Project Description

Stopwatch, Chinese renminbi, Euro, and document statement iconsCompanies are paying attention to cash flow hedging as a way to mitigate the risk of currency volatility. This includes heightening their focus on multicurrency cash flow forecasting in order to hedge effectively.

The relationship between working capital and foreign exchange risk (FX risk) differs for receivables versus payables, according to Paul LaRock, Principal at Treasury Strategies, Inc. Companies must consider this in balancing the management of working capital and risk.

Receivables versus payables

For receivables, the goal of collecting payment for sales as quickly as possible aligns with an objective of shortening the duration of foreign currency exposure.

Companies are devoting more time and resources to understanding the timing gap between sales and collection.

“One of the important things about working capital management relative to FX hedging is the risk period,” LaRock said. “The longer the window of time between booking a sale and collecting a payment, the greater the risk.”

For payables, improving working capital by lengthening vendor payment terms increases the time window for potential foreign currency fluctuation and therefore increases currency risk.

“In extending payables, companies must consider the potential additional expense of hedging for longer durations, which can reduce the benefit of extended payment terms,” LaRock said.

“Companies need to find the right methodology for their business to compare the working capital benefit versus the impact to hedging costs.”

Predictability is key

What are companies doing to increase predictability for receivables and payables?

  • Collaborating with internal business partners. It’s important to work closely with operating units to increase the predictability of the timing and amount of collections.
  • Increasing predictability of payments. LaRock notes that gaining predictability over invoice and payment timing mitigates the risk associated with elongated payment periods.
  • Performing a formal variance analysis. Understanding and reducing variances is critical to an accurate cash forecasting model.
  • Collecting in functional currency where possible. To a more limited extent, where customers are amenable, some companies are trying to sell more in their functional currency.

“Businesses are using cash flow forecasting to better understand foreign currency inflows and outflows for their operating units,” LaRock said.

“Gaining cash flow predictability and visibility enables a disciplined approach to deciding whether or not to hedge.”

For more information, contact your Wells Fargo representative or fill out the Contact Us form on this site.