FX volatility calls for stronger cash management strategies to reduce impact on earnings

Currency risk management needs to be a priority for CFOs this year amid growing foreign exchange (FX) volatility, latest research from Kyriba concludes.

Currency volatility continues to be a major challenge for multinational corporations, with the impact of FX exposures leading to significant swings in earnings.

Insights from Kyriba’s Currency Impact Report CIR shows the impact of currency volatility on North American and European corporations at the end of last year.

In the third quarter of 2022, the collective quantified negative impact reported by both North American and European companies totalled $47.18 billion, a 26.6% increase from the previous quarter.

“These trends highlight the ongoing challenges faced by multinational corporations in managing currency risk and underscores the need for effective currency risk management strategies”, says Bob Stark, global head of market strategy at Kyriba.

The report also found that 24% of the 1,200 multinational companies quantified positive or negative currency impacts totalling $64.22 billion. Of this amount, $47.18 billion were currency headwinds, and $17.04 billion were tailwinds.

Stark says this highlights a growing awareness of the importance of monitoring and managing currency risk, as more companies become aware of the potential impact on their earnings.

One business which appears to have got the balance right is Procter & Gamble, a multinational consumer goods company that operates in over 180 countries. Given its global footprint, P&G is exposed to fluctuations across exchange rates. To manage this risk, it uses a comprehensive currency hedging strategy that involves both natural and financial hedging techniques.

It also has a dedicated currency risk management team that continuously monitors and assesses their exposure to currency risk. Additionally, P&G uses a centralised treasury system that allows them to efficiently manage their currency exposures across their global operations.

Currencies in focus

According to the report, the Euro was the currency most frequently mentioned as impactful by North American and European companies, which Stark says is not surprising given its importance as a global currency.

“The Euro’s value dropped by almost 20% over the year, which had a significant impact on revenue, guidance, earnings, and cash flows. We saw this trend unfold throughout the year, and it garnered multiple warnings,” Stark says.

However, the Argentine peso was the most volatile currency, indicating that even less frequently traded currencies can have a significant impact on corporate earnings.

Discussing the trends observed, Stark also notes Kyriba’s analysis revealed that the strength of the US dollar had a major impact on other currencies and their cash flows and revenues, making them relatively weaker.

“For example, when Euro-based cash flows were converted to US dollars, they were worth less. This caused American organisations to report a decrease in revenue by 2-3% almost every quarter,” he says.

He emphasised that senior finance professionals must understand these trends and their implications for their organisations, and that currency risk management must be a top priority for CFOs and finance teams.

Strong currency management strategies

When CFOs understand the impact of currency on their financial statements, balance sheets, revenue, and expenses, they can create forecasts for cash and liquidity.

“When you create those forecasts with a level of precision that allows your financial team to then decide on how you are going to protect that and whether that’s hedging with derivatives or whether it’s natural hedging by creating a transformation of your operations,” Stark explains.

“To be able to have a better alignment of the incoming and outgoing flows in the same currency, whatever that action is going to be, the data is going to drive those decisions precision in data will drive a much more effective decision to protect the value of the organisation.”

For CFO’s whose primary goal is to reduce earnings volatility, they may choose to focus on hedging near-term exposures that could have an immediate impact on earnings. Alternatively, if the goal is to maximise returns, CFO’s may choose to take a more opportunistic approach to currency risk management, using hedging techniques only when the potential benefits outweigh the costs.

Coca-Cola uses a combination of forward contracts, options, and natural hedging techniques. This allows the company to hedge its exposures while also taking advantage of favourable exchange rate movements[1]. Toyota uses a similar strategy but also engages in natural hedging by sourcing some of its components locally in the countries where it operates.

[1] David, F . (2019) Strategic Management: A Competitive Advantage Approach, Concepts and Cases, 17^th Editon. Harlow, England: Pearson Education Ltd.

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