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Budgeting in Multinational Companies

Table of Contents

The definition of a multinational company
The Positive aspects of a multinational company
The drawbacks of operating across borders
Budgeting methods
Types of contracts
Other factors affecting performance
The goals of budgeting

The definition of a multinational company

A multinational company is an organization or firm which operates across borders or delivers its services in two or more countries (McDonalds, Federal Express, Pfizer, Wall-Mart, Ford Corporation).

The Positive aspects of a multinational company

At present, a substantial number of American or Western-European firms can operate in the countries, which were previously inaccessible to them, for instance, Russia, Ukraine, China, Vietnam. Unlike the United States, the competition in those areas is not so high, so the products of foreign enterprises may enjoy considerable demand. Additionally, these firms can transfer some of their production processes to these countries because the quality of education is considerably high. Finally, the governments of these states may give them various privileges such as an exemption for taxes for a certain period. The thing is that many countries try to attract new investors, and low taxes is one of the ways to do it.

The drawbacks of operating across borders

International companies run significant risks when they enter a new market, First, they have spent a considerable amount of time finding partners, suppliers, distributors. They need to learn about the peculiarities of infrastructure in the state. Secondly, their partners may be organizations with different structures, values, and performance standards. Therefore, multinational companies have adjusted themselves to the new operating conditions.

However, one of the most crucial obstacles is currency fluctuations. They earn revenues and incur expenses in countries with different currencies. They need to issue income statements to the shareholders and governmental organizations. Thus, they have to translate their performance into a single currency, for instance, the US dollar or Euro. Any fluctuation of the exchange rate, especially if we are speaking about local currencies can significantly reduce the net profit. For instance, the enterprise can lose many of its assets if the local currency devaluates.

Another difficulty that may be faced by international corporations is the policy of protectionism, for example when the government tries to shield local producers from any competition. This is frequently done by imposing quotas on imports.

Budgeting methods

Multinational organizations employ different methods to minimize the hypothetical risks of currency fluctuations:

Forward Contracts
Futures Contracts
Option contracts
Combination of these approaches.

The use of these strategies heavily depends on such factors: market stability or instability, the political situation in the country, long-term objectives of the enterprise, the nature of their goods and services, and so forth.

Peculiarities of budgeting:

The translation of performance into a single currency like (US dollar, Euro, Yen, etc.)
The use of the average exchange rate, prevailing for a certain period.

Types of contracts

A forward contract is an agreement according to which the parties are obliged to purchase or sell a certain asset (product or currency) at a certain time in the future. The major peculiarity of a forward contract is that the price is settled beforehand. We can construct such a scenario. The multinational company wants to sell a product at the price of five dollars, and the other party agrees. The dollar considerably strengthens concerning the local currency. So, it is no longer profitable for one of the parties to buy this product. Yet, they are obliged to do so. This is one way of securing the assets.

A futures contract is an obligation to buy or sell a certain product or asset at a market-determined price. The futures contract differs from the forward contract in the following way: first, there is a third party, the exchange, which ensures that the terms of a contract are fulfilled. Furthermore, both parties must give performance bonds. In other words, if one of them fails to buy or sell the product, the clearinghouse (mediator) covers the losses.

An options contract is an agreement according to which one party can have a right to buy an asset in the future. However, this party is not obliged to do it. In his turn, the seller receives preliminary payment. The major advantage of such a technique is that both sides can feel relatively independent from one another. and the risks of currency fluctuations are not so perilous to them.

Other factors affecting performance

The political situation in the country
Culture
Legislation
The functioning of governmental institutions

Many examples illustrate the impact of the foreign environment on the companys performance. Such firm as Starbucks, the largest American coffee chain, is frequently boycotted in some Arabian countries, mostly since their governments are hostile towards the United States. Starbucks had to close a considerable number of their shops in Lebanon even though the performance was quite satisfactory.

The goals of budgeting

adapt the companys policies to the new market.
allocate the companys assets more effectively.
establish better coordination between various parts of the company.
minimize hypothetical risks of operating in an uncertain environment.

If we are speaking about multinational companies, the main purpose of budgeting is not to evaluate the performance but to ensure that the risks such as currency fluctuations are effectively managed. So, budgeting should not be taken as an assessment tool.

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