Report On Global Hardwood Corporation

Published Date: 02 Nov 2017

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April 15, 2013

A report on the current financial practices of GHC, the risks, threats, shortcomings and inefficiencies and recommendations for improvement

Global Hardwood Corporation started as a family run business but now has grown to be a multinational company listed in London, on the Alternative Investment Market. With such growth has become the necessity to have many different departments take care of such things as finances, human resources and marketing to assist the company’s growth and development as a major player. Global Hardwood Corporations (GHC) is mainly concerned with decorative hardwoods that are utilised in both construction and the manufacture of furniture. The hardware that is utilised by GHC arrives in a raw state at the factory and is then processed in their own sawmills which are located in the industrial towns of the English Midlands. GHC major customers are in the United Kingdom’s, the USA, Western Europe, North America and Australia.

A subsidiary company is Real Furniture Company (RFC) whereby hardwood and cane furniture are imported from overseas, primarily Asia and South America. These require no processing as they arrive in there completed form. Each company has separate identities and separate business plans and dealings. It is interesting to look at the financial organisations of each to look for similarities and differences, as well as advantages and areas that may need addressing. Global Hardwood Corporation needs to be able to communicate and negotiate with various overseas governments in order to affect meaningful trade. They also need to establish their own expectations of the governments that they are working with and the risks of such investments. The roles of the finance department (treasurers and accountant) are critical in continuing fruitful negotiations. The current accountant has 30 years experience. They have also appointed A Group Finance Director who heads a team including the Group Treasurer. Their brief is to ascertain the risk, threat, shortcomings and deficiencies concerning all financial practices of the company. Currently, the Global Hardwood Company pays their suppliers in the currency of the country where it was purchased. This money that is received by GHC is then converted into pounds and all manufacturing, marketing, shipping and taxes are paid in pounds. Considering all this aspects, it is clear that GHC is exposed to foreign exchange risk.

Transaction exposure

The transaction exposure risk occurs whenever the cash inflows and outflows are not in home currency but are denominated in foreign currency. GHC is exposed to the transaction risk since when the cash outflow and inflow are not in British pounds but rather in the currency of the particular supplier. The company profit is severely affected by fluctuations in exchange rates since all financial dealings such as invoices, taxes, shipping have to be converted to home currency (Baker & Powell, 2005).

Translation exposure

This can occur when there are variations in the exchange rates which make it very difficult to predict profit and establish a dedicated financial plan. Therefore the ride on effect is that the companies’ assets, equities and liabilities cannot be pre-determined (Baker & Powell, 2005).

Economic exposure

This is the concern of the present value of the operating cash flow which could affect the Global Hardwood Company. The economic changes that can and do occur with such fluctuating exchanges rates as are currently being experienced put GHC and other companies at risk (Baker & Powell, 2005).

Threats to GHC

Exchange rate risk is one of the major threats that face GHC. The exchange rate is an enormous contributor to the ‘risk’ of the company’s growth and development and indeed stability. For example, in a transaction with Australia if the exchange rate at the commencement of the deal or operation is £ I = 3 Australian dollars initially, but falls from £1 to 2.5 AUD, then the company will need to pay 30,000AUD to its supplier. This payment can be done by paying £10000, but with the fall of the Sterling this amount is now £12000. The situation above is repeated whenever the company pays its suppliers in their home currency. A huge loss could be incurred if the value of the pound significantly depreciates. This could lead to significant losses for Global Hardwood (Wachowicz & Horne, 2008).

Short comings

The major limitation that GHC faces is operating in different countries. It is inherently difficult to run a company and/or business in another country, and to financially manage the cash inflows and outflows according to the differing economic conditions. The challenges that face GHC are to maintain and adapt standard prices against varying countries. However in employing certain methods many risks can be minimised. These should and undoubtedly are very carefully considered by the Global Hardwood Company. These would and should include:

Netting – This involves settling mutual obligations at a contract’s net value rather than its gross dollar value and may be implemented by reducing the transfer of funds between a parent and a subsidiary to a net amount. Although netting is used only when a firm is experiencing extreme financial problems such as bankruptcy, GHC may use this method to associate result of trade and to reduce bank costs

Matching – this is where a company acquires investments whose costs are the same as the firm’s liabilities. In the matching strategy, GHC may choose the investments on the basis of the firm’s cash flow requirements and risk profile.

Leading and lagging – involving advance payments or delayment of payments on the amount due in the nominated currency.

Pricing policies – the changing prices according to the expected change in exchange rates. There should be less risk in this method with a fixed exchange rate as opposed to a floating exchange rate. Since the floating rate system indicates currency values are determined by supply and demand ((Wachowicz & Horne, 2008).

Factoring – in factoring, GHC may sell its stock (invoices or account receivables) to a factor (a third party) at a discount.

Currency options – with currency options, GHC will be able to hedge against adverse movements in exchange rates by selling its currency at a predetermined exchange rate at a specified date.

A report on each of the two issues identified in "recent developments and opportunities

There several recommendations that GHC will need to implement to be able to reduce its exposure to financial risk. Several issues have been identified which affect the recent opportunities and developments at GHC. This include; the initiatives in supplier countries to encourage GHC to establish processing, manufacturing and finishing goods facilities in the respective countries. GHC needs to take on board these methods to reduce their risk and to encourage growth. With GHC being sought by foreign investors to establish manufacturing, processing and finishing facilities they will have to endorse these and other concerns.

Taxation

Laney (2006) states that profits made and cash flows earned in a foreign country are of little to no value if they cannot be repatriated in the home country of the mother company – that being, GHC. These need to be passed on to the share holders. The Exchange control regulatory body says that any capital put into a country may be repatriated but the return of profits has limiting factors. Tax concessions may be available dependent upon where the start up manufacturing businesses is to be located.

Currency swaps

Currency swaps are much simpler than parallel loans, despite the same objectives being attained. Basically two parties, come to the one agreement which is hopefully a win-win situation. Basically the two parties will sell currencies to each other at the current rate may determine to reverse the rate after a specified period. Currency swaps are more user friendly than parallel loans which require a significant amount of paperwork to set up. The three steps of currency swap are the initial exchange of the principal, the continuing exchange and re-exchange of the principal amounts on maturity. This enables a fixed rate debt in one currency to become a fixed rate liability in another; not necessarily a bad thing as it can be useful in hedging for a company (Wachowicz & Horne, 2008).

Currency invoicing

This can be utilised to avoid or in fact evade capital controls. That is if the currency is depreciated profit margins can be reduced in that particular subsidiary, despite what the subsidiary had previously earned in hard currency. However if the currency rate improves in a country then the cash from the devaluing country can be shifted to another part of the country (Laney, 2006). This will ass GHC from avoiding depreciation of the currency in that country and avoiding the losses there.

International corporate taxation

The taxes applied to an international corporation include withholding tax and taxes on dividend remittances and branch versus subsidiary. Credit is usually collected from foreign corporations or individuals for withholding taxes, from sources which have been received within the country. Therefore, authorities usually receive taxes relative to the amount of withholdings. This can mean that foreign governments collect a higher amount with higher withholdings, leaving home authorities to collect a smaller amount. Taxation is one of the most important factors for a corporation when considering whether to set up a subsidiary or branch operation in a foreign country. When a country looks forward to high profits overseas, this can be advantageous to the foreign subsidiaries if the income is not allowed to be repatriated by the home government. This is because home branches are usually required to pay taxes on income, but foreign income from subsidiaries is usually not taxed until the income is repatriated back to the home country (Laney, 2006).

Interest rate inflation

Inflation is an important concern for exporters. For example, if inflations were to occur in the exporting country, the importer must verify the changes in the price of the imported goods in their respective home currency, as this could affect the real profit margin. This consideration can help the company to pre-empt inflation by adding an appropriate mark-up to the price of the goods. This is often a concern in developing countries. They will mark up the price of merchandise under the banner of "inflation expectation," to cover any potential difference in price due to inflation (Laney, 2006).

Foreign Direct Investment

Companies in home countries often acquire foreign equipment, plants, and other hard assets, a process which is called foreign direct investment (FDI.) In these schemes the operational control does not rest with the foreign unit being acquired – it rests with the home company which is doing the acquiring of the foreign unit. The host country receives the benefits of the foreign investment, as it will often spur the local economy in the host country.

Trade Barrier

Trade barriers are regulations and/or policies put in place by a government which serves to restrict international trade. This is a tactic which can be used by a host company while a foreign government is setting up a subsidiary in the host, because trade barriers can restrict growth in a country and therefore be detrimental. The reduction of trade barriers can increase productivity in a country, and allow certain sectors to exploit newfound advantages, at the expense of the old protected sectors. Entrepreneurs are especially energized by this process. This liberalization of trade can lead to a virtual avalanche of capital accumulation, as well as productivity increases, as entrepreneurs take advantage of new opportunities (Laney, 2006).

A recommendation of a Structure of assessing in risks associated with any inward investment which might follow the negotiations with the host Governments

Corporate directors will often resort to hedging their exposures, also called risk management. This is primarily meant to reduce the volatility of the profit of a firm. For example, covering the exposure will usually reduce the volatility of the firms’ cash flow. This is important because reducing the volatility of cash flow can effectively reduce the probability that a company will find itself in financial distress. An increase in the probability of financial distress, because of a lack of adequate hedging, can lead to suppliers requiring higher returns in order to offset the increased probability of bankruptcy. They could even negotiate high debt covenants as a result (Wachowicz & Horne, 2008).

The capital asset pricing model (CAPM) suggests that an international investor, which is well diversified, should not be willing to pay for advice regarding asset allocation, when they can in fact simply replicate a successful allocation system by simply adjusting their portfolios. Managers are often simply interested in hedging to reduce the overall variability of cash flow because they are compensated based on short term results. But, the ups and downs of individual investments are irrelevant to the diversified shareholder. They are compensated by holding a well-diversified portfolio. It is CAPM’s suggestion that what matters in share pricing is that systemic risk is exchanged for interest rate risk and exchange rate risk – if unsystemic – their effect can be diversified away. This is achieved by holding a balanced portfolio. If, however, the risks are systemic, and CAPM priced the forward and interest rate instruments, then the firm will not add value by entering into hedging contracts. Instead, the firm will simply move along the security market line. The good news for managers and employees, customers, financers, and especially shareholders is that, under a convex schedule tax regime, firms net of tax generation may actually be increased under a policy of exposure management. Shareholder value would be increased, on average, by using this approach – even under a pure CAPM approach (Wachowicz & Horne, 2008).

A proposal on a spilt of responsibilities between the Chief Accountant and the Group Treasurer

The responsibility of the treasurer of the group is to borrow, to invest liquid resources, and to manage both foreign exchange and interest rate exposures. It is their job to use both internal exposure management techniques, and external exposure strategies in the best manner possible. Internal exposure management techniques do not rely on special contracts made with companies outside of the specified group of companies, and generally use the firm’s regulatory financial management. In contrast, external techniques seek to use contracts as the means to insure against losses on foreign exchanges. With GHC, the chief accountant of the company develops all financial aspects. Management of daily activities, such as: managing accounts payable, managing accounts receivable, managing payroll, overseeing bank deposits, overseeing tax remittances, managing the preparation of financial statements for the organization and its subsidiaries, providing senior management with advice and guidance on financial and managerial issues, and developing and presenting an annual budget for the organization as a whole and its subsidiaries (which is approx. $5.4 million) to the Principal, Board of Directors, and Vice-President.

In order to avoid fluctuations in the foreign exchange, the company must begin to make payments in their own currency. By this method the company will appropriately maintain its overall financial aspects. So using an appropriate structure helps the company avoid risk. This will ensure a satisfactory position for the company, but it can later be improved.