Multinational business operations require a steady flow of funds from parent to subsidiary, from subsidiary to parent, and between subsidiaries. Because these fund flows are unique, we will consider one at a time.
Fund flows from parent to subsidiary The largest flow of funds from parent to subsidiary is the initial investment. The subsidiary may also receive additional funds in the form of loans or added investments. The purchase of goods from the parent offers another form of fund flows from parent to subsidiary. This form of fund flows involves transfer pricing, the price on goods sold between related entities.
Fund flows from subsidiary to parent The major components of fund flows from subsidiary to parent consist of dividends, interest on loans, principal reduction payments, royalty payments, license fees, technical service fees, management fees, export commissions, and payments for goods received from the parent. The parent does not have total control over the size of the flow of funds because of various external factors, such as foreign-exchange controls and tax constraints. For example, many governments impose a withholding tax when dividends are remitted to foreign owners.
Fund flows from subsidiary to subsidiary Funds flow from one subsidiary to another when they lend funds to each other or buy goods from each other. Funds from one subsidiary may also be used to establish another subsidiary. When such investments are made, all dividends and principal payments may go directly to the home office. However, it is possible for these two subsidiaries to have cash flows similar to parent-company cash flows.
Many factors, such as exchange controls and domestic political pressures, can block dividend repatriation or other forms of fund remittances. If funds are blocked in perpetuity, the value of a foreign project to the parent company is zero. However, MNCs have secretive methods to remove blocked funds, including (1) multilateral netting, (2) leading and lagging, (3) transfer pricing, (4) reinvoicing centers, (5) intracompany loans, and (6) payment adjustments.
Multilateral netting Large MNCs often require a highly coordinated interchange of material, parts, work-in-process, and finished goods among various units, because they must handle a large volume of intracorporate fund flows. These cross-border fund transfers involve the foreign-exchange spread, the opportunity cost of the float, and other transaction costs such as cable charges. Netting has been frequently suggested as one method of minimizing the total volume of interaffiliate fund flows.
Netting is a method designed to reduce the foreign-exchange transaction cost through the consolidation of accounts payables and accounts receivable. Multilateral netting is an extension of bilateral netting. For example, if subsidiary A purchases $10 million worth of goods from subsidiary B and B in turn buys $11 million worth of parts from A, the combined flows are $21 million. On a net basis, however, subsidiary A would pay subsidiary B only $1 million. Bilateral netting would be useless where internal sales are more complex. Think of a situation in which subsidiary A sells $10 million worth of goods to subsidiary B, subsidiary B sells $10 million worth of goods to subsidiary C, and subsidiary C sells $10 million worth of goods to subsidiary A. In this case, bilateral netting would be of no use, but multilateral netting would eliminate interaffiliate fund transfers completely.
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