International Issues

Chapter 3
Financial Analysis of Multinational Corporations

The tools of financial analysis developed in this chapter are useful in evaluating the financial performance of purely North American firms as well as firms with small international operations. However, assessing the financial performance and condition of a firm with sizable international operations is generally more complicated than analyzing a firm whose operations are largely domestic.

Part of the complication involves the translation of foreign operating results from the host country’s currency to dollars. To illustrate, suppose Harvey’s European Union operations show net earnings of 200 million euros. Harvey’s reports its results to shareholders denominated in dollars. Therefore the euro income must be translated into dollars. The dollar amount of Harvey’s euro earnings depends on the exchange rate between dollars and euros. If this exchange rate is 1.2 euros per dollar, the dollar earnings from 200 million euros are reported as $166.67 million (200 million euros/1.2 euros per dollar). But if the exchange rate changes to 1.5 euros/dollar, the dollar value of 200 million euros drops to $133.33 million. Thus, the earnings reported by a Canadian-based company with sizable foreign operations depend not only on the local currency earnings but also on the exchange rate between the dollar and the local currency. When the dollar is relatively strong against a foreign currency—that is, when the dollar will buy more euros, for example—foreign earnings translate into fewer dollars than when the dollar is relatively weak.

An additional complication in financial analysis of multinational firms arises because of fluctuating exchange rates. What happens to the dollar value on the parent firm’s balance sheet of its European assets and liabilities as the exchange rate between euros and dollars changes? Assets and liabilities are normally translated at the exchange rate in effect on the balance sheet date. However, any gains or losses resulting from the translation of asset and liability accounts are not reflected on the income statement and therefore also are not included in the retained earnings figure on the balance sheet. Instead, gains and losses from foreign translation are reported separately on the balance sheet as a part of shareholders’ equity, usually under a heading such as “Currency translation adjustment.” For example, during 2001, Magna reported a decrease of US$158 million in its translation adjustment account. This decrease did not affect Magna’s 2001 earnings, but it did change shareholders’ equity on its balance sheet.

Financial managers and analysts will have to be knowledgeable about the complex international aspects of financial statement analysis.

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