Hedging with Helen: Balance Sheet Performance Reporting

Welcome back to Hedging with Helen. Today we’re going to talk about currency balance sheet hedging, and, specifically, we’re going to talk about the performance reporting around balance sheet hedging.

Management, unfortunately, lives in a world where they believe that the FX gain or loss line should be zero when we’re hedging. And there are a number of reasons that the answer isn’t zero. So let’s talk about them. All of them, good news, can be calculated, quantified and provided in a report.

Why Your FX Gain or Loss Line Isn’t Zero

The first reason that, you know, the number isn’t going to be zero is, generally, we’re not hedging all of the currencies that we’ve got. We’ve decided some exposures where we have thought too small. There may be currencies that we find too expensive to hedge. There may be entities that we’re not including in our program. So, capture the amount of unhedged currencies.

Forward points. Forward contracts come with forward points. So there’s a gain or loss, money coming to you or going against you, depending on the currency in your direction.

And then we have whether you’re over or under hedged. It’s not a perfect world. We’re not perfect forecasters. In fact, in Treasury, how are we doing all this forecasting? Anyway, we’re over-under hedged at the end of the period.

And then there’s the conversion activity that’s happening at subsidiaries, you know, in other organizations, activity that is actually impacting our FX gain or loss line.

Those are the big ones that really should be controlled by Treasury. But then we have like the other big piece of the puzzle, which is the accounting discrepancies that arise because of how people are using currency in their ERP systems.

For Example: Accruals

And I just want to give you a real quick example: accruals. If you make an accrual at the end of the month, a large marketing accrual, and at the end of the month, you go ahead and you note that you’ve got this accrual, it’s in a foreign currency. If you use prior month balance sheet rate for your income statement, it’s going to go back to the beginning and revalue to the end of the month. And if you’re using daily rates, you’re going to book it in. It’s only going to revalue for one day. Well, what’s going to happen is now Treasury is going to come in and capture what all our balances are, what are all of our exposures are and hedge them. Well, what’s happening with that accrual?

Well, day one of the next month, it’s being reversed. If it was booked at the prior month balance sheet rate, it’s being reversed at the prior month balance sheet rate. So we just booked in FX and now it disappeared off of our books. Last month’s FX just evaporated. And if we use the daily rate, well, guess what? We’re we captured that balance. We’re hedging it. It’s not going to exist at the end of the month.

There’s a number of accounting related issues how the accounting is managed in your system, that is part of the problem. So, a lot of times when the FX gain or loss line is not zero, people go looking at the derivatives. I’m going to suggest you go looking at the underlying exposures and the transactions that are driving FX.

It Makes Me Crazy…

Okay, what makes me crazy?

In balance sheet performance reporting, so frequently I go in and I look and we have that three line chart. We have the exposure gain or loss. We have the derivative gain or loss. And then we have the net effect. We don’t need what the hedge does. The only person who cares, are you in Treasury? Management doesn’t care about the hedge gain or loss. Take hedge gains and losses out of the picture. What you want to do is the exposure before hedging and hopefully after hedging.

That’s my hint for today.