By Ian Lavis on behalf of Praxity
As companies expand internationally, the economic and financial risks increase significantly. Managing foreign currency exposure is critical in mitigating one of the biggest risks.
Trading in multiple currencies is a complex and high-risk business. With unprecedented volatility in global markets in recent years, the need for robust programmes to mitigate the risk is more important than ever.
Whether a company is entering international markets for the first time or already operates in multiple jurisdictions, currency fluctuations can have a significant impact on the success of business projects, the value of assets and liabilities, and cash flows.
Minimising the risks associated with foreign currency exposure doesn’t just require local treasury and cash management, it requires a high level of expertise in foreign currency exchange (FX) exposure and sophisticated IT systems capable of handling multi-currency accounting.
Mathieu Vincent, treasury and cash management specialist at the Paris office of global accounting firm Mazars, says: “In any type of international business operation, the key issue is to identify the measure of FX exposure. If you don’t have a multi-currency accounting system, there is no way that you can keep track of this FX exposure.”
There are many currency challenges when operating in different markets around the world. Companies need to translate transactions denominated in foreign currencies into their functional currency. This functional currency isn’t necessarily the local currency. It’s the currency of the primary economic environment in which the entity operates.
Financial statements of subsidiaries held in functional currencies must then be translated into the group’s reporting currency. Measuring foreign currency transactions and translating financial statements is where things get a little tricky, or interesting, for the accountants. This is where companies with access to FX expertise and advanced IT systems can gain the leading edge.
What if an organisation has contracts with FX bands that don’t appear in accounting systems as an FX transaction but expose the company to price volatility? What if the contracts have price adjustment mechanisms that don’t show up as FX transactions either? These are just the tip of the iceberg.
How to mitigate risk
One option to manage foreign currency exposure is to transfer the risk to customers or suppliers. This carries obvious risk in itself as it could potentially damage trading relationships. Another option is to use financial derivatives. This can be extremely effective but requires deft management due to the complexities involved. There is no magic wand. It’s a case of analysing the individual risks associated with each company’s operations.
Mathieu Vincent explains: “Different accounting operations can have a big impact on the financial statements. We analyse how we can better portray these operations and, where appropriate, we recommend using hedge accounting. We try as much as possible to promote what we call natural hedging by aligning the cash-in with the cash-out by currency. We measure exposure and we try to centralize it by, for example, changing the currency of intragroup invoices.”
An international group in the luxury industry, for example, could be manufacturing products in Italy and selling all over the world. If the group sells to the retail subsidiaries in their local currency, say US dollars, the FX exposure is centralized in Italy. This centralization makes it easier to manage. It must then be correctly reported in financial statements.
Hedging to buy time
Used effectively, hedging can help manage foreign currency exposure. “If you hedge it, it’s easier to address the volatility and you gain time,” according to the Mazars foreign currency specialist. If the value of the dollar goes down compared to the euro, for example, it is not profitable to have a factory in Europe and to sell in dollars, so hedging can mitigate the FX exposure and allow you to buy time.
In the current climate of globalisation and high market volatility, internationally-minded companies need to be sure they are adequately equipped and have the expertise to manage the challenges of multi-currency accounting.
The key areas to consider are:
1. Are you fully aware of the FX risks of your international operations?
2. Do you have the FX accounting expertise to manage the risks?
3. Are you accounting for foreign currency exposure in your reporting?
4. Are your accounting systems up to the job?
5. Do you have effective FX policies in place?
The complexity of multi-currency accounting is encouraging many companies to turn to international accounting firms for advice rather than trying to manage multi-currency accounting in-house. A growing number of these accounting firms belong to Praxity Global Alliance, the world’s largest alliance of its kind for the sharing of knowledge and skills across international borders. By accessing local expertise anywhere in the world, clients can benefit from advice where they need it most. The solution to minimising risk, it would seem, lies in international cooperation as well as accounting and IT expertise.