by Wolfgang Koester, CEO of FiREapps
At a time when managing risk and cutting costs are at the top every corporate board agenda, the majority of U.S. multinationals have been forced to explain substantial, unanticipated foreign exchange (FX) losses in the third and fourth quarter. While FX gain/loss has not traditionally been managed as a business cost, its impact on quarterly earnings in the second half of 2008 was unmistakable—but not unavoidable.
The combined effects of increased globalization and currency volatility, including some recent dramatic directional moves, have affected company earnings and share prices, and painfully reminded corporate board members and senior executives that foreign exchange is the cost of doing business internationally. The good news: rather than accept these costs, multinational companies can control and manage them by understanding the sources of exposure and managing them with smarter processes.
Questions to ask about foreign exchange risk
To understand their company’s FX risk, executives and board members need to dig deep and push internal auditors, or treasury and controller organizations, to answer some fundamental questions about how existing systems and processes have performed under real world conditions. Here are the questions board members need to ask today—and the kind of answers they will need to fully understand their FX risk.
1. What is the company’s total foreign exchange exposure?
This is a fundamental question that companies routinely get wrong. Too often, treasury lacks proper visibility to the underlying details of the transaction data they receive from finance to manage foreign exchange. Often, revaluation rules within the ERP systems used to generate this data have been improperly configured. Many times, complex spreadsheets are used by treasury to calculate the company’s foreign exchange exposure—a process that introduces potential errors into the final result. Finance and treasury need to demonstrate confidence in the data that drives foreign exchange risk management decisions.
2. What actions are you taking to manage foreign exchange exposure effectively?
Beyond demonstrating the ability to define the company’s FX exposure based on complete data accurately, companies need to achieve those results in a timely basis. In today’s volatile global markets, any process that requires a week or more from period close to produce results and drive decisions can introduce significant market risk into the process, as currencies continue to move.
At the same time, treasury must demonstrate that it is able to clearly articulate the actions it has taken to manage risk and demonstrate the results. If the two don’t add up, it’s time to dig more deeply into the underlying data, systems and processes that define the FX risk management program.
3. What is your real FX risk?
Board members should examine the company’s real FX risk in terms of its total FX exposure multiplied by currency volatility. Often, by examining FX risk in these terms on a currency by currency basis, companies discover that their greatest potential risks lie beyond the G10 currencies that make up the bulk of their exposures. In the last two quarters, currencies such as the Brazilian real or the Aussie dollar have snuck up on treasurers who saw exposures in these currencies as insignificant—while the risk they represented was substantial.
Managing Foreign Exchange as a Business Cost
How well finance organizations can answer these questions and how well they can demonstrate transparency within their FX policies, processes, and results will speak volumes about a company’s FX-related compliance and economic risks. The only remaining question: what to do about it?
Companies that cannot adequately answer the basic questions outlined here need to begin by outlining the steps to achieving complete FX exposure data, timely FX exposure calculation, and transparent FX processes, so they can respond quickly and effectively to changing market conditions. Achieving these goals may require an investment in resources or automated tools to ensure ongoing success, but avoiding another quarter of FX losses can translate into an immediate ROI.
About FiREapps
FiREapps is the leading provider of on-demand software solutions that help multinational corporations reduce the cost and risk of foreign exchange. www.fireapps.com