A solid grasp of finance is important for any business leader, but issues can grow more complicated in international business dealings, with multiple factors in play that vary from country to country. Knowing how the system works in the United States is not enough to allow an executive to operate effectively abroad.
And, effectively, “abroad” may not mean “abroad” any more. In today’s market, taking into account differences across countries is inescapable. The global market can have an impact on even small, relatively local businesses. “When we talk about globalization, a common measure of the degree of globalization in the world is the sum of all countries’ exports and imports divided by world GDP,” says Harbert’s James Barth. “Today the figure is 56 percent, whereas in 1960 it was 24 percent. So, on the basis of this measure, we can say the world has become more globalized over time.”
And there’s probably no reversing this trend. Though there can be fluctuations over short periods of time—Barth cites trade wars and isolationism as curbs to globalization—and despite overheated political rhetoric, international trade is in general beneficial.
“One has to realize that countries have different comparative advantages and therefore trade across national borders can be good for both economic growth and development. Therefore, one generally should not be opposed to exporting and importing goods and services across countries,” says Barth. “Of course, sometimes some countries may impose restrictions on imports from other countries that may create unfair advantages for themselves. The result may be so-called trade wars.”
Banks play a major role in globalization because they make loans and facilitate payments, among other transactions that are essential for business firms everywhere. Unfortunately, however, banking isn’t the same everywhere.
“Every country has banks, where funds can be deposited and those funds loaned to both individuals and firms. Banks also play an important role in the payment system. It is in this way that banks contribute to economic growth and development,” says Barth. “However, different countries choose to regulate their banks in different ways, so banks in some countries have better opportunities to serve their customers than banks in other countries.”
Payment practices considered routine in the US aren’t necessarily routine—or even available—elsewhere in the world. Blogger Katie Reynolds, writing for the Hult International Business School in London, notes that because “payment methods that are commonly accepted in your home market might be unavailable abroad, determining acceptable payment methods and ensuring secure processing must be a central consideration for businesses who seek to trade internationally.”
Monetary policy is not identical everywhere, either. A decision by a central bank can have broad repercussions for a company and, indeed, an entire country.
“Almost every country has a central bank that is responsible for monetary policy. A main purpose of a central bank is to pursue policies that contribute to economic growth and low inflation by influencing interest rates, either lowering or raising them,” says Barth.
“If a central bank lowers rates too much, there may be excessive growth that creates higher inflation, while raising them too much can curb or slow economic growth and thereby contribute to more unemployment. Unfortunately, central banks—particularly those in big countries—sometimes make mistakes that can adversely affect not only their own countries but other smaller countries through trade and investment.”
There are scores of different currencies around the world, so exchanging one currency for another is a key consideration for businesses. Monitoring potential changes in exchange rates and taking into account their impact on transactions is a challenge. Barth notes that if every country issued its own legal currency, there would be roughly 24,000 exchange rates. “However, not every country has its own unique legal currency. Still, there are many exchange rates, many of which fluctuate over time,” he says. “This can create problems for business firms that sell and buy goods across national borders, since they might exchange one currency for another at one exchange rate, but find that when they subsequently reverse the transaction, the exchange rate may have changed, and thereby created losses.”
Significant currency rate fluctuations “can seriously impact the balance of business expenses and profit,” Reynolds writes. Say a US company purchases goods and raw materials locally and sells a finished product to the Chinese market. Overall operations will become stronger if the Chinese currency appreciates and weaker if the dollar appreciates. Reynolds: “If your company is paying suppliers and production costs in US dollars, but selling in markets with a weaker or more unpredictable currency, your company could end up with a much smaller margin—or even a loss.”
That’s the risk with conventional currencies. Now there’s also the question of cryptocurrencies, or digital currencies, not backed by any central bank or government. Bitcoin is the best known of these, but it is far from the only one.
“Cryptocurrencies are a new financial development to facilitate payments around the globe,” says Barth. “There are now more than 1,600 cryptocurrencies. However, cryptocurrencies are not yet considered to be money to the extent they are not universally accepted, a stable source of value, and a unit of account. In particular, some cryptocurrencies have experienced wide swings in their prices, such as Bitcoin. Of course, their use as a currency and the stability in their prices may change in the future.”
Taxes are an inescapable part of business calculations as well. “Different tax systems, rates, and compliance requirements can make the accounting function of a multinational organization significantly challenging,” says Reynolds. A savvy CFO may be able to reduce the company’s overall tax burden by borrowing in countries with high tax rates and distributing that cash to operations in countries with lower rates. The same may be true for profits where the timing and recognition of profits from foreign operations may be used to offset the tax burden on profits of the parent company. “Accounting strategy is key to maximizing revenue, and the location where your business is registered can impact your tax liability.”
Grant Thornton, the international accounting and advisory firm, notes that “Multinational tax challenges are among the most complex and potentially expensive issues facing companies bringing employees across borders and building operations in foreign jurisdictions.” Companies risk creating a “permanent establishment,” a key element in many countries’ tax laws that can determine whether a company does enough business in another location to create a taxable corporate presence.
Navigating this maze of rules and regulations and regional realities requires a lot more than a spreadsheet and a calculator. As important as all the financial considerations and regulations are, ultimately the policies and practices of the corporation must benefit the company and the markets in which it operates.
“The most important asset in every country around the world is human capital,” says Barth. “Ultimately, it is human capital that generates innovations and thereby importantly contributes to economic growth and development.”
Banks and currencies and taxes, oh my!
