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Five mistakes companies make in FX risk management

When dealing in foreign currency, CFOs need to mitigate risk from fluctuating

In order to compete in an ever-expanding global market, CFOs need to be aware of changes to monetary policy and foreign exchange rate fluctuations. There have been a lot of developments in this area recently. With countries around the world beginning to recover from the economic turmoil of the last half-decade, it's more important now than ever before that financial executives mitigate their risks on the international stage.

Most market fluctuations are small and gradual, but occasionally, exchange rates can jolt wildly in one direction or another. One IRS report highlights an instance in 1998 when the yen/U.S. dollar exchange rate shifted 20 percent in one day. While this is certainly an outlier, businesses need to be prepared for the potential risk to profits related to even the smallest adjustments. Here are the top five mistakes most companies make when it comes to FX risk management:

Overpaying on exchange fees

Banks are in business, too, and are looking to make as much money on their services as possible. But that doesn't mean money market traders and companies buying and selling goods overseas should get taken advantage of. CFOs or other executives should always have live rate information in front of them while dealing with the banks in currency exchange situations, according to Atlas FX. Internal trading can also help limit risk by avoiding third party traders who make their profits on businesses' external trades.

Over analyzing the direction of the market

Markets rise and markets fall, and companies that have a presence in various countries and deal in multiple currencies need to understand that sometimes they will be on the losing end of a foreign exchange equation, according to MoneyShow.com. But fixating on just this aspect of trading and limiting capital to one currency overlooks the natural ebb and flow of the market place. It's important for financial executives to hedge their bets, but over thinking the downside could lead to missed opportunities.

Overconfidence in yearly, quarterly reporting

International trade is a complicated area, and there are bound to be some points along the way where the numbers simply don't add up, according to Atlas. Companies should not wait until the end of the quarter or end of the year to begin sifting through their FX data, assuming everything will fall into place. Staying on top of discrepancies is sound advice not just for FX risk management, but for all accounting and auditing situations.

Over reliance on American currency 

More and more, foreign purchasers are insisting on paying for American goods and services in their local currency, which carries some risk to the U.S. seller. But by avoiding foreign currencies entirely, companies may be losing out on profitable trade opportunities, according to a U.S. Commerce Department trade finance guide. Companies could also face non-payment by foreign buyers who have difficulty meeting the exchange requirements.

Oversimplifying records

A spreadsheet can be a remarkably effective tool for keeping track of business dealings, finances and other things. But relying on one large spreadsheet for something as complex as foreign exchange risk management could be counterproductive, according to Atlas. Complicated business practices cannot be boiled down to a two-dimensional spreadsheet.

"Too often, a monster spreadsheet can only be navigated by the person who built it, which might be good for their job security, but not so good as an ongoing risk management solution," according to Atlas. "An investment in the right platform to support all the complexities of FX exposure management is very likely a worthwhile one."

Comments

Topic Expert
Philippe Gelis
Title: CEO
Company: Kantox
LinkedIn Profile
(CEO, Kantox) |

Create a natural hedge is definitely the better way to hedge FX risk but when it is not possible, solutions corporate-to-corporate which make it possible to match cash-flows in foreign currencies with third-parties (or between subsidairies with different ownership) is a very cheap and simple way to hedge.

Topic Expert
Joan Varrone
Title: CFO
Company: Cloud Cruiser
LinkedIn Profile
(CFO, Cloud Cruiser) |

I managed foreign currency risk at a number of multinationals and actually did a benchmarking study of similar companies in Silicon Valley. The most common practice is to hedge transactions rather than take a position on the direction of the currency markets. As noted in the article these markets can change rapidly.

However, the best practice is to create natural hedges in your operations which can happen over time. A perfect example of this is the move of Japanese car makers to the US so that they could shift some of their costs to USD where they had revenue in USD.

Joan Varrone.

Topic Expert
Mike Caruana
Title: Director of Financial Services
Company: Diamond Resorts International
(Director of Financial Services, Diamond Resorts International) |

Great points. We have 220 resorts globally and wrestle with this daily. Our organization extends FX considerations to our customers as well. Even a mishandled transaction that is quickly corrected can result in additional customer dissatisfaction. When the refund is calculated in U.S. dollars instead of their local currency, additional calls and letters may result from subsequent complaints that their refund was short (due to exchange rates)...not to mention that always defaulting your calculation to U.S. dollars may swing the refund the other way and hurt your cash position when the dollar is in a stronger position.