Budget Rate Setting for Next Year
Today, I’d like to talk to you about the use of a budget rate and how to set the budget rate.
What we see is a lot of our folks calling and asking questions [like] what would be the most appropriate budget rate for them to be using as its budget season right now? And it really depends on what’s going on with your hedge program.
So I would say, first of all, if you don’t have a hedge program, I would suggest you actually figure out what rates you could use to hedge your exposures and provide that rate because that is the rate that you could protect and you could deliver if you had a hedge program.
Is that rate the rate that you’re actually going to experience rates at next year? The answer is no. Is the rate that the banks are providing as their best forecast of the rates that you’re going to experience, the rates next year? No. They’re not any better at guessing rates than you are; otherwise, they wouldn’t be working.
So when we go to do rates, how sophisticated do we need to really be? And I think that the budget rate setting is really just kind of putting a stake in the ground from which we’re going to measure, you know, have we delivered? So the best place to measure without a hedge program is from a rate that you could hedge.
If, on the other hand, you’re hedged, and you’ve hedged the coming year, and if you’re hedged at 90% for the coming year, you should definitely be using the hedge rates that you have.
But let’s say you’re 50% hedged for the year. Well, what you should be doing is contemplating the hedges that you have for the notional amount that is hedged and take that against the budget and then the rest of the budget—the pieces that aren’t hedged, that you’re not using the hedge rates. What we should definitely use for that is the rates that we could lock in now to hedge for that period.
Again, that gives us, you know, had we been fully hedged, what the rate could have been because we’re partially hedged. Those numbers are baked in. Hopefully, they’re baked into the appropriate period. If you’re a company that has most of your hedges associated with the first quarter and almost nothing in the fourth quarter, then hopefully you have a budget rate that’s applicable to the first quarter. And we’re not trying to use all the locked in hedges for Q1 to inform the rate that we’re using for Q4.
So use the hedges that you’ve got and, if you don’t have hedges, use the hedges that you could have to lock in the rates.
It Makes Me Crazy…
What makes me crazy is when companies have hedges and those hedges are not used or factored into the results that FP&A is delivering to management on where we’re going to land.
If you have a hedge program and it is totally independent of everything that FP&A is doing, then you probably don’t have a very effective hedge program. It’s not informing management, it’s not contributing at all. Hopefully, at least you’re protecting margins, and if you’re not protecting margins, you’re just building your resume.
I think it is critical that your hedge program be deeply entwined with FP&A.
The numbers, the values that they’re delivering to management about where we’re going to be coming in for this quarter, next quarter, the coming year. And if you don’t, then you need to revisit whether you’re hedge program is delivering any value to your corporation.