FX Uncertainty: Why Financial Planning and Treasury Must Work Hand-in-Hand
Introduction: Two Sides of the Same Coin
The ongoing macro-economic and foreign exchange (FX) volatility presents a critical challenge for businesses that operate internationally. Its impact on earnings predictability, liquidity, and solvency demands a proactive and strategic approach. While Financial Planning & Analysis (FP&A) teams focus on forecasting and scenario planning, CFOs or finance executives in charge of managing Treasury are tasked with safeguarding the business against catastrophic scenarios.
This dual responsibility makes it imperative for FP&A and treasury teams to work in tandem. Collaborative action is the only way businesses can build resilience amid today’s ongoing market turbulence.
Understanding FX Uncertainty and Its Dual Impact
FX volatility doesn’t just affect large corporations; mid-market enterprises and even small businesses also feel the pressure. Its impact is twofold:
- Earnings Predictability (FP&A’s responsibility): FX fluctuations can directly influence revenues and margins, destabilising operational budgets and forecasts.
- Liquidity & Solvency (Treasury’s responsibility): Sudden or severe fluctuations threaten cash flow stability and financial health.
Distinct Roles:
- FP&A: Focuses on crafting likely scenarios to support accurate budgeting and
operational forecasting and often gets FX budget rates from Treasury. - Treasury: Develops strategies to mitigate severe risks through hedging and liquidity management and ensures that budget FX rates can be achieved regardless of macro environment.
Achieving alignment allows businesses to address both predictable and extreme impacts, fostering a cohesive and reliable financial outlook.
FP&A's Role: Forecasting Likely Outcomes
FP&A teams are at the forefront of modelling likely scenarios to ensure organisations are prepared for foreseeable market conditions. For businesses that operate internationally this includes FX rates used in the scenarios - so called “budget rates” but more often than not, require treasury teams or other experts to provide such FX budget rates to FP&A.
The FP&A priorities focus on the following key areas:
- Revenues & Margins: Evaluating and forecasting the transactional and economic exposure of currency fluctuations on income streams.
- Earnings Volatility: Anticipating risks associated with translation exposure and ensuring accurate financial reporting.
FP&A teams often employ forecasting techniques like rolling forecasts, sensitivity analyses, and scenario planning to create accurate and actionable models.
These models include:
- Baseline Scenarios (neutral, predictable market conditions)
- Moderate Stress Scenarios (potential but manageable currency shifts)
By focusing on agility, accuracy, and responsiveness, FP&A establishes a strong foundation for decision-making.
Treasury’s Role: Preparing for the Worst
Treasury plays a complementary role, focusing beyond expected scenarios and preparing for extreme risk. This forward-looking approach ensures the business is safeguarded even under the harshest conditions.
Key priorities include mitigating financial crises, extreme FX volatility, and even systemic banking risks. Treasury’s toolkit comprises a variety of strategies:
- Budget rates: Establishing and protecting FX rate forecasts that used by FP&A and other teams and realistic and achievable given prevailing market conditions.
- Tail risk modelling: Identifying and quantifying the risks to potential macroeconomic and other shocks.
- Hedging Policies: Instrument options such as forwards, options, and natural hedges ensure stability.
- Liquidity Buffers: Adequate cash reserves for unexpected shortfalls.
- Counterparty Risk Assessments: Evaluating the reliability of FX specialist firms and banking relationships.
Treasury ensures that even under catastrophic scenarios, the organisation’s liquidity and solvency remain strong.
A bit of theory - the probability angle
Planning for FX uncertainty is married to the notion that exchange rates move randomly over time and the changes in value of currencies over a specific period of time have different likelihood. This likelihood is distributed in a manner close to a normal distribution.
For example, the graph below shows the historical distribution of 90-day moves of the Pound Sterling vs the US Dollar (grey) and it is a normally distributed model. As one can see, most of the potential outcomes are small moves, clustered around zero but in more rare outcomes the exchange rate moved more than 20% over 90 days.
Treasury managers should be most concerned with potential 1 in 100 and 1 in 5 chances (red and orange areas) while FP&A team is focused on the area closer to the middle of the bell curve, trusting that the treasury or risk manager will take care of the tail risk scenarios.
Connecting the Two: A Holistic Approach
The connection between FP&A and Treasury lies in their ability to inform and enhance each other’s work. A coordinated approach can help businesses achieve more accurate forecasting and better risk mitigation.
How FP&A Supports Treasury:
- Identifies currencies and expected cashflows in.
- Provides actionable data that helps Treasury craft targeted hedging strategies.
How Treasury Enhances FP&A:
- Delivers hedging insights that stabilise forecasting efforts.
- Provides FX budget rate forecasts and a more predictable financial baseline that FP&A can use to build reliable financial outlooks.
For example, if FP&A forecasts a 10% risk to revenues and Treasury executes a targeted hedge using forward contracts, the combined effort ensures both predictability and protection.
Bridging the Communication Gap
Collaboration hinges on effective communication. Here’s how FP&A and Treasury can bridge the gap and work better together:
- Joint Planning Sessions: Collaborate on scenario planning to evaluate the full picture of FX risks.
- Regular Exposure Reviews: Frequently review and analyse currency exposures as a team.
- Integrated Dashboards: Implement tools that deliver combined visibility into forecasts and hedging activity.
- Unified Narrative: Present a cohesive story to leadership and stakeholders, ensuring alignment across key functions.
Practical steps like the above can transform two siloed departments into a unified force against FX uncertainty.
Real-Life Examples & Case Studies
Success Story:
An international mid-market retailer successfully navigated 2022’s currency chaos by establishing a joint FX task force between FP&A and Treasury. By pooling data-driven insights and implementing collaborative hedging strategies, the company reduced its FX-related earnings impact by 15%, while maintaining 20% liquidity buffers.
What Happens Without Collaboration?
On the other hand, a mid-sized manufacturing company experienced losses of up to $2 million due to misalignment. FP&A correctly estimated currency exposures, but Treasury underhedged due to making their decisions on the back of stale forecasts from FP&A, leading to unnecessary FX losses. This siloed approach resulted in volatile cashflows and strategic missteps.
Collaboration is not just a best practice but a financial imperative.
Common Pitfalls of Isolated Approaches
When FP&A and Treasury operate independently, the risks grow exponentially, including:
- Underestimating tail risks: Less experienced teams often underestimate the
magnitude of potential FX moves during crisis time and are slow to react when the events unfold, hoping that everything normalises soon. - Forecasting Gaps: Misaligned assumptions lead to inaccuracies that affect the business strategy.
- Inefficient Hedging: Either under-hedging (leaving the company exposed) or over-hedging (creating unnecessary costs).
- Strategic Disconnects: Lack of communication creates vulnerabilities, impacting earnings, liquidity, and operational stability.
The cost of isolation far outweighs the investment in collaboration.
Checklist: Integrating FP&A and Treasury
Aligning FP&A and Treasury doesn’t have to be daunting. Use this framework to get started:
- Schedule Regular Risk Assessments: Establish joint meetings to review FX exposure scenarios.
- Define Clear Roles: Clarify responsibilities to prevent overlap or gaps.
- Adopt Integrated Tools: Use dashboards or software such as HedgeFlows that collates forecasts, exposures, and hedging data.
- Share Metrics: Agree on success metrics to track alignment and progress effectively.
This checklist ensures a practical roadmap for integration and synergy.
Key Takeaways
The key to managing FX uncertainty lies in the alignment of FP&A and Treasury. Together, they:
- Build resilience by addressing both predictable and extreme FX scenarios.
- Combine insights and actions, leading to stronger financial outcomes.
- Provide leadership with a unified narrative, empowering better decision-making.
With the stakes of FX volatility higher than ever, mid-market businesses must act now. Begin strengthening your FX strategy by fostering collaboration between these vital functions.
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