International Business Planning 4

Note: The following is an excerpt from CPA’s Guide to Developing Effective Business Plans by Tim Berry, originally published by Harcourt Brace Professional Publishers, and reprinted and revised several times. It was subsequently published by Aspen Law and Business. Copyright © Timothy J. Berry. All rights reserved.

A rainy day in Rio

I looked out the window of a parked plane, at a dark, drizzly airport in Rio de Janeiro. Whatever spectacular views there might have been were obscured in low-hanging clouds. I was half a day from my starting point and still several hours from my eventual destination, Buenos Aires.

As I looked into the dampness outside the plane, I worried about exactly the same subject as discussed in this chapter — business planning for the international company. Apple Computer, which was then riding the height of its success in the late 1980s, had hired me to travel to Argentina to instruct its local dealers on business planning.

Why not? I had lived in Mexico, spoke fluent Spanish, and had written books on business planning. As a consultant, I had helped Apple develop its annual Latin American business plan for four years running. I had also developed the specialized software Apple dealers were using to do annual business plans.

What I worried about, however, that particular morning at the airport, was exactly that same question: why not? How about because I had never been in Argentina, hadn’t studied their local tax laws and accounting practices, wasn’t ready to predict their volatile currency exchange rates, and didn’t know their standard business practices? So I worried.

I know now that I needn’t have worried. Even though accounting practices and tax treatments may vary widely from country to country, the techniques of business planning are far more international than country-specific. That Buenos Aires occasion was the first of many. In the following three years I gave business-planning seminars in eight different Latin American countries, and five in Asia for four different computer manufacturer sponsors. At each one, I dealt with a few dozen computer dealers who ran their small businesses in their local markets. In 2003, I did another series of seminars in Europe and Latin America for software company owners. As I presented business planning and we discussed the specifics of their markets and their businesses, the techniques held up. A good plan is essentially a good plan, or not, depending on a lot of factors besides tax treatments and accounting practices.

Your business, your client’s business: what’s different?

So let’s assume you or your client are in the United States developing a business plan for an international business. How different is that business plan from a business plan developed for a strictly domestic business? The first answer, you’ve probably already guessed, is: not that much. However, we can be more specific than that. We can look at what kinds of differences there might be and how you might accommodate those differences.

Currency exchange rates?

Currency exchange rates are the first thing that concerns most people as they consider an international-oriented business plan. How do I handle currency exchange rates? How much does this influence my plan? Can I do a standard plan when I deal with currency exchange rates?

A big deal in international business

Currency fluctuations can be critical in international business. Changes in currency can mean changes in your costs and expenses, your sales, and even the value of your assets and liabilities.

For example, suppose you are importing handicrafts from Mexico. Your costs are mainly in Mexican pesos. When the peso trades at 3 pesos per dollar, then the hand-painted bowl from Oaxaca that costs you 15 pesos per unit costs you $5 per unit. When the peso exchange rate changes and the peso drops to 5 pesos per dollar, then the same bowl costs you only $3 per unit. If you think the peso is going to increase in value, you want to buy up bowls and convert them to inventory quickly. If you think the peso is going to decrease in value, then you want to postpone your purchases to reduce the ultimate cost.

The problem with currency fluctuations, however, is a classic problem of guessing the future. Like prices in the stock market, currency exchange rates are a guessing game. Guess right, and you make money. Guess wrong, and you lose.

In the larger international businesses, predicting and managing currency exchange can be critical. When I was consulting to Apple Japan in the early 1990s, chief financial officer Judy David produced substantial profits, occasionally comparable to the profits from the computer business, with astute currency management. This involved detailed programs to keep assets in whichever currency seemed likely to increase in value and liabilities in currencies likely to decrease in value. When I was with McKinsey Management Consulting in Mexico City in 1981, I saw major companies lose millions of dollars when the peso devalued, catching them with assets in pesos and liabilities in dollars.

Simple mechanics in the plan

As critical as currency exchange may be in your business, its specific treatment in your business plan is not much different than how a wheat farmer would treat fluctuations in the market price of wheat. To understand that, you should first recognize that regardless of how international your business might be, you are still going to do your books and report your numbers to the tax authorities in a single currency. If you are based in the United States, your business plan should be in dollars. It doesn’t matter how many countries you deal with, you still do your plan in dollars because you pay your taxes in dollars.

So where does the currency exchange come in? That depends on your business. Some businesses buy products in foreign markets and bring them into the United States to sell. Some export products made in the United States and sell them in foreign markets. You can sometimes be involved in multiple currencies, three or four in a single transaction. For example, you can buy computer circuit boards made in three countries and other hardware made in a fourth and a fifth, and then manufacture computers somewhere else and sell them in more than one country. In all these cases, however, if you are based in the United States then you are still going to have to translate all your currencies into dollars for your plan, your accounting, and your taxes.

Figures 1-2 show a simple example of how an import business handles its foreign currency costs in a start-up business plan, using LivePlan Premier Sales Forecast and User-Added tables. In Figure 1 the sales forecast consists of projections for unit sales, dollar revenues per unit sold, total dollar sales, dollar costs per unit sold, and of course total dollar costs of sales.

Figure 1: The sales forecast consists of projections for unit sales, dollar revenues per unit sold, total dollar sales, dollar costs per unit sold, and total dollar costs of sales.

Figure 2 shows a simple two-row table for handling the currency exchange rates in the LivePlan User-Added table. Use the Table menu to select the User-Added table.

  • You can use copy and paste to copy the dates in the top row by selecting the date areas in any other table, copying them with the “Copy” command in the Edit menu, then returning to the User-Added table and using the “Paste” command in the Edit menu.
  • Use your “Custom Number” command in the format menu to change currency format display from dollars to any other number format. When the dialog for formats appears, use your mouse to select the bottom option (“Custom”). Then click the indicated area on the upper right and type in your new currency format, using quotation marks for currency symbols. In Figure 2, for example, the format for the rows showing Mexican Pesos is “MN”$#,##0.00_);(“MN”$#,##0.00). The format for the rows showing Quetzals is “Q”$#,##0.00_);(“Q”$#,##0.00). Figure 60 shows that detailed custom format dialog.

Going back then to the sales forecast in Figure 1, focus on the second group from the bottom, the dollar costs per unit sold. These costs have to deal with the Mexican Peso (MN$) and the Guatemalan Quetzal (Q$). Notice how these costs change in March when both currencies (looking at Figure 2 again) change. You can work this into your business plan with some simple formula mechanics:

  • The formula for the first row in costs refers directly to the Peso exchange rate in the User-Added table. To make that work, start with your mouse selecting in the first column, then type the equals (=) sign, then the number 25. You are saying that the average price in this row is 25 pesos. Then type the divided by sign (/) to indicate you want to divide that 25 by something else. Then use your Table menu to select the User Added table, find the peso rate for the first month, and click on it. Press Enter and LivePlan entered your formula for you: “=25/’User added’!C2.” In practice that formula means that you are paying MN$25 per unit, which is worth (in this specific example) $8.33. The dollar cost is exactly 25 divided by 3. The peso rate below indicates that it takes 3 pesos to make up a dollar.
  • With that formula entered in that cell, you can copy to the right (using the command in your Edit menu) to copy it to all the other monthly columns in that same row. From then on, when you go to the User-Added table to change your exchange rate forecasts, you will see your dollar cost forecast also changing automatically.
  • You deal with the Quetzal prices with similar formulas, referring to the number of Quetzals required to equal a dollar.

Currency and expenses

Figure 1 shows an example of currency rates affecting costs of goods sold. Even without the specific details, you can imagine how to handle a business in which currency rates affect expenses instead of costs of goods. In this case, for LivePlan purposes, your expenses are included in the Profit and Loss table instead of the Sales Forecast table. You can use a formula similar to the one in the example above to make expenses in the Profit and Loss change when the Peso or Quetzal rates change.

What’s the difference? It’s about standard accounting conventions. Accountants talk about costs as the cost of what you sell, and expenses are the operating expenses related to running the business. In the import example, an operating expense running in Pesos might be the rental of an office suite in Mexico City, with a voice mail box, for 250 pesos per month. Exactly as with the products in the detailed example, the dollar value would change when the peso rate changes.

Foreign currency in sales

Looking at these examples, you can imagine how to handle a situation in which you are exporting United States goods to other markets. For example, if you’re selling computers in Mexico your costs might be in dollars and your sales in Pesos. You would take your unit price estimate in the second block of the Sales Forecast table and create a formula calculating dollars from Pesos much like your formula that calculates dollars for pesos in costs.

Currency exchange: planning decisions

In all of the examples above, the business plan mechanics are relatively simple. The thinking can be quite complex, and the significance of planning and forecasting is huge. At this point in the example the mechanics end and the planning begins. The problem is not a problem of software or formulas; it is a problem of projecting rate fluctuations in the future. Guessing currency exchange rates is a major field of study and investment, every bit as much as guessing the future of interest rates. Factors affecting a change in currency exchange include political factors, economic factors, market factors, even psychological factors.

As an example, in the 1970s I was living in Mexico and writing for Business Week magazine. The Mexican Peso had traded at 12.5 to the dollar since the 1940s. In 1971 the United States dropped the gold standard and currencies began to fluctuate more than they had. By 1976 the peso was still stuck to 12.5 to the dollar despite growing capital flight (Mexicans investing their money outside the country in dollars) and balance of trade problems (Mexico was buying much more than it was selling). The economics suggested a devaluation by 1975, but politics kept the peso unchanged until the presidency changed hands in 1976. The peso dropped about half its value, meaning it took more than 20 pesos to equal a dollar. To guess the timing of the devaluation that eventually took place, one had to guess the flow of dollars and pesos and political will as well.

The business plan in the example needs to deal with the possibility of changes in exchange rates affecting costs. How do you price your goods in dollars when your costs are in other currencies? Do you commit to steady unchanging prices? This is not an unusual problem. The business plan mechanics are easy, but the related decisions are not.

Taxation and accounting environment

Aside from currency exchange, some international business plans must also deal with different tax and accounting practices. Still, the business plan for a U.S. company has to remain in dollars, and taxes paid outside the U.S. serve as a credit against U.S. taxes. For example, the value-added tax (VAT) is a major factor in most European markets, as well as Mexico and Japan. It is very significant for accounting and calculating tax burdens. However, in business planning, you are looking ahead and planning business decisions, not reporting to tax authorities. While you might use additional formulas to calculate your taxes, for planning purposes they are still going to be summarized in a single line towards the bottom of your profit and loss statement. Using LivePlan, you could use the row in the Cash Flow worksheet to calculate the VAT or other taxes in more detail, and then run the results over to the tax line in your Profit and Loss. The form of the Profit and Loss doesn’t change for taxes: sales less cost of sales is gross margin, and gross margin less operating expenses is gross profit, also called Earnings before Interest and Taxes, or EBIT. Then you subtract interest and taxes to calculate net profits.

Added uncertainty

In general, as you plan the international business there is more uncertainty than with the strictly-domestic business. You have the immediate impact of currency exchange rates to start with. Then you add in some extra problems with estimating costs, sales, and expenses. Also, there are factors affected by when you translate your foreign currency elements into dollars.

Costs, sales, and expenses

The problems of estimating your business numbers are relatively easy to understand. When you buy your goods in Mexico and Guatemala, you are farther away from your suppliers. When you sell your goods in Japan or Europe, you have a different view of the same problem. The markets in Mexico might change because Japanese buyers are affecting supply and demand, which raises prices. Maybe the government needs to focus its weaving industry on producing low-cost basic goods instead of export items for international markets. Maybe a group of U.S. weavers gets the U.S. government to restrict imports from Mexico to prevent competition. Any of these changes in the local economy can change your business. Local politics, national politics, and international politics can affect import and export policies, availability, and pricing. Since you are farther from the market, you can expect more trouble estimating future trends.

Translation factors and timing of translation

As currencies fluctuate, the timing of your transactions can change your business. For example, if you are importing goods from Mexico and Guatemala, at what point do you translate their foreign-currency costs into dollars? Your accountant should be able to help you decide when – and at what exchange rate – to transfer your values to and from dollars. The timing can make a difference to profitability.

Market factors

Although the business planning mechanics don’t change as a result, the information gathering for international business is more complex. When doing business in multiple countries, you also have to deal with multiple markets and market trends. This makes your business plan preparation harder, even if it doesn’t change the mechanics of business planning. If you are selling in Europe, you need to know about your European customers. If you are buying in Central America, you need to know about market factors that could be affecting your costs.

International planning is still planning

When preparing this chapter, I was struck by an irony related to planning the international business. Despite having lived in three countries, and worked in more than a dozen others, I had to remind myself first how planning an international business might be different. I had the privilege of doing the annual business plans for Apple Computer’s Latin America group from 1984 to 1987, and for Apple’s Japan subsidiary from 1991 through 1994. I was also involved in smaller start-up companies, mostly high tech, some of them focused almost entirely on the U.S. domestic market. My own company now has a fully-owned subsidiary in the United Kingdom. There was always much more similarity than difference. Planning is still planning, not accounting.

  • Juan

    Nice approach to the problem! I am from Buenos Aires and actually I am doing my first Business Plan for a start up project. Your post´s and BP examples are very useful to me.

  • kim beckley

    Hi There,

    I found your statement very useful, but would be nice if you could elaborate more on advantages and disadvantages of choosing weak or strong currency.

    Thanks

  • http://www.ArticlesForKnowledgeSharing.com Pankaj Trivedi

    Nice explanation that can be very well understood even by a layman.

    Pankaj

  • suwon

    Please help me.
    I am unable to understand which currency is economically cheap for our company. I work in a Korean company which pays a lot of money to an Indian company for the services rendered to it by the Indian company. The Korean Company has an option to either pay in US dollar or in Indian rupee. I have data of average monthly rate of dollar and average monthly rate of rupee for last ten years. Can anyone please tell me how I can convince my boss which currency is good for Korean company. I checked the exchange rate and found out that the Korean won fluctuates more than Indian rupee does against dollar. Is there any statistical or financial technique to find out which currency is favorable?

    Thanks in advance.
    Hope someone explains it to me.

About the Author Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry. Follow Tim on Google+ Read more »

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