Setting Your Foreign Exchange Budget Rates for 2024

Heading into 2024, precision in setting foreign exchange (FX) budget rates is crucial for businesses engaged in international transactions. Serving as an internal reference exchange rate, the budget rate allows businesses to employ hedging strategies, fortifying their ability to forecast cash flows and evaluate overall business performance over a specified accounting period.

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Factors that can create currency movements

1. Inflation and interest rates: Generally, countries with lower inflation rates see an appreciation in their currency value. An increase in interest rates can attract foreign investors, leading to an appreciation of the local currency.
   E.g. Which central banks will cut rates first? What effect the anticipation of disinflation will have on the market?
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2. Political Stability: Countries with stable political environments tend to attract more foreign investors, leading to a stronger currency.
   E.g. US and UK general election.
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3. Geopolitical: Uncertainties and potential disruptions in international relations, politics, and global security that can impact the economy.
   E.g.Global events including the Israel and Palestine conflict, natural disasters etc.

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Choosing the Budget Rate

When building the budget rate companies can aim for a ‘buffer’ between the market FX rate and the rate used in pricing to allow for more time to update forecasts. Committed orders provide a safety net in a worst-case scenario. The following are a few ways to choose a rate:

• Current Spot Rate: Utilising the current spot rate involves a strategy betting on the rate increasing from its current levels over the next 12-month period.
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• Historical Data Rate: Businesses often use an arbitrary rate derived from a combination of the current spot rate and factors such as historical rates to create a buffer against potential rate movements.
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• Forward Rates Approach: The forward rate is a  commonly favoured, accurate approach employed by corporate treasurers. It theoretically allows businesses to lock in rates for forecasted transactions over the next 12 months. However, it's worth noting that businesses usually don't hedge a full year of transactions, and the forward rate doesn't consider the margins taken by FX brokers.
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• Weighted averages of previous hedges: Using historical data to make realistic assumptions about where the rate should be set.
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• Bank forecasts/ Independent consensus forecast: This can be choosing one forecast or combining and taking the average.
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• Off-market rate: Spot rate plus/minus a  predetermined buffer (i.e., one standard deviation).

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Budget Rate variations

To prepare for the uncertainty of the currency market, companies should consider creating budget rates for three different scenarios:

1. The base case is the scenario most likely to occur given the current market expectations.
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2. The bullish outlook in this market the currency pair prices rise continually and are expected to keep growing (positive movements).
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3. The bearish outlook In this market the currency pair prices fall with a pessimistic outlook. The prices are assumed to keep falling in the future (adverse movements).

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Creating the Budget

When creating the FX budget, the finance team uses the budget rates combined with the following information:

1. Treasury Policy: Leverage your company treasury policy (click here if you need a free checklist), by utilising parameters for foreign exchange hedging, understanding which derivatives to use, what costs are involved, and adhering to policy objectives.
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2. Exposure Identification: Create a realistic forecast for 2024 by identifying exposures, both committed and uncommitted exposures.
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3. Risk Management: Find the risk level that is appropriate for your business by understanding the levels of volatility your business is willing to enter into the market.

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An Example of a company selecting a budget rate.

Maintaining the Budget

The timing and method of executing currency transactions play a pivotal role in influencing profit margins, costed levels, future cash flows, and external pricing. Minor variations, often overlooked, can wield a significant impact on the bottom line. As businesses expand their reach, it becomes imperative to navigate the intricacies of currency transactions with foresight and strategic planning. Maintaining the budget poses challenges for many small to medium businesses lacking comprehensive treasury management software and teams.

CNS has spoken to 70+ CFOs and Financial Controllers and has found that FX risk is only one of the many priorities managed by finance teams and that many organisations struggle with systems that are manual, time-consuming, complex, or lack reporting and insight. Having large FX exposures with many contracts is often difficult to manage.

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Simplify FX management with CNS Treasury

CNS Treasury stands as a cost-effective solution tailored for importers and exporters, offering automation and digitisation across the entire derivative transaction lifecycle. Our mission is to simplify the complexities of treasury management, ensuring a level playing field for all businesses. With our cloud-based platform, users can effortlessly identify, manage, and report on FX transactions. Streamline financial operations and embrace a better 2024 where FX management is accessible and efficient for businesses of all sizes.

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