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Plan and Protect your budget for next year

Plan and Protect your budget for next year

Market challenges are part of the daily routine for businesses today. For many corporations, growth usually means expanding overseas by targeting foreign markets, or moving manufacturers, or using foreign suppliers. This usually brings a wealth of brand new challenges for corporate financial teams. Relationships with banks need to be established, foreign payrolls and tax facilities need to be set up, and much more.

There is an increasing trend of companies with exposure to foreign markets and currencies lacking the knowledge of how best to deal with currency risk. The difference between growing your business and going under can often depend on the amount of forward planning involved. Similarly, we understand that the management of incomings and outgoings is particularly complex in multicurrency environments. It is important to understand the market challenges coming up in 2018, identify your risks in order to put a plan in place to help protect your profits from currency fluctuation. Currency Risk should be addressed by structured policy and not managed by occasional, market driven decisions.

One of the biggest new challenges faced by corporations that expand internationally is multi-currency budgeting and planning. So, if the market is full of surprises, how do you plan ahead?

Where to start

While forecasting future inflows and outflows, it’s very important to try to address the currencies that you are expected to be dealing in significantly – of course, it can be a challenge to predict where your orders and customers will come from, but it is necessary in order to protect your budget in the long term.

The Treasury Management Systems today provide a tool to build multi-currency budgets, but not analytics. The most important decisions are left to financial directors, and one of the biggest is: which rates should I use to build the budget?

We often receive questions asking for our projections on the rates. The answer we give every time is ‘We can give you an idea of what the future holds, but the foreign exchange market is particularly myopic, so that picture could change in a very short space of time.’

So which rate do you go with? There are four most common methods of budgeting and protecting one’s company from currency risk and discuss their efficacy; historical data, forecasting, company internal rates, and market rate at the time of budgeting.

Historic data

Arguably the most popular method is to look back at historical data – last year’s average, last quarter’s average, last month’s average etc. One issue with this practice is the huge differences between averages due to volatility. This high volatility means that just looking at averages isn’t particularly accurate or informative due the amount of fluctuation exchange rates experience.

Let’s take a look at some data to elucidate this point:


1 month

3 month

6 month










1 month

3 month

6 month









The tables show the rates against GBP. On the EUR table you can see some significant disparity between the 1 month average and the 2017 average (1.09 vs 1.15), which is a difference of over 5%. Further, neither are particularly close to the spot rate.

The USD has seen less volatility according to the table, but again, the averages are still noticeably different to the spot rate. So we can see that looking back at historical data isn’t particularly useful for budgeting your next financial year.


Another popular method is looking to forecasts. There is no shortage of forecasts provided to us all the time by banks and financial institutions. The problem is that, by definition, forecasts are predictions; no one really knows, and no one really can know Philosophers refer to this generally as the ‘problem of induction’, that is, how can events we have no experience of resemble events we have experienced?

Hedgewiz recently conducted a survey analysing the FX predictions made by top banks. The results were far from promising. Leading banks cannot predict FX rates, even in the short term. The average error is 4% for 90 day forecasts, and the majority of institutions showed an error margin of more than 10%. Some were even 23% off!

There are always ‘unexpected’ events, the most recent significant one being Brexit, causing ”updates” in predictions, and by that we mean that forecasts have to be amended because they become almost completely irrelevant.

The referendum itself presented a fairly unique problem in that businesses, quite reasonably, hadn’t prepared risk scenarios for a future outside the EU. The headlines were telling us there was a reasonable chance that nothing would change, but that if it did it could have a massive effect on currency. So, if you didn’t have a hedging plan in advance, the Brexit-related media noise ramped up the worry levels and distracted from the usual business planning parameters. Many were paralysed by indecision, they didn’t plan, and therefore took a position by not acting. The forecasts were: GBPEUR could be anywhere between 1.2000 and 1.4900, and EURUSD pair could be anywhere between 1.2000 and 1.6300.

When the Referendum polls closed and the results filtered through, we saw Sterling fall more than 10% against the Dollar at $1.33, compared with $1.50 just after polling stations closed. This was the lowest GBPUSD rate since 1985. The Pound also fell more than 7% against the Euro. Drops of 7% and 10% in value in 24 hours provide no time to react. The charts looked horrible, the panic set in, and in the following days, Prime Minister David Cameron abdicated, meaning Sterling continued to fall. Let’s not forget that this event chased out more subject experts than ever before and the collective advice was a disaster to follow.

Company internal rates

The next method companies may use is to look to their own internal rates – such as the rates they get for their supply costs, their manufacturing costs, their project pricing, and such things. The common issue with this is that the prices/rates a company gets in each of these different areas may vary significantly and may not be representative of where the market actually is. There is always a cost involved that separates the interbank rate from the actual rate quoted by banks and brokers to their clients, so just looking at this data doesn’t give you the whole picture.

Market rate at planning period

The final method, and, in our opinion, the most accurate and reliable, is looking at the market rate at the time of budgeting. We’ve seen that looking to the past and predicting the future have failed time and time again, so the most accurate source to base your budget on is the actual market rate – emphasis being on the market rate.

Of course, it’s not foolproof, and when budgeting a margin of error and allowances for fluctuations should be considered, but looking at the rate at the time of budgeting is the best method of planning your budget.

Stress test

After choosing the rate, it is important to ‘stress test’ it for fluctuations to understand how significantly volatility can impact your budget.

For the companies that operate using multiple currencies, every currency should be stress tested against their main currency – there is no room for cross-currency assumptions to be made when it comes to your bottom line.

In some cases, however, the exposure may not be captured fully by stress testing. For example, in cases where there is no significant net exposure but there are time gaps between incomings and outgoings.

One thing you can look at is an unpredictable shock event – the big moves that come out of the blue. Back in January 2015, the Swiss National Bank took it upon themselves to unpeg the Swiss Franc from the Euro. Even the European Central Bank (ECB) was taken by surprise as there was no warning at all. The Euro slumped and the Swissy soared 30%. To put this in context, the UK EU Referendum is considered shock event and there was only a 7% move in a day.

Consider another example; in the twelve months leading up to the 2008 Credit Crunch, which is a topic in itself, the US Dollar gained a whopping 44% on the Pound. At that time, the Chinese Renminbi (Yuan) wasn’t terribly accessible, so any UK businesses importing from China would have seen a jump in Dollar rates from 2.0680 to 1.4353. Looking back, the headlines were grabbed by related dramas but the reality is a lot of businesses hit the wall because costs weren’t hedged. Very few can swallow a 44% rise in costs in a year, and worse, it was highly visible but inexorable.





% change










































Looking back over the years, the GBPEUR has seen some big swings; not only in 2008 and 2016 as we have mentioned, but also in many of the years in between. Percentage fluctuation ranges from 6.5% to 12.5%, and those were the supposed ‘dull’ years. This highlights the importance of the stress test in ‘normal’, real life situations – these fluctuations can be larger than some companies’ profit margins.

So if this is the problem, and it seems to be a dire one, what’s the solution? Is there light at end of the tunnel?

In short, yes. While your 2018 budget plan is going to include a lot of assumptions, currency risk can be mitigated, the impact of volatility can be limited, and it’s a financial director’s job to make this happen.  

Make sure your company has an appropriate risk management policy for changes in the rates you use for planning and budgeting.

Very briefly (because this could be an entire discussion on its own), such a process should start with understanding corporate exposures, defining company objectives, and assessing risk factors. Stress testing is invaluable for this last point.

The final policy should address the above and include:

  • A defined goal

  • The scope of exposure to currency risk

  • Your term to hedge (3 months, 6 months, 1 year, depending on your exposure characteristics)

  • A hedging strategy in terms of periods and percentages to hedge

  • A decision on hedging tools that will best serve the company’s hedging objectives

So, when is the best time to start planning? Quite simply, now!

Long-term stability

Risk management is an on-going process and should continue as long as the exposure exists. To better understand this, here’s an example.

Let’s say we build our budget each September, immediately hedging it for a year to come. The fixed budget GBPEUR rate for 2016 in this case would be 1.37 (based on the September 2015 rate). Now let’s say we were doing the same for the 2017 budget starting in September 2016, it will be planned with a rate of 1.19 – a decrease of 13%. This is why we recommend an ongoing hedging process to average the market and deal with these changes.

Looking back at how you responded to market challenges this year can help you plan for 2018 and provide guidance so that you are not left exposed. Naturally, your primary goal should be to grow your business, not monitor where the exchange rate is. That’s where we can help.

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