How to Identify FX Exposure: Why Treasurers Fail

Managing foreign exchange (FX) exposure is crucial for businesses operating across borders. However, many companies struggle to accurately identify and mitigate their FX risk. In this blog post, Toni Rami, COO at Kantox, will explore why treasurers often fail to effectively manage FX exposure and provide actionable steps to close the gap.

In my experience over the years, I have been fortunate enough to engage in in-depth discussions with hundreds of Treasurers and CFOs. When the topic of FX exposure management inevitably comes up, everyone agrees it is important. However, I am continually surprised to hear that many of the leading firms in a wide range of industries - travel, e-commerce, ad tech, food - have difficulties in both understanding and agreeing where FX exposure starts.

How is it, given the vast importance of FX exposure management in international operations, that there is no consensus as to where it begins? Let’s first define the FX exposure gap at the sales level.

Understanding FX Exposure

At its very basic, FX exposure occurs any time a company sets a price in a currency other than their own. This exposure lasts until the funds get converted back into the firm’s working one. During this period, the company’s profit is at risk as currency markets can and do move with any open position vulnerable to these movements.

Current best practice dictates that firms mitigate their FX exposure through hedging. Be it a natural hedge, a forward contract or more exotic options, the CFO and Treasury have a broad range of tools at their disposition, ready to be deployed when exposure is detected.

Common Reasons for FX Exposure Misidentification

From what I have learned while working with CFOs is that one of the principal causes of FX exposure misidentification lies in the accounting process. When a company completes a sale, the transaction will eventually get recorded only at the moment the invoice is generated. In domestic business (or at least in a single currency zone), registering the AR in the ledger is not a time-critical activity. The book entry can occur hours, days, even weeks after the sale takes place. In cross-border sales, though, this workflow does not accurately translate.

When companies buy and sell in different currencies, the CFO, Treasurer and accountants must all take into consideration how exchange rates impact the firm's financial strategy. When they sell a product in a currency outside of their working one, they must, at some point, perform a conversion, usually when the foreign funds are received.

In many of the companies I’ve been privileged to consult for, the CFO, Treasurer and accountants chose to mimic their domestic sales workflow - complete with a sizeable gap between the time of sale and when the event gets recorded as an AR. The problem, however, is that accounting only asks the Treasury to hedge once they get the foreign-denominated FX onto their books.

By this time, the exchange rate has moved; either being higher or lower than what it was on the day of the sale or even the moment when the price was fixed; potentially wiping out profits or at the very minimum, distorting the books.‍

Fundamentally, this creates two distinct risks that prevent the gap from being closed:

• Operationally, the Treasury is not able to mitigate exposure on time
• Strategically, the firm cannot protect its profits, harming the long-term vision of the company.

Closing the FX Exposure Gap

To remedy these pain points and mitigate this risk, firms must re-examine their workflows and apply new procedures that focus on closing the gap between the time foreign currency-denominated sales take place, and exposure-eliminating actions are executed.

The underground in London is known the world-over for its iconic signs telling passengers ‘mind the gap’ between the platform and the train. Unfortunately, such signs aren’t so present in the corporate world warning the CFO of the interval between a sale in a foreign currency and when the risk attached to it is hedged. Considering that not heeding this guidance can be deadly to the profit margin, maybe it’s time to mind the gap.

By understanding the common reasons for FX exposure misidentification and implementing effective strategies to close the gap, treasurers can protect their companies from financial losses and ensure long-term profitability.

How Kantox can help Treasurers manage their FX exposure

We are a leading provider of FX risk management solutions offering a suite of tools and services designed to help businesses effectively identify and collect their foreign exchange exposure. Our tools help international businesses:

• Automated Data Collection: Kantox's platform can automatically collect data from various sources, including ERP systems, accounting software, and payment gateways. This eliminates the need for manual data entry and reduces the risk of errors.
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• Real-Time Exposure Monitoring: The platform provides real-time visibility into a company's FX exposure, allowing treasurers to stay informed of changing market conditions and potential risks.
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• Advanced Analytics: Kantox's analytics tools enable businesses to analyse their exposure data in depth, identify patterns, and make data-driven decisions.
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• Customisable Dashboards: Users can create customised dashboards to visualise their exposure in a way that best suits their needs, making it easier to identify areas of concern.
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• Integration with Other Systems: Kantox can be integrated with other financial systems, such as ERP and treasury management systems, to streamline workflows and provide a comprehensive view of a company's financial position.

By leveraging Kantox's capabilities, businesses can gain a deeper understanding of their FX exposure and take proactive steps to manage risk. Learn more about our FX risk management solutions.

*Updated September 2024