Financial Risks of Conducting Business Internationally

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Recession and financial unrest have in recent years provided an uncomfortable reminder of the financial risk of international business. International corporations, financial institutions, and international investors have experienced that the profitability of their primary business has been adversely affected by major fluctuations in exchange rates, stock market prices and in the credit rating of counter parties. Additionally, the business risk inherent in the primary business of an international corporation, which is dealt with by long term strategic planning and business cycle monitoring, the international corporation has to deal with financial risks.


Interest rate risk - The risk of increased funding costs due to high rates of interest, which may dominate for longer or shorter periods.


Liquidity risk - The risk of running short of cash when liquidity in the banking system is scarce and expensive.


Credit risk. -The risk of losses due to the inability to pay by counter parties,


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The internationalization of business has made the management of financial risk more important. It is a natural consequence of conducting international business that a corporation is exposed to one or more of the above financial risks.


The finance department must be able to record all group companies operational, investment and financial cash flows, the balance sheet exposures, financial investments and loans as well as the hedging operations in one multidimensional database of a Finance Management System. The currency and maturity structure of the flows must be reportable in any manner desired. The financial risks must be calculated by analyzing the total net result of incremental changes in currencies, interest rates and stock market values. A system should be implemented that is easy to operate, reliable and able to communicate with the accounting ledgers of the company as well as the international financial markets. The finance department should be able to update the positions in real time, produce regular and ad hoc management reports as well asanalyse and simulate the financial risk exposures of the group. Selection must be possible on subgroups, divisions and individual group companies. The financial risk exposure must be available to the corporation management at any point in time.


The management of financial risk should be considered as early as possible in the strategic business plan. Important markets may be protected by establishing local production. In addition, some corporations allow the financial know-how of the Finance Department to be directed toward creating financial income based on arbitrage opportunities and opportunities arising from the longer-term fluctuations of the financial markets. Modern financial derivatives opens the possibility of substantial gearing of financial positions, and it is important that clear rules regulate the activities of the finance department in this respect.


Numerous examples have illustrated how the financial activities of finance departments have developed a scope that has rivaled that of the primary business. In several cases the loss on currency and/or derivative positions has resulted in substantial financial loss. However, the corporation cannot let horror stories of financial failures lead to a policy of ignoring the financial risk of the primary business and opt for a passive hands off strategy.


Not dealing properly with the financial risk of an international business is equivalent to passive speculation and contrary to the rules recommended in the GAAP standards for corporate management and accounting. The objective of a finance department is to protect the cash flows of the primary business and to manage the financial assets and liabilities of the group.


It is the responsibility of the corporate Board and Management to make sure that accounting and management of assets and liabilities are controlled in a satisfactory manner by the corporation. As a consequence management must work out rules for the overall risk strategy of the corporation. Limits for the hedging of commercial currency cash flows and balance sheet exposure as well as other financial activities must be implemented. Written guidelines must be drawn up for the activities of the finance department.


References


Gitman, L. J., Horngren, C. T., Harrison, W. T. Jr., & Bamber, L. S. (00).


Financial analysis for managers. (Vol. II). Boston Pearson Custom


Publishing.


Delaney, P. R., Nach, R., Epstein, B. J., Budak, S.W. (00). GAAP 00,


Interpretation and application of generally accepted accounting principles.


Hoboken, New Jersey John Wiley & Sons, Inc


CRMFS, ‘Managing financial risk’, retrieved from the World Wide Web July , 00,


http//www.crmfs.se/risk_.htm





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