Managing the black ink and red flags of FX: quantifying foreign exchange risk is harder than you think.

• Author: Koester, Wolfgang
• Position: COMPETITIVE EDGE

AS A BOARD MEMBER of a multinational corporation, are you being told that the weak dollar has resulted in increased corporate revenues and profits?

Today, the multitude of risks associated with foreign exchange exposure has largely been masked by the long-term decline of the U.S. dollar relative to other major currencies. Rather than highlighting flaws in accounting and foreign exchange exposure management processes, U.S. multinationals have regarded these surprises as a "gift."

In reality, no surprise is a good surprise when you are talking about accounting practices. While windfalls from the weak dollar have allowed many CFOs to cast a blind eye to irregularities that typically plague multi-currency accounting and foreign exchange risk management, the trend can't continue forever (just ask fellow board members or CFOs of Canadian or Asian multinationals).

"Foreign exchange exposure management is the toughest job in finance," says former Microsoft CFO John Connors--and with good reason. Positing a confident, well-informed response to any of the following FX-related questions is no easy task for any corporate board member, or for any member of their organization:

* Do I clearly understand the gross currency exposure of the company?

* Do I understand the actions the company is taking to reduce that exposure?

* Do I understand the real risk that the company is managing towards?

* What controls are in place to ensure that the process is well defined, and what benchmarks are in place to ensure that policies are effective?

Getting to the truth behind these questions--a reliable, quantifiable foreign exchange exposure value--is even harder.

To truly understand your company's FX risk, you need to dig deep and push internal auditors, or your CFO's treasury and controller organizations, to answer more pointed questions about their practices and policies.

1. What is the level of confidence in the data provided by the controller and used by the treasury organization to manage foreign exchange exposure?

   Ask your FX manager how confident they are in the data they use to manage foreign exchange exposures. The likely answer: "Not very." Setting up multi-currency accounts for re-measurement in ERP systems is a very complex process. Despite the talents and best efforts of most finance organizations today, the limitations of these underlying accounting systems mean that most are--literally--set up to fail.

2. How does your treasury organization calculate...