Foreign currency: Looking beyond the risk

Foreign currency: Looking beyond the risk

By Antoine Lajoie, President of FINMETRIX

Measuring and managing exchange rate and its impact on profits represent important challenges. As an initial step, and this may be surprising, it is not recommended to use accounting method. Yes, the very same approach many consider essential in business finance.

Look beyond accounting data

Your financial statements are not designed to indicate nor measure your exchange risks, neither your risks of fire, equipment breakdown, supply, labour, competitive positioning, etc. Another important component, your income statement produces adjustments for your exchange gain/loss. This information, often perceived as a reliable indicator, only meets the rules of accounting. Therefore, it has no value in measuring the real impact of exchange rates on your profits. Think about your real estate assets where the accounting value, which meets the accounting rules, doesn’t represent the real market value. This explains why we need to look beyond accounting data.

Lack of standards and procedures

As an entrepreneur, standards and procedures are imposed for virtually everything from factories, machinery, electrical installation, rolling stock, environment, customs procedures, logistics, packaging and more. These often binding “guidelines” have a great merit, namely, to indicate precisely how to mitigate risks and conduct your business. This can’t be left to chance. At the same time, however, with regard to exchange risk, there is a lack of standards and procedures. We leave you alone. There are no rules imposed on you. As a result, you are not told when or how to act. You are left on your own. It’s not surprising in this context that currency hedging generally doesn’t meet the real needs of profit protection.

Cash flow risk

Keep in mind that the reality of exchange rate is one of the first challenges when making international sales. Exchange risk arises when you evaluate the selling price and its impact is manifested in the cash flow in foreign currency. At this early stage of the transaction cycle, this risk is completely absent from accounting reality and financial statements. And yet, it’s time to take action immediately. For most of us, it’s counter-intuitive to proceed as quickly as possible to currency hedging. But the alternative, which consists of doing nothing immediately, exposes the company to an uncontrolled risk, whose real financial consequences will only be known later, i.e. after exchange conversions. And beware, this scenario has nothing fictitious. Risk is real. Many financial disasters can attest to this.

Common sens

More than a science, foreign exchange risk management is an art where we preach common sense. Effective way to hedge foreign exchange risk is accessible to enterprises. Hedging tools are easily accessible, efficient and flexible. Make sure you keep it simple. A hedging strategy doesn’t have to be complicated to be effective.

Offer

In the current crisis and market volatility, FINMETRIX provides support in terms of financial risk management and offers free consultation.

To register by e-mail: strategie@finmetrix.com

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