How do you evaluate the impact of currency fluctuations on your project budget and cash flow?

While major currencies like USD, EUR, or JPY often dominate the discussion, minor currencies can significantly affect the cost structure, especially if local suppliers or contractors are part of the project. For example, a minor currency's devaluation could suddenly make local materials cheaper or, conversely, imported materials prohibitively expensive. Evaluating the influence of minor currencies in the overall financial health of a project can be as crucial as monitoring major ones, especially for projects with a broad geographical footprint.

Evaluating currency fluctuations requires monitoring exchange rates, using financial instruments like hedging, and adjusting budgets accordingly. For instance, a US-based manager with a project in India should closely watch USD/INR trends, consider forward contracts to mitigate risks, and ensure flexibility in the budget to accommodate rate changes.

In hedging, the currencies involved depend on the specific context and the risks being mitigated. Here are a few common scenarios where currencies are typically involved in hedging: Foreign Exchange (FX) Hedging Commodity Price Hedging Interest Rate Hedging Cross-Currency Hedging It's important to note that the choice of currencies for hedging will vary depending on the specific circumstances and the objectives of the hedging strategy. Different currencies may be used to achieve the desired risk management outcomes in different situations.

Determine the currency in which you will budget the project. This is usually the currency in which your shareholders think. The company's financial statements are typically prepared and audited in this currency as well. This is the currency in which you need to earn money, meaning having cash flow for the shareholders.

In estimating currency exposure, one employs various strategies to assess the potential impact of currency fluctuations on project budgets and cash flows. Firstly, the individual identifies all currencies involved in project transactions. Then, they analyze historical exchange rate trends to gauge potential risks. Utilizing financial instruments such as forward contracts or options can help mitigate these risks. Additionally, maintaining clear communication with stakeholders and regularly reviewing and updating currency risk management strategies are vital for effective risk mitigation.

Understand the relationship between the project's timing and market trends. During periods of geopolitical instability, currency values can fluctuate more wildly and projects with long timelines may see different phases of currency strength and weakness. Assessing not just the snapshot of current exchange rates but also the historical volatility patterns can provide deeper insights into potential financial impacts over the project's lifecycle.

After assessing the impact of exchange rate fluctuations, you need to evaluate the materiality of this impact. You need to assess the significance of the risk that your project carries. Agree that a reduction in ROI from 25% to 20% is one thing, but a change from profit to loss is quite another. The higher the materiality, the more effort, including additional expenses, is required to hedge the risk. The scale of hedging is also important; hedging $200,000 or $100 million are different. The capacity of hedging markets is not infinite. Finally, it is important to consider the time frame over which you need to hedge. A 6-month horizon is very different from a 5-year horizon. External hedging instruments may not offer the duration you need.

Evaluating the impact of currency fluctuations involves regular monitoring of exchange rates, assessing their effect on project costs and revenues, and forecasting potential future shifts. Implementing hedging strategies like forward contracts or diversifying income sources helps mitigate risks, ensuring stable cash flow and budget management.

One aspect often missed when considering currency fluctuations is the opportunity for strategic investment. If a currency is weak, it might be an opportune time to invest in assets in that currency zone, which could be resources, property, or even entire businesses. Conversely, a strong home currency could make foreign investments less attractive

To implement hedging strategy is important to determine the time frame over which you need to manage currency risk in international trade. My practice has taught me that it is necessary to identify two different time horizons for nternational projects. each with its own possibilities and instruments. The first time horizontal is distance over which you can predict your revenue and where there are currency hedging instruments. The second horizon is beyond the available forward contracts. This is a scenario where only increasing the share of expenses incurred in the currency of the local country is possible. For example, organizing local production from your ingredients.