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Foreign Exchange Rate Fluctuations - A Risk Or An Opportunity?
The Risk Echo
Foreign Exchange Rate Fluctuations - A Risk Or An Opportunity?
Anybody who is involved in international business or who makes payments or receives foreign currency or trades in foreign currency, is exposed to foreign exchange (FX) fluctuations.
Foreign exchange fluctuations can result in huge FX losses or gains, depending on the side of the transaction and amount involved.
Foreign exchange risk arises from fluctuations of the exchange rates from time to time, between the domestic currency and the foreign currency. These fluctuations (up/ down movements), lead to either foreign exchange gains/losses. The gains arise from a favourable movement; e.g if a Ugandan exporter sold goods worth USD100,000 on credit at a time when the exchange was USD/UGX 3,500. If by the time of receipt of the money the exchange rate is 3,600, he will make a foreign exchange gain of UGX 100 (3,600-3,500), which translates into UGX 10,000,000 (100X100,000). The same amount would be a loss if the trader above was an importer, because he will have to pay an additional UGX 100 for every dollar paid.
According to IAS 21- The Effects of Changes in Foreign Exchange Rates, exchange rate differences (gains/losses) arising from when monetary items are settled or when monetary items are translated at rates different from those at which they were translated when initially recognized or in the previous financial statement, are reported in the profit or loss in the period, with one exception that, exchange differences arising on monetary items that form part of the reporting entity’s net investment in a foreign operation are recognized, in the consolidated financial statements that include the foreign operation, in other comprehensive income; they are recognized in profits or loss on disposal of the net investment .
It is important to note that FX risk manifests in a number of ways as described below:
Types of foreign exchange risk i) Transaction FX risk
Foreign exchange transaction risk arises when one sells or buys good or services to or from a buyer or seller in another country (Outside a monetary union). The example given above reflects a foreign exchange transaction risk.
ii) Translation FX risk
A translation risk is the likelihood that a subsidiary will convert its revenues and profits to the parent company’s currency at a lower rate.
iii) Economic FX risk
Economic risk refers to the likely impact on a company’s market value due to currency fluctuations and shifts in other economic variables
Impact of exchange rate fluctuations on receipts and payments
Generally, payments and receipts are directly correlated with the exchange rate. Meaning that when the exchange rate increases, the expected payment obligation (liability) or receipts increases, and vice-versa.
Edward Senyonjo MBA, FCCA, CPA, BCOM
Head Of Risk, National Social Security Fund
ISSUE FOUR|JAN 22
Foreign Exchange Rate Fluctuations - A Risk Or An Opportunity?
