Foreign Exchange Management in Perfect Pieces Limited
Ltd is exposed to foreign exchange risk because it buys some of its production inputs from overseas and pays for them in foreign currency; has sales revenue in foreign currency and competes with other manufacturers whose costs are denominated in foreign currency. The company imports from New Zealand, Japan, and the United States. The company’s foreign currency payable are in the US Lars, NZ dollars, and Japanese yen. On the other hand, the sales are mostly conducted in US dollars.
Proceedings of the International Academy for Case Studies, Volume 10, Number 2 Lass Vegas, 2003 page 74 UP Lad’s exposure environment consisted predominantly of the US dollars, the NZ dollar, and the Japanese yen. The foreign currency denominated sales were about 52 percent of total sales: 40 percent in US dollars, and 12 percent in New Zealand dollars. The company’s estimate of US dollar denominated payable was 36 percent of total sales: 19 percent in US dollars, 12 percent in Japanese yen, and 5 percent in New Zealand dollars.
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In general UP Ltd gives customers an average credit period of between 3 to 6 months while the average credit period for all foreign currency denominated payable was 3 months. There was therefore a working capital gap as the collection of accounts receivable was longer than accounts payable. This situation was made worse by the fact that 40 per cent of the sales were denominated in US dollars and the US dollar was weakening against the Australian dollar. There was no cover taken out for the exposure in US dollars because the financial accountant who acted as the company’s exposure manager thought the US dollar would shortly strengthen.
Previously the US dollar was stronger than the Australian dollar and the company had gained from the US dollar denominated receivables. This experience had apparently, surprisingly, made the company’s exposure manager consider it inappropriate to hedge the US dollar. The responsibility for identifying FEMME was in the hands of a financial accountant, with the assistance of the general manager. They hedged 50 per cent of the transactions for accounts payable in Japanese yen, and accounts receivable in New Zealand dollars. The financial accountant, in consultation with the general manager, bought forward contracts to cover the exposures.
Most senior members of the company were concerned with manufacturing, promoting and marketing products rather than foreign exchange exposure management. It was increasingly becoming difficult for the general manager to meet the financial accountant in order to manage FEE because the general manager had to deal with other company duties. Previously, the general manager and the financial accountant met at least once a day to assess foreign exchange market movements. The increasing inability to meet the general manager as frequently as before was making the financial accountant concerned.
The financial accountant was anxious that he should be left alone to make decisions in matters as volatile as the foreign exchange movements. The financial accountant felt that it was important to specify Job descriptions in order to attach responsibility for the monitoring and compilation of foreign exchange information. Presumably, he hoped, that would lead to increasing resources in his section. He explained: The two clerks in my section are responsible for helping me in ash management, pension management, as well as compiling foreign exchange exposure management forecasts. The finance section is very understaffed.
The engineering and marketing functions were considered more important than financial management. The finance section was not only understaffed, but it also lacked properly qualified and experienced personnel. The general manager thought that taking personal interest in treasury matters would mitigate the sense of alienation that was perceived by the financial accountant. The lack of understanding about the importance of FEMME among most of the company officers was discernible urine the interview. Most senior managers considered the primary tasks in the company to be the operational activities, namely; manufacturing, procurement, and selling.
Lass Vegas, 2003 page 75 In terms of the organizational structure for exposure management, members of the company felt that centralization should be pursued subject to other considerations. One senior member of the company said: The task of identifying and managing foreign exchange exposure is too onerous to be left in the hands of only one functional unit The financial accountant was a relatively Junior officer in the company and had robbers in trying to obtain information he needed to manage exposure.
Since FEE is a result of activities that transcend one functional unit, and can be constrained by lack of resources such as trained and experienced staff, and lack of appropriate equipment, this seemed to call for a company-wide policy from the top. The dialogue with most members of the company confirmed that there was no company-wide policy for FEMME. The next point was to consider the extent of risk aversion. Most members of the company were keen that currency risk should be avoided as much as possible.
Some of the members wondered why the company should not invoice customers in Australian dollars rather than foreign currencies. As to the general attitude to foreign exchange risk, some members said that they generally preferred average expected return with average risk to high return with high risk for any business involving foreign currency denominated receivables and/or payable. But if the company was considering projects which involved no foreign currency receivables or payable, then high expected return and high risk projects could be considered.
One of the senior officers, however, pointed out that foreign exchange considerations are but one factor. He was supported by another senior officer who said that sometimes the company may have other overriding strategic considerations to take into account, such as obtaining a share of the market even if that means at the expense of incurring foreign exchange loss. The company’s foreign exchange rate forecasts were mainly obtained from banks and publications such as the Financial Review newspaper. The information on foreign exchange rates was prepared manually.
The lack of computerizing was considered hindrance to better monitoring of exposure management. The influence of the satisfaction with previous foreign exchange forecasts on hedging could only be commented on by the financial accountant and the general manager who carried out hedging of FEE. They both said that satisfaction with previous foreign exchange forecasts had minimum influence on the way they hedged. They were not confident with the forecasts they used. As they said: Foreign exchange forecasts are Just forecasts, they are never the same as the actual exchange rates so we are usually less confident about them.
The extent of hedging is a situational matter. UP Ltd was involved in foreign exchange transactions at least once a fortnight. It was evident that the intensity of involvement in foreign exchange transactions did not have any influence on the hedging behavior. In spite of the fact that the US dollar denominated receivables were left exposed, Proceedings of the International Academy for Case Studies, Volume 10, Number 2 page 76 most members felt that the extent of involvement in foreign currency denominated business should be accompanied by more hedging activity.