The multi-currency marketplace: is your company up to it?

The multi-currency marketplace: is your company up to it?

American companies have learned a tough lesson in recent years: competing effectively in a global marketplace requires playing by a different set of rules than those governing purely domestic purchasing and sales. The increasing sophistication of all the major trading countries' banking systems has meant that international credit and settlement facilities are now within the reach of even the smallest organization. Ten years ago, such international trading was the sole province of the major multinationals and specialist import/export houses. However, the new cutthroat economic climate has mandated that nearly all American companies look beyond our shores for new markets and sources of materials.

Given this inherent internationalization of business, American firms must understand and adjust for forces that increase their exposure--and also create new opportunities--in the worldwide marketplace. One critical force all too often overlooked by American firms is the multi-currency environment of international trade. The need to buy and sell in a variety of currencies other than dollars presents two critical points of exposure for American companies large and small: currency value and financial reporting and accounting.

Currency-exposure safeguards

Changes in exchange rates can have a material effect upon profitability, especially when a company extends or accepts credit. A simple example illustrates the problem of losses due to exchange rate movements.

An American company sells goods worth $1,000 to a British company and offers 30 days of credit. At the time of the sale, the value of the goods is 543.48 based on an exchange rate of 1.84 to the pound. After 30 days, the payment of 543.48 is made, but, when converted to dollars, the American company receives only $989.26. The discrepancy between the selling price and the amount received reflects the change in the exchange rate of $1.84 to $1.82 during the intervening month, causing an $11 loss.

Such a situation is called a realized loss because, now that the transaction is over, it can be quantified. The same consideration also applies to a realized profit when it occurs. In either case, factors such as the length of time before payment and the volatility of the currency involved can have a negative effect on the firm's financial statements.

The company can employ a variety of tactics of safeguard against shifts in currency value. These techniques include:

Trade only in the domestic currency. This is the preferred option of most American companies, but we do not always have the economic muscle to demand all-dollar transactions and, with the value of the dollar falling against many currencies, all-dollar exchanges are not always desirable.

Deposit known amounts of foreign currency for payment of debts at fixed dates in the future. This is a form of hedge; however, it implies that a company has the expertise to create foreign currency reserves in lieu of investing these funds in more profitable instruments, servicing debt, or maintaining a healthy cash flow.

Match revenue and costs that arise from the trading of goods and services in any particular foreign currency. Logically, the company wants to insure that the payment after the credit period is adjusted to remain equal to the original value at the time of sale. In practical terms, however, in a highly competitive situation the shifting of the burden to the other party may jeopardize the ability to make the purchase or sale.

Trade in a host of currencies to spread the risk of an adverse currency movement in one currency against the gains in others. This option is often the safest bet because, in the long run, the issue of currency fluctuation is functionally neutralized without having an impact upon any given purchase or sale. However, playing the currency market is itself a fine art mastered by few companies and, to cover the bases effectively, a company must be engaged in a high degree of foreign trade around the world. Not many American companies have this level of international trade or can make the internal investment in currency manipulation expertise.

Purchase foreign currency protection through foreign currency, or FX, contracts. This is the most common form of hedge. An FX contract is an

agreement to sell or buy an amount of foreign currency from a bank at a fixed rate on a specific date in the future. This protects the company from any adverse movements in the relative value of the currency.

The real costs of the FX contract vary with the size of the contract itself and are measured by the "spread," which is the difference between the present (or spot) exchange rates and the future exchange rates with respect to the two currencies' respective interest rates.

The FX contract has the virtue of rationalizing the process, for the cost of protection against currency fluctuations is fixed and predictable. However, these costs must be passed on and accounted for either through pricing or the overall profitability of the company.

Regardless of what tactic a company chooses to cope with the roller coaster of changing currency values, the financial manager must still integrate multi-currency accounting into his overall accounting system.

What about financial reporting

and accounting?

To integrate multi-currency accounting into an established computerized accounting system, a firm needs computer software that is both specialized for addressing multi-currency issues and flexible for easy integration.

When implementing a worldwide accounting standard, the financial manager will need to consider the three problem areas that are listed below:

Determining supplemental accounting features required for multi-currency interactions--Any multinational software vendor can supply checklists to assist in this straight-forward process.

Addressing local needs with accounting software that defines and works in the functional currency, keeps records in compliance with the local tax code and requirements, and provides a systematic reporting structure for local management and statutory bodies--The software must be sufficiently flexible to cope with local needs and to encourage local cooperation with the home office. To do so, the software should have specific capabilities.

It should be able to establish a functional currency for record-keeping. This functional currency would be either the local currency or U.S. dollars, whichever is more appropriate to meet local management needs. It also must be able to define the structure of the chart of accounts, create an analysis hierarchy for management reporting, and develop report formats for compliance with the requirements set forth by tax and statutory bodies.

Consolidating and translating foreign subsidiary results into a comprehensive group report--FASB Statement 52 defines the requirements for U.S. multinational corporations to translate and consolidate their foreign currency financial statements. Since different methodologies can be used--although the temporal and current-rate methods are the most popular--it is essential that the software can accomodate FASB statement compliance in all its forms.

A number of functions are needed in the structure of the software in order to meet Statement 52 compliance regulations: translation tables for currency rates, selective revaluation capabilities, multilevel consolidation hierarchies, procedures for elimination and adjustment entries, and flexible report writers accomodating differing charts of accounts.

The spin-off benefits of the functions listed above include the ability to track group as well as local exposure in currencies and to assist in reporting gains and losses by currency. Both of these benefits allow more efficient currency risk management with consequent positive effects on the bottom line.

Strategic planning and standardization 

Clearly, multi-currency software is critical at the functional, day-to-day level of financial accounting and reporting. But, for the CFO, the real virtue of multi-currency software is as a decision-making tool to plot short- and long-term strategy, monitor ongoing profitability, and adjust to changes in the international marketplace.

The key to getting maximum strategic use from multi-currency software is systemwide integration and standardization. Most American companies competing in an international marketplace face a difficult problem: how to reconcile and interconnect the various financial computer hardware platforms and software applications in the environments in which they are working throughout the world.

The three solutions that are used most often are:

Mandate a purely American software package for use by all international divisions. This answers the home office reporting needs, but can cause tremendous problems for the international offices for whom the software may not be applicable for local accounting and reporting requirements. Nor does this ensure that the software can be used on the differing operating systems in place around the world.

Assume a laissez-faire approach. Letting each office solve its multi-currency accounting problems in its own way may solve short-term local needs, but it is an expensive and inefficient answer. Generally, what results is that the local office produces its reports in a standard spreadsheet form, e.g., using Lotus 1-2-3, and the data must be re-keyed at the home office. Not only is this costly, but the process is very slow, inhibiting the senior manager's ability to know his exact position at any moment in time by delaying closing times and consequently delaying group consolidated reporting.

Choose a company-wide standard. This option is the most practical, for the right company-wide standard financial software accomodating local and home office multi-currency needs has a number of virtues.

It satisfies local and home office needs, because all parties have the software they require to account, monitor, and report, without sacrificing features for the "good" of other parts of the company. In fact, the software should be easy to customize to adapt to particular needs.

It also completely integrates vertical reporting. Local data is integrated directly into home office data without reentering the information, thus saving valuable time and money.

And it provides for systemwide use and compatibility. The same software is used on each hardware platform/operating system employed by the company (e.g., DOS, VMS, Unix, AS/400) or within a given type of hardware (e.g., all DEC machines). Moreover, the software has the same look, feel, and responsiveness, regardless of the system upon which the software is running.

In a nutshell 

American companies must adapt to a multi-currency environment in order to compete successfully in the international marketplace. Miscalculations on currency exposure can cost millions in the buying and selling of goods and services.

Further, once a mechanism is established for coping with currency fluctuations, the American firm must still integrate multi-currency accounting, reporting, and monitoring into its overall financial management program.

Ideally, a firm should have a software application that is flexible enough to meet both local and central accounting needs--without compromise or sacrifice. This allows the direct transfer of data vertically throughout the organization, without reprocessing information from spreadsheets, and runs on all the company's hardware in the same manner. It should also have a clean and direct interface with other financial and DBMS packages used by the firm.

Systemwide multi-currency integration is especially critical for the CFO, who must set overall corporate policy, plan long- and short-term strategies, and react swiftly and surely to changing market conditions. To achieve this level of integration, the company should adopt a single accounting software standard which includes currency management as an integral part of its design. In this way, currency risks can be minimized and benefits to the bottom line maximized.