sold in different geographic regions. Companies outsource as many non-core activities to other firms around the world as possible. Thus, transportation and distribution networks may influence performance and competitiveness within international markets (Zeng, 2003).

Futures, Options, & Derivatives Management

International financial managers are actively involved in business investment decisions and futures, options, and derivatives analysis. Futures, options, and derivatives are an important category of investment used to protect investors from dips in stocks or indexes as well as to create portfolio diversification. Derivatives refer to financial instruments, such as options and futures, which do not constitute ownership but a promise to convey ownership. Options, such as stock or index option, are a form of derivative that derives its value from something else. Futures refer to an agreement to buy or sell a commodity at a fixed price on a fixed date. International financial managers use computational methods to analyze advisability of investing in futures, options, and derivatives. Computational methods for futures, options, and derivatives analysis include the following: Determinants of option values; portfolio strategies; binomial models; option deltas; hedging; forward rate agreements; interest rate and equity swap methods; and the analytic formula for derivative pricing and option pricing.

Investment Management

International financial managers participate in international investment decisions. Investment management, also called money management and asset management, refers to the process of investment analysis involving portfolio management, budget making, banking, tax planning, and investment risk assessment. Investment managers work for pension funds, corporations, governments, institutions, endowments, foundations, and high net worth individuals. Investment managers help grow and manage assets through multiple products and services including analysis, research, and risk management. Investment management is divided into two main types: Active investment management and passive investment management.

• Active investment management is an approach based on informed and independent investment decisions. Active investment management generally involves the frequent buying and selling of bonds. Active investment management has as its primary goal to outperform benchmark returns.
• Passive investment management, also referred to as indexing, involves investing in a wide range of assets classes and working to match the overall performance of the market. Passive investment management generally involves holding bonds to the point at which they mature.

Investment managers, both active and passive money managers, work to control and balance investment return, risk, and cost. Investment managers control return, risk, and cost by analyzing the following variables within a client's portfolio: Exceptional return, benchmark return, opportunity loss, transaction cost, objective value, and information ratio.

• Exceptional return refers to the residual return plus benchmark timing return.
• Benchmark return refers to the standard value against which the performance of a security, index, or investor can be measured.
• Opportunity loss refers to the estimated lost resulting from not choosing the best option or solution.
• Transaction cost refers to the cost resulting from buying or selling assets including commissions.
• Objective value refers to the prevailing value established by the market.
• Information ratio refers to the expected exceptional return divided by the amount of risk assumed in pursuit of that exceptional return (Grinold, 2005).

International Accounting Management

International financial managers oversee and participate in international accounting and reporting activity. International accounting management is an integral part of international financial management. International finance managers in multinational corporations must choose which accounting systems and standards their firms will use. Options include national and international standards and systems. The predominant international accounting standards include IFRS and US GAAP (Tarca, 2004). Accounting systems, which include accounting concepts, reporting practices, and principles, reflect the culture, philosophy, goals, and objectives of their users. Modern accounting systems are increasingly international in scope and standards. Economic globalization has created the demand for shared international accounting principles, standards, and practices. International accounting refers to accounting practices that cross national boundaries or is conducted in a location other than the firm's home country. International accounting encompasses multinational enterprises, global movements to shape the direction of accounting, and comparative accounting requirements and practices (Prather-Kinsey & Rueschhoff, 2004). The stakeholders of international accounting, including shareholders, corporations, and governments, require accurate and comparable economic data to make economic decisions (Speidell & Bavishi, 1992). Comparable systems of transnational financial reporting facilitate international investment.

Ultimately, international financial management includes a wide range of practices and tools that allow financial managers to respond to changing international business environments. The main practices of international financial management are characterized by flexibility and market responsiveness.

Issues

International Financial Management Software

International financial managers are responsible for controlling and aligning financial information between national corporate offices and headquarters. Financial managers rely on ready access to company information or knowledge such as data, company history, production processes, and financial reports. Information or knowledge management (KM), which refers to the systematic and explicit management of vital information, and financial management are intersecting as the physical distance between offices and co-workers grow in multinational corporations. Knowledge management tools must be matched to the technological interests and abilities of the organization. International financial management software is one important example of international knowledge management.

Financial Management Software Packages

Financial management packages, specifically developed to deal with international business operations, are growing in popularity. International financial management packages are considered to be value-added business solutions. International finance issues, such as complex tax laws, international regulations, and currencies are made easier by the use of accounting and reporting software. Multinational corporations need financial accounting systems that provide significant flexibility and the ability to grow with the company. Firms choose their international financial management packages based on the scalability, flexibility, customization, multi-currency capabilities, ease-of-use, and implementation assistance of the software. Software implementation usually requires training by the software company. International financial management packages create a standard global chart of accounts, implement standard global processes, and offer centrally controlled procurement. International financial management packages create lower costs, increased flexibility in training, interchangeability, and knowledge-sharing (Wolfendale, 2002).

Financial Accounting Software

International financial managers use financial software to handle international accounting issues. Financial accounting software and manual accounting systems have significant differences. Financial accounting software has the potential to optimize multicurrency transactions, offer significant auditing capabilities, minimize transaction costs, optimize cash management, and improve cash flow. In particular, international accounting systems have the potential to facilitate currency handling. International financial managers use accounting systems to summarize and analyze changing currency environments. Multinational corporations that rely on international accounting software must take the following issues into account: The release of the accounting software must be uniform worldwide to prevent communication difficulties; multilingual capabilities must be built into the product; and multiple address formats must be editable into any language.

Evaluation of International Accounting Software

International financial managers evaluate international accounting software with the following questions: How does the accounting system handle inter-company processing and currency handling? How effectively does the accounting system and the vendor meet the demands of the international marketplace? Does the software maker offer simultaneous release across all countries and regions? Are multilingual capabilities built into the accounting software? In the twenty-first century global economy, international accounting financial systems are necessary tools for international business. International financial management software systems support company funding, maintain true cash balances in different accounts, and make all account balancing adjustments automatically (O'Brien, 1995).

Conclusion

In the final analysis, international financial management has much in common with traditional or classical management. Management refers to the work or act of directing and controlling a group of people within an organization for the purpose of accomplishing shared goals or objectives. People in management positions control and coordinate organizational activities, employees, processes, resources, goals, and objectives in every field and industry. The structure of organizations, from financial investment firms to industrial production facilities to colleges and universities to hospitals and medical facilities, are similar in their goals of establishing a work flow, clear leadership, and shared objectives. Managers, in all industries, must handle employees, information, change, crisis, and ethical issues. While international financial management shares much in common with traditional or classical management, there are significant differences. International financial managers are responding to economic and political change resulting from economic globalization. International financial management is a field requiring great flexibility, adaptability, and cultural sensitivity.

Terms & Concepts

Benchmark Return: The standard value against which the performance of a security, index, or investor can be measured.

Capital Budgeting: The strategic process used to ascertain a firm’s future investments such as new machinery, replacement machinery, new plants, new products, and research and development projects.

Emerging Markets: Capital markets of developing countries that have decided to liberalize their financial systems to encourage capital flows and foreign investment.

Exceptional Return: Residual return plus benchmark timing return.

Futures: An agreement to buy or sell a commodity at a fixed price on a fixed date.

Global Markets: The economic markets of countries and regions open to foreign trade and investment.

Globalization: The internationalization of financial markets.

Information Ratio: The expected exceptional return divided by the amount of risk assumed in pursuit of that exceptional return.

International Financial Management: A division of management responsible for both resource management and finance operations across multiple countries.

Interpenetration: The increased competition among financial institutions that results from reduced boundaries between types of banks and securities firms.

Investment Management: The process of investment analysis involving investments, portfolio management, budget making, banking, tax planning, and investment risk assessment.

Liberalization: Deregulating domestic financial markets to promote expansion.

Objective Value: Prevailing value established by the market.

Opportunity Loss: The estimated lost resulting from not choosing the best option or solution.

Options: A form of derivative that derives its value from something else.

Organization: A formal arrangement of people committed to shared goals and objectives.

Securitization: A greater tendency toward marketable financial instruments rather than bank loans.

Bibliography

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Suggested Reading

Ferguson, M., Lam, K., & Lee, G. (2002). Voluntary disclosure by state-owned enterprises listed on the stock exchange of Hong Kong. Journal of International Financial Management & Accounting, 13, 125. Retrieved October 3, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6639585&site=ehost-live

Glaum, M. (2000). Bridging the GAAP: the changing attitude of German managers towards Anglo-American accounting and accounting harmonization. Journal of International Financial Management & Accounting, 11, 23-47. Retrieved October 3, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4374179&site=ehost-live

Jaggi, B., & Tsui, J. (2007). Insider trading, earnings management and corporate governance: Empirical evidence based on Hong Kong firms. Journal of International Financial Management & Accounting, 18, 192-222. Retrieved October 3, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26516941&site=ehost-live