Academic journal article Journal of Accountancy

How to Manage Fluctuations in Foreign Currency Rates

Academic journal article Journal of Accountancy

How to Manage Fluctuations in Foreign Currency Rates

Article excerpt

Managing the P&L and cash flow impacts related to foreign exchange exposures can appear daunting. The following steps, while not all-inclusive, make this task easier:

* Develop a foreign currency policy and procedure. Include the company goals related to foreign exchange management, types of derivatives that may be employed, and personnel authorized to execute transactions.

* Apply a bottom-up approach to identifying consolidated foreign currency exposures. Determine in what currencies each subsidiary collects receivables and makes payments. Identify assets and liabilities that are denominated in a currency other than the individual subsidiary's functional currency, including intercompany receivables and payables.

* Prepare a consolidation of all subsidiaries' foreign currency assets and liabilities. The consolidation should result in a natural offset or netting of some of the foreign currency balance sheet exposure. Remaining net consolidated balance sheet positions by foreign currency should represent the exposure that will be remeasured due to changes in foreign exchange rates with the impacts recorded in the income statement.

* Determine the anticipated annual foreign currency cash flows of each subsidiary. Estimate the total receipts and payments made by each subsidiary in each currency by month for the next 12 months (longer if possible). Add up the total projected receipts and payables by foreign currency (other than the respective subsidiary's functional currency) for each subsidiary by month to arrive at the company's total annual net anticipated foreign currency cash flows.

* Develop a strategy to manage consolidated exposure. For foreign currency net balance sheet positions, consider forward contracts in combination with currency swaps--selling one currency for another and simultaneously agreeing to exchange the same currencies at a specified time in the future--to substantially offset the P&L effects of changes in currency rates when the balance sheet positions are remeasured. …

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