Even with current technology, managing large funds across oceans is no easy task. After all, funds are the lifeblood of your business, and you can’t risk losing them through mismanagement. Though international financial management is much more complex than financial management at the company or industry level, it’s nonetheless rooted in the same basic concepts.
The payback period is roughly the number of years it takes a company to recover its initial investment. Suppose your company invested $1,000,000 in a project. You expect your profits or annual cash flows to be around $200,000. Based on the payback period, it will take you about 5 years to recover your investment.
Net Present Value
After being able to estimate the time it would take to recover your investment; the next question you need to answer is “How much is my project worth now?” Net present value answers this question; you need to know how much cash you’ll spend (cash outflows), how much cash you’ll receive (cash inflows), and your required rate of return or your interest rate. Using your required rate of return, you calculate the value of all your cash flows now, and deduct your initial investment and salvage value, if any.
Cost of capital
While calculating cash inflows and outflows is easy; calculating the required rate of return is another matter. Most companies use their cost of capital, or the estimated interest rate their creditors and investors charge. You can base this factor on the current interest rates; for projects that will be completed far into the future, you can add a risk factor to your estimated interest rate.
You can apply the abovementioned international capital investment concepts to one project at a time. If you want to compare the projects’ values against each other, you use the profitability index. This is determined simply by dividing your calculated net present value by your initial or required investment. This means, course, that your profitability index should be at least equal to 1 to be good.
Annual rate of return
As part of your international capital management strategy, there’s your required rate of return, then your annual rate of return. Required rate of return is based on estimates most favorable to you. On the other hand, the annual rate of return considers factors beyond your control, such as your future profits. The annual rate of return is your estimated annual net income divided by your average investment. If the result is greater than your required rate of return for a project, you can push through with it.
If you grasp these concepts, dealing with independent capital international fund services shouldn’t be too difficult. For more information, read capitalbudgetingtechniques.com.
Five Basic Concepts of International Capital Management