Hedging Foreign Exchange for the Average Co. (Part I)

Imagine heroically taking over the landing of a Boeing 747 after discovering an incapacitated flight crew. While hearing the air traffic controller utter the words "autopilot is now off" may seem frightening in this case, in the workplace hearing the words "here is your new office" while stepping into your first role as Controller or CFO may be a close second. A slight exaggeration perhaps but this holds true for many senior positions garnered by your fancy new (insert 2 or 3 letter acronym here) accounting designation or any senior role in general where you feel overwhelmed starting out.

In this multi-part episode of Practical Business 101 we will demonstrate how to handle foreign currency issues and look like a pro right out of the gates.

There are two simple questions you need to answer before choosing how you will protect your company against blowing their brains out in FX losses.

1. Do you have any lines of credit or debt? .....(most likely).
2. How easily can you predict when you get paid and when you pay your Accounts Payable?

The answers to these simple questions will assist you in the selection of the method of hedging. Having operating credit will allow you to utilize the simplest method of hedging which is to balance your debt to the amount of net assets you hold in the foreign currency. In this case, there is no exposure so long as these two are identical. Also, this approach works well no matter what the timing of collections and payments as these are simply added or subtracted from your loan in the foreign currency.  However, this approach becomes challenging if you add a third currency. Realistically, it is best suited to Canadian or US companies with receivables in the other currency.

Consider the following illustration:

You have AR of $70,000 Domestic and $30,000 Foreign Currency with a line of credit of $75,000 Domestic. Consider also that you have had some foreign supplies in your purchasing and now have $10,000 in Foreign Currency Accounts Payable.

So, you have an exposure of $20,000 ($30k AR less $10k AP) which is your net monetary assets.

Therefore, to hedge this exposure you simply need to convert enough of your credit line into $20,000 Foreign Currency. It's as simple as this!

The best part is that this works for companies of various sizes and industries. I've utilized this for companies for $100 Thousand to $50Million and it is effectively a perfect hedge other than some small interest rate differentials that can actually work in your favour.

In part II, we will look at a few other methods when this method is not possible perhaps due to limitations of your financial institution.  We will also look at ways to protect your company where your transaction timing is both predictable or not.

Check back soon. Until then...keep it simple!