Exchange rate fluctuation is an everyday event. From the holiday planner planning an abroad trip and wondering when and how to obtain local currency to the multinational company buying and selling in multiple countries, the possibility of getting it wrong can be enormous. Even after so much technical innovation, companies fail to properly mitigate foreign exchange risk. For this reason, we create a simple guide for those interested in learning about the ways one can counter currency risk.
Types of Foreign Exchange Risk
Transaction Exposure - This is the simplest kind of foreign currency exposure and it arises due to an actual business transaction taking place in international currency. This exposure enters into a contract and settles it.
Translation Exposure - In this, the translation of the financial statements of a foreign subsidiary from its local currency into the reporting currency of the parent. It arises because the parent company has reporting obligations to shareholders and regulators which require it to provide a consolidated set of accounts.
Economic Exposure - This final type of exchange exposure is caused by the effect of unavoidable and unexpected currency fluctuations on an organization's future cash flows and market value. This type of exposure is helpful for long-term decisions.
Small and medium enterprises may think that FX risk is only for big multinationals. However, according to a study, 80% of MSMEs have experienced losses or gains due to currency fluctuation. Companies do not act proactively and later suffer a major loss. So, a company must identify exposure within their organization. This may sound like a simple process but some FX exposures are quite complicated to identify. Evaluate your company's balance sheet and cash flow forecasts. These steps can mitigate FX risk and prove beneficial for your organization. A solid plan can help you avoid expensive mistakes and discover new opportunities as your company deals globally.