Importance of being currency aware | HighRadius

Why is foreign exchange risk awareness important?

What you’ll learn

  • Learn the challenges in FX risk management and effective strategies to mitigate FX risks.
  • Learn how to transition from operational to strategic risk management.
  • Learn the benefits of an automated FX hedging approach.

In currency-aware organizations, every business leader understands the impact of FX risks on their functions and uses that information to make more profitable decisions. It has become more important for every multinational organization to handle FX risk proactively. Today many companies fail to appropriately manage foreign exchange risks. Learning different ways to counter currency risk companies face can protect the company before the risks impact its financial health. To make risk management decisions proactively, a CFO needs accurate forecasts and timely reports. But, manual systems make it difficult to track FX fluctuations and thus handle foreign exchange risks effectively.

Challenges in FX risk management

The significance of FX risk management has increased greatly over recent years due to globalization, increased levels of market volatility, and new regulations. Therefore, treasurers are becoming more active in monitoring FX exposures, and refining policies more frequently. Companies of all sizes and industries are growing internationally, seeking new sales opportunities and expanding supply chains. As a result, treasurers are managing risks of increased proportions spanning multiple currencies which adds to the operational and financial complexity.

Market volatility is predominant due to economic fluctuations, supply chain disruption, and global geopolitics. The ability to gain timely, accurate, and complete visibility over FX risks and pursue more adaptable hedging solutions to tackle them has become a priority for treasurers today.

Types of Foreign Exchange Risk

There are three types of foreign exchange risks that companies usually face such as:

  • Transaction Risk: It occurs due to a real business transaction taking place in foreign currency. FX fluctuations can lower the functional-currency value of predicted foreign-currency revenues and raise the functional-currency value of anticipated costs for transactions that will take place outside of the organization’s functional currency but are not shown on the financial statements.
  • Translation Risk: This is the translation of the financial statements (such as P&L or balance sheet) of a foreign aid from its local currency into the reporting currency of the parent. It arises when the parent company must report in its reporting currency for all its subsidiaries to shareholders that need it to deliver a set of accounts in its reporting currency for all its subsidiaries. Companies with international subsidiaries may experience financial losses as a result of exchange rate fluctuations.
  • Economic or Operating Risk: It is the type of foreign exchange risk that is caused due to the impact of unpredictable and unavoidable currency fluctuations on a company’s future cash flows and market value and it is also long-term in nature. This type of exposure impacts longer-term strategic decisions such as investments in manufacturing capacity.

How to manage FX risks proactively?

FX risks can be managed using this standard risk management process:

  • Identify: Identify underlying exposures from cash flow forecasts
  • Analyze: Analyze value at risk and other metrics of FX exposures
  • Treat: Perform hedging accurately
  • Monitor: Mark-to-market frequently (daily, if possible) to ensure that
    hedging works properly and risks the limits are not exceeded

The transition from operational to strategic risk management

Previously, the key to flexible, comprehensive risk management solutions may have been restricted to the biggest multinational corporations with the most sophisticated treasury management function. But today, treasuries of all sizes and levels of complexity are embracing the opportunity to visualize, model, and manage risks more effectively to add significant value to their organizations.

The first phase is to identify global exposures or risks, which is more difficult if treasury movements are decentralized. Therefore, many companies are choosing to centralize some or all financial risk management processes and direct exposure data from across the business into a global treasury center. With the information in a single location, treasury will be in a position to visualize these risks jointly with existing hedges. Treasurers can then revalue and observe the effectiveness of an existing or suggested hedging, against different market strategies.

Benefits of an automated FX hedging approach

The benefits of an automated FX hedging approach along with a broad risk reporting and modeling approach are significant so:

  • Hedging decisions are made along with both FX and credit policies.
  • Transaction processing and integration are made seamless. This end-to-end approach to capture and analyze FX risks allows treasurers to spend time exploring and refining the effectiveness of the hedging policy and analyzing potential hedging strategies.
  • Helping treasury to optimize hedge effectiveness and minimize costs to handle the impact of FX volatility on the business. This places treasury to support further international development without creating any extra complexity or capacity restrictions, adding actual value to the business and enabling success.
  • Automation makes it easier for CFOs to keep a closer look at the exchange rates, and manage the impacts of currency fluctuations.

Modern cash forecasting technologies are transforming organizations into proactive risk managing organizations. Schedule a demo with us to learn how to handle currency risk fluctuations with a robust cash forecasting solution.

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HighRadius Integrated Receivables Software Platform is the world's only end-to-end accounts receivable software platform to lower DSO and bad-debt, automate cash posting, speed-up collections, and dispute resolution, and improve team productivity. It leverages RivanaTM Artificial Intelligence for Accounts Receivable to convert receivables faster and more effectively by using machine learning for accurate decision making across both credit and receivable processes and also enables suppliers to digitally connect with buyers via the radiusOneTM network, closing the loop from the supplier accounts receivable process to the buyer accounts payable process. Integrated Receivables have been divided into 6 distinct applications: Credit Software, EIPP Software, Cash Application Software, Deductions Software, Collections Software, and ERP Payment Gateway - covering the entire gamut of credit-to-cash.

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