Best Practices to Set the Budget Rate Like A Champion

Budgeting season is approaching and it can be a dreadful time for those finance professionals. Too many things that can go wrong, especially in currency management, when trying to set a budget rate for the budget period. How do you make sure you are well prepared? And can you really set a budget rate that will keep your company's profitability afloat in a stormy economic environment?

In this article, we will give you some tips and best practices when it comes to budget hedging and setting the budget rate to be the FX champion in your company.

What is the budget rate?

The budget rate is the foreign exchange rate that is used when setting prices at the start of a budget period. For example, a firm that buys key inputs in USD and sells final goods in EUR may set the price by using the EUR-USD rate to arrive at the cost of sale in EUR. Many firms conduct more than one campaign per year. If so, the FX to protect should be the rate of each individual campaign rather than an annual budget rate.

When setting the campaign/budget rate, some common practices include:

• the spot rate
• the forward rate
• an off-market rate
• a market-consensus rate

Best practices to set the budget rate

The built-in budget rate

Instead of defining a budget rate first and then applying a hedging program to protect it, some companies hedge the forecasted exposure beforehand, building the FX rate used to set prices.

• ‍Advantage: the campaign/budget period that gets underway is already protected against currency risk
• ‍Disadvantage: with a locked-in FX rate, competitors who hedge later may profit from better market conditions
• ‍Disadvantage: the built-in budget rate presupposes a high degree of forecast accuracy, a luxury that not all companies can afford

Protecting a ‘worst-case scenario’ rate

There is a much better approach. When the budget is created, the finance team sets a ‘buffer’ between the prevailing market rate and a less favourable rate it desires to protect using conditional stop-loss orders.

That rate is usually the FX rate used in pricing, but it can also be a ‘worst-case scenario’ rate. This brings up some intriguing questions:

• How is that budget rate calculated?
• How do hedging programs protect it?
• What are the advantages of this approach?

We answer all these questions and more in our latest Budget Hedging Report, download it in the link below and be ready for budgeting season. And if you are looking for an automated FX solution that allows you to be more strategic and effectively protect your budget rate, check out Kantox Dynamic Hedging®