Foreign currency issues
The strategic risks come from investing in devaluing currencies and borrowing in appreciating currencies. The accepted wisdom is that if you are investing in a currency, fund the investment in the same or similar currency.
Operational risks arise from fluctuating currencies and related pricing and costing issues. The accepted solution is where possible to pay for currency cover. Large multinationals have the advantage that their treasury operations can arrange such internal cover.
Another risk with foreign currency transactions is that of the rogue trader, and we hear of examples every year, particularly in the financial sector. I am sure we are all surprised by the extent of losses that some trusted employees can run up. The answer has to be choosing the right people and good internal controls.
Finally, some companies deliberately have strategies of making money on foreign currency transactions - good luck to them, if they have the expert dealers. But the logical conclusion has to be that not everyone can be a winner.
Apart from currency, hedging companies that consume or sell commodities have the financial risk of availability and price fluctuation. Accepted policy would be to purchase forward and thus fix costs for a period, or, if you can, match (hedge) inputs and outputs.
Again, a strategy of traders is to make money from hedging your own or others' activities. Again, logic dictates that not everyone can win every time, unless, of course, it is a rigged market!
- The most likely financial strategy that executives will be involved with is that of gearing either the business or a project.
- Gearing can deliver return to investors but with risk attached.
- Leasing has many benefits, but the one of accounting illusion is likely to be curtailed.
- Sale and leaseback of assets may release much-needed cash but is this just an easy option?
- Operating as a group often makes sense, but if it is to hide reality then you have to be clever and prepared to understand the required accounting disclosures.
- You can gamble on currency and commodities if you wish or are allowed to do so.
Revision and learning pointers
Pure financial strategies are often sophisticated, particularly where tax management is concerned.
Do review the basic definitions of gearing or leverage, off-balance sheet finance and leasing.
Check your understanding of group structures and SPVs.