Building an FX Budget Rate
Corpay Cross-Border Solutions
Powering cross-border payments and currency risk management, seamlessly
The Intersection of FP&A and Hedging Series
Financial planning for businesses operating cross-border can be challenging. Foreign exchange rates move almost constantly, and their movements can have a material impact on a business’s financial performance.
Setting a budget rate for each currency pair is a starting point for financial planning. The budget rate can serve as a benchmark for assessing performance against plan, isolating variances due to FX movements from other factors.
From there, a business can begin to develop strategies to help mitigate negative impact from FX movement.
Businesses use a number of ways to set the budget rate, including weighted averages of past hedges, the current spot or forward rate, or relying on bank forecasts as the most available.
Each of these methods has validity in planning; understanding the pros and cons of each, and determining what might best suit your business, is key to mitigating risk.
Corpay has tools and resources to help support your planning. To learn more, please read on or contact me for a chat.
A well-known saying is that ‘What doesn’t get measured doesn’t get managed.’ But how do you measure foreign exchange rates (FX), which fluctuate around the clock six days a week?
This is a key question for businesses operating across borders. The reality is FX rates and their movements can have a material impact on financial performance and long-run sustainability. Like all things financial, getting a handle on those impacts often starts with setting a budget.
Setting budgeted rates for a business’s FX exposures is often the first step businesses take.
Why might you want to build an FX budget rate
Analyzing & measuring performance relative to plan. This tends to be key for FP&A and assessing business performance drivers, as operational performance can be clouded by rate movements. Setting budget rates can help you isolate variances in performance due to rate movements and other factors within the business.
Assessing FX risk and developing a plan to mitigate it. FX variations in and of themselves can have substantial impact on profitability and operating performance. Using the budgeted rate as a performance benchmark can help finance professionals to assess the impact of FX movements, and ultimately help with developing strategies to mitigate any negative impacts.
How to determine a budget rate
There are multiple ways for businesses determine a budget rate for FP&A purposes. It is key to focus on a way that is realistic and achievable.
Calculating a budget rate: examples
Weighted-averages of previous hedges. Achievable and realistic, this can be a good starting point for businesses with an active hedging program.
Current spot rate. Many businesses with no history of FX hedging use the current spot rate as a starting point, but this can be a misleading metric depending on the currency pair(s), and the nature and time horizons of the exposure. This approach also doesn’t factor in the pricing of goods and services and the business’s target profit margin.
Forward rates. Often more realistic than the current spot rate, forward rates have the added benefit of embedding the cost and timing of hedging in the price.
Bank forecasts. A commonly used approach – but arguably problematic:
Often not achievable: you can’t execute an FX-spot or hedge transaction at that rate.
Incorrectly implies that a bank (or a business) can predict the future. The reality is these projections are wrong about 65% of the time or more.
Implied volatility derived expected range. Backed into from existing deliverable forwards pricing for the specific currency pair, this method is realistic and achievable, though sometimes too complex to be useable. This can provide an excellent framework for sensitivity analysis and assessing the materiality of FX movements to the business.
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How to set an FX budget rate
Often businesses without access to a treasury management system (TMS) or data feeds like Bloomberg have difficulty accessing the above data. This may lead them to rely either on spot rates plus a cushion, or more easily accessible bank forecasts.
What might work for your business?
Corpay has a free-to-use budget rate calculation tool that allows you to access a wide range of key data points. This can help you achieve a better-informed decision.
We have other self-service resources that might add perspective and insight to your financial planning.
Probability index: Corpay Currency Research
Corpay’s Currency Research site includes up-to-date newsfeeds and proprietary analysis. Our team have developed a Probability Analysis, based on a standard deviation bell curve. It uses realized historical volatility to illustrate the likelihood of a currency pair trading band within a specified period.
An example is below.
Please contact me to set up an informational chat or meeting at your convenience. I’d like to learn about you and your business, and explore ways our FX solutions and capabilities might support your business.
Please note: Opinions expressed in this article are those of the author. Please contact an independent advisor to ensure that solutions discussed here are right for your business.
Want to read more? Visit our blog.
Additional resources
Watch our recent webinar, Establishing an FX Budget Rate: Preparing for 2024
Author
Director, Strategic Sales, & Market Strategist
Sean works with mid-market corporates, focusing on FX risk management and international working capital optimization. He blends experience in finance and capital markets with a robust understanding of business performance and capital markets knowledge.
Contact Sean: [email protected]