Making cents of foreign currency

By Dean Love - October 9, 2017

Many aspirational Australian companies seek to grow their business and expand their markets by engaging in the global economy. Businesses that take their first step beyond Australia are faced with global headwinds, often outside of their control, and have the potential to impact their bottom line. Foreign exchange risk is one that businesses should consider when transacting on the global stage.

Foreign exchange or currency exposure can be broadly categorised as translational exposure or transactional exposure. Translational exposure arises when your business holds monetary items that are denominated in a foreign currency. The value of those monetary assets and liabilities will be exposed to movements in the AUD against the foreign currency. The simplest example would be an Australian business holding cash in USD. If the AUD strengthens against the USD then on translation your business will receive less AUD.

Transactional exposure arises when your business has expenditure and or revenues denominated in a foreign currency. This can present a problem for businesses who import goods or services denominated in a foreign currency. For instance a business relying on imported goods or services will experience higher costs in a lower AUD environment as the cost to import will increase. If the additional cost cannot be passed onto customers then it must be absorbed by the business which will invariably reduce profitability and impact cash flow.

If we look at historical trends the AUD has generally tracked movements in commodity prices and interest rates, however this appears to have broken down somewhat in the past year. In fact in recent times we have seen that the AUD is not doing what it’s “supposed to do”. Unfortunately no one has a crystal ball to predict how the AUD will behave and therefore businesses are challenged by the uncertainty of currency markets.

To help reduce this uncertainty business owners should consider how their business may be impacted by movements in the Aussie dollar under different scenarios. Sensitivity analysis is one technique that can be used to help assess the impact that movements in currency will have on the profitability and the overall financial position of the business. Business owners can then consider their tolerance to movement in currency and if necessary implement a strategy to manage the currency exposure. A number of global and Australian banks offer foreign exchange products and specialists that can assist you to identify the right product to suit your currency risk management strategy.

The unpredictable nature of currency markets means that currency exposure will continue to be a risk faced by Australian businesses engaging on the global stage. Understanding how currency risk will impact your business and your tolerance to such risk allows you to make informed decisions on how you will manage currency risk. Even without a crystal ball. 

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