Currency risk

What it means

Currency risk is the risk that a change in exchange rates reduces the value of income and receivables in a foreign currency or increases the value of costs and liabilities. It affects any company buying or selling outside the euro area, for example in Czech crowns, forints, zlotys, dollars or pounds.

The risk takes several forms. Transaction risk arises between issuing an invoice and its payment, while the rate can move. Economic risk affects competitiveness over the long term, for instance when a competitor’s currency weakens. Translation risk shows in the books when balances are retranslated at the balance sheet date.

In the books, exchange rate movements appear as FX differences. Realised ones arise on payment, unrealised ones when receivables and payables are retranslated at year end at the ECB reference rate. Both affect profit and the tax base.

How it works in practice

The simplest approach is a natural hedge: if the company both buys and sells in a currency, income covers costs. A foreign currency account lets it hold money in that currency and pay from it without converting back and forth.

For larger sums, hedging is used, most often a currency forward that fixes the rate for a future payment in advance. It costs a fee or a less favourable rate, but the company knows how many euro it can count on. The risk can also be shifted contractually by invoicing in euro.

In reporting we recommend showing FX differences separately so that management sees what is the trading result and what is currency movement. In planning and budgeting we factor in sensitivity to the exchange rate so the company knows how large a swing it can absorb.

What to watch out for

A common mistake is ignoring the risk on long contracts. A quote in a foreign currency valid for months can lose its whole margin if the rate moves a few per cent. On longer contracts the rate should be fixed or the price indexed.

The second risk is speculation instead of hedging. Financial instruments unconnected to real trading flows can cost the company more than the losses they were meant to prevent. A hedge should match actual income and costs.