When you carry out international transactions, you are exposed to various risks, particularly exchange rate risk. Indeed, in the short or medium term, exchange rate fluctuations between two currencies can be significant and thus have a significant impact on the invoice and competitiveness of the products sold or purchased.
In order to deal with exchange rate uncertainty, it is therefore necessary to adapt its strategy as well as possible and to anticipate exchange rate trends. We return here in detail to exchange rate risks and the importance of taking them into account in order to optimize your management.
To help you in your hedging strategy, DeftHedge offers you its currency risk management tool which will allow you to set up a totally personalized strategy. Our web application has been designed to offer companies a simple and fluid use.
With the different functionalities at your disposal, you will be able to improve your positioning and adapt your strategy to the changes in the exchange rates of different currencies. In order to be serene in this market and have the best strategy, DeftHedge is the ideal ally.
What is the foreign exchange position?
The foreign exchange position defines the financial situation of a company that works in several currencies. The calculation of a company’s foreign exchange positions is based on several elements: forecast cash flows, receivables, debts and assets in foreign currencies. When the amount of debts and commitments is equal to the amount of assets and receivables, then the foreign exchange position is closed. Conversely, in the event of a difference between these two amounts, it is necessary to make calculations based on the company’s situation and activity. Indeed, the value of a company’s assets will vary according to the currencies in which it exports or imports. This foreign exchange position is an important element in identifying the financial situation of a large company as well as an SME.
Why manage foreign exchange risk?
Foreign exchange risks for a company’s business are very real and should not be overlooked. In order to avoid the consequences of exchange rate fluctuations, this risk must therefore be managed as well as possible. A good management of the exchange rate risk will be beneficial for a company’s activity on several levels:
- Improved cash flow forecasting and reduced income statement volatility
- Decrease in financial losses caused by unfavorable changes in the value of currencies.
- More accurate evaluation of product selling prices.
- Guarantee of the competitiveness of the company.
Protecting yourself against exchange rate risks thus appears to be an essential element to guarantee your company’s activity and ensure your competitiveness for your international exchanges.
Managing risks: hedging foreign exchange risks
Fluctuations in the value of currencies can have a particularly significant effect on your company’s bottom line. To protect yourself against these risks, it is therefore necessary to have a strategy adapted to the risk ratio that the company sets for carrying out its transactions. In order to protect companies against exchange rate risks, several solutions exist today:
- Natural hedging
- Financial coverage
The natural hedging strategy consists of balancing all purchase and sale transactions in the same currency. To implement this hedging, it is generally necessary to adopt a strategy of relocating all production to the country where the market is located.
Financial hedging can be implemented with different strategies. Hedging instruments can be used through the foreign exchange market, also known as the currency market or FOREX. Several types of financial instruments exist to protect against foreign exchange risks:
Forward contracts: a firm agreement between the seller and the buyer on the price and amount of a transaction for which delivery and payment will be made at a later date.
Foreign exchange options: An option is a right whose value (premium) is paid by the buyer of the option to the seller of the option.
Foreign exchange swaps: a transaction in which two parties agree to modify the date of a flow provided for in a forward contract.
Zero-premium contracts: agreement fixing a range of exchange rates within which the company undertakes to carry out the transaction (both for the sale and the purchase).
In the face of exchange rate risks, companies therefore have several instruments at their disposal to protect themselves in the best possible way and avoid any consequent financial losses.
Insurance for the exchange rate
In addition to implementing a currency hedging strategy, companies can also take out insurance policies against exchange rate fluctuations in the event of a tender. These contracts allow companies to be covered for 100% of the foreign exchange loss assessed in relation to the short term. Calculated on the basis of currency exchange rate fluctuations, this insurance enables companies to avoid any significant losses throughout the duration of the business operation.
Leveraging to reduce exchange rate risks
Other ways of reducing exchange rate risk include hedging. Currency risk accounting backing is verified when the notional amount (in amount or volume) of the hedging instrument is equal to that of the hedged item. The purpose of matching is therefore to avoid currency, interest rate and liquidity risks in the event of failure of the financial transaction.
Foreign exchange accounting: Gain, loss
Previously, foreign exchange gains and losses were recorded in financial income (loss). Now, the General Chart of Accounts requires companies to itemize these gains and losses by recording them in different accounts:
- Account 656: exchange losses on trade receivables and payables
- Account 666: exchange losses on financial receivables and debts
- Account 756: exchange gain on trade receivables and payables
- Account 766: exchange gain on financial receivables and debts
- Account 766: exchange gain on financial receivables and debts
With this new measure, foreign exchange gains and losses must now be reflected in the company’s operations.
Reporting of exchange rate risks
Although no limits are currently imposed on companies to manage exchange rate risk, DeftHedge nevertheless proposes the implementation of a governance system and a mechanism designed to :
- Frame the exchange rate risk
- Measure the exchange rate risk
- Monitoring the various financial risks on the exchange rate risk
This reporting of exchange rate risks is essential to avoid any significant financial losses to which companies may be exposed during their transactions in foreign currencies (Dollars, Euros, Swiss Franc, Pound Sterling, etc.).