4 things to think about when setting FX Budget rates

Exchange rate volatility is not a new concept to the CFO or CEO of a business involved in international trade but as more and more businesses trade across boundaries and open up new markets, its impact is gaining more and more attention.

As part of the usual start of year process of budgeting CFO’s will no doubt be locking in their plans for 2016.  The reality is that most businesses are starting to realise that producing detailed annual budgets at the start of the year does not fully take into account the uncertainty that trading in currency markets puts on to the budgeting process.

The only thing that a CFO can reasonably expect is that there will be change within the next twelve months and it is probably time to accept this reality.  Rather than fighting against this uncertainty, CFO’s should be embracing the uncertainty to create plans that are flexible and agile.  By moving to a more dynamic process of revising and resetting budget rates on a rolling basis, businesses can take advantage of uncertainty to gain a more competitive advantage.

Stress testing their budgets against market movements with scenario analysis can help decision making under a variety of expected conditions.  For example a 5,10 or 15% revaluation (in both directions) of their base currency can help define the business strategy and remain agile – which suppliers to use, which customers to target.


The following are four typical approaches used by businesses in setting budget rates:


Using the current spot rate


The current spot rate could be used as a strategy however this is effectively betting the rate will go up from current levels over the next 12 month period.  Probably the most frequent used by businesses is an arbitrary number based on a combination of the current spot rate and some or all of the below factors give the business a buffer against rate movements.


Average exchange rate from some previous time


Basing the rate on historical rates is also a potentially flawed approach.  The AUD/USD devalued 19% over FY15 so for an Australian importer using the previous 12 month average would be locking in a budget rate 8% higher than the spot rate at the time.


Forward rates


Using the the forward rate is probably the most accurate approach and used by most corporate treasurers as it is the rate that you could theoretically lock in the businesses forecast transactions over the next 12 months.  In reality businesses do not hedge a full year of forecast transactions out this far.  Further using this rate does not take in to account the margin your dealer will make.


Bank Forecast rates


As at the end of March, 2016 the Bloomberg bank forecast tables for AUD/USD showed a significant disparity.  The highest 12 month forecast was 0.8 and the lowest for that period was 0.58.  Even the range for the next quarter was 18 cents.  Banks rarely get their forecasts right (even in the short term) and they are constantly updating them as economic news becomes available.



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