World Currency | Dollar Market | Cash Dealings | Cash Flow | Risk Management

Cash Flow at Forex

Management of Forex Cash Flow Exposure

Management of cash flow exposure is still being developed. Unlike balance sheet hedging, with which existing transactions are protected, hedging in currency markets to offset an anticipated operating variance falls outside the realm of standardized hedge accounting practices. Rather than sorting out assets and liabilities to find a net exposure, anticipatory models must be set up and projections and forecasts playa much more important role.
Put-'em-on-and-forget-'em hedges can work for accounting exposures, where the risk is contractual and unchanging; however, they are deadly for protecting cash flow. This type of exposure requires continual hands-on management as the actual figures and revised projections flow in.
If the projection is wrong and the anticipated amount of mismatched currency does not equal the amount of the hedge, a foreign currency manager can suddenly find himself a currency speculator. This is why the FASB is reluctant to establish accounting standards for cash flow exposure.
We considered three types of hedges in forex operating strategies, transactional hedging, and financial adjustments. We've found the first to be the most suitable for operating exposure. Accounting exposure can be managed quite well with the second type, transactional hedging. The third type, financial adjustments, defines methods that lay half way between the first two. Financial adjustments are not as time consuming, as expensive, nor as permanent as the operating strategies listed above. Although they are

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more flexible than operating strategies, they are not as flexible as transactional hedges. Financial adjustments as hedging techniques seem well suited for cash flow exposure.
We've listed below the various adjustments and transactions usually considered for the management of cash flow exposure. Remember that they are not permanent solutions and should not be considered as such. Flexibility is the key to cash flow exposures, and the degree of flexibility offered by each method is of paramount concern in the selection process.

Home-Currency Invoicing

One common financial adjustment is to revert from foreign currency to home currency invoicing. The company simply prices everything in the home currency, such as the U.S. dollar. This method is most effective when the product line is unique and not price driven. Pharmaceuticals and other high tech items are good examples. Home currency invoicing should be continuously monitored because it invites competition from countries with weaker currencies. Also, if price sensitivity increases, the market itself may simply disappear.

Strong-Currency Invoicing

There may be instances when a choice of invoicing currency is available, but the home currency is not among the options. Then, the best hedge is to invoice in the strongest world currency, where there is a better chance for gain. For example, if invoicing can be denominated either in ECUs or in Deutsche marks and the Deutsche mark is the strongest currency in the ECU composite, and then Deutsche marks should be the invoice currency.

Home-Currency Sourcing

Here, inventories of components are bought and paid for in the home currency wherever possible. The purchasing department of a U.S. corporation favors the foreign vendors who agree to invoice in U.S. dollars. This assumes that the finished product is to be sold in the home currency. Again, it is a way of transferring the risk to a different party. It works as long as the vendors agree to accept the risk. There are caveats. Marginally profitable vendors may be unable to afford the additional burden, and vendors who do accept the risk often add the potential cost to their price quotes.

Same-Currency Sourcing

An alternative is to find suppliers in the same country that is producing the revenue exposure. Purchasing from those sources in the local currency will help hedge the exposure. This is similar to sourcing methods described above as an operation strategy, but on a shorter-term contract basis.

Long-Term Fixed-Rate Borrowing

This is perhaps the most common method used to hedge long-term translation exposures; for example, a firm that constructs a plant or distribution facility abroad finances the construction and operation in local currency from a local bank.
The ensuing revenue is then offset by the payment of principal and interest over a number of years. This hedges exposure to nominal exchange rate changes. What remains is risk of change in the real rate of exchange because fixed-interest-rate loans do not compensate for changes in inflation. Because the greater exposure of fixed assets, over time, is to the real rate of exchange, this method affords only a partial hedge solution.
Long-term foreign currency borrowing can be used to hedge cash flow exposure in forex trade as well. The proceeds from the loan must be converted into the home currency to reduce the exposure.
Repayment is made by reconverting the currency at higher or lower rates, offsetting risk to future foreign currency revenue. Borrowing funds from foreign banks to take out of the country in the form of another currency can involve some intricate maneuvering around foreign exchange regulations. Two strategies used are to payout the proceeds as dividends, and to use them for paying off existing loans to the parent company.