How to minimize multi-currency accounting risks
It's unlikely the late rapper Notorious B.I.G. had the logistical challenges faced by international enterprises in mind when he recorded one of his most well-known songs. But the fact remains that more money — or at least more currencies — truly can lead to more problems when you're a business operating globally.
With the right tools, however, the rewards of running a business on an international scale can outweigh the risks of multi-currency accounting.
When does multi-currency accounting come into play?
A company can be considered international if it produces a product domestically and sells it in one or more other countries (or vice versa), or if it has offices or manufacturing facilities in countries other than that of its main headquarters. Even outsourcing a portion of labor, such as a call center, to another country is enough to put a company in the "international" category.
There are two types of international businesses, according to Harvard Business School Online. In a transnational company, different offices in different countries each have responsibility for a particular facet of the organization. In a multinational company, each office is a microcosm of the business as a whole.
While globalization can have some advantages, including the potential for low cost labor or saving on freight by locating production closer to the end user, there are also obstacles to overcome.
Language barriers and cultural differences can be tempered with effort and education. Unfortunately, however, the risks associated with doing business in multiple currencies are not as easily mitigated.
The risks of multi-currency accounting
Multi-currency accounting is inherently risky. Foreign exchange rates fluctuate due to factors outside of your company's control, and those fluctuations can't always be predicted, even with the best AI or experts available.
"Despite decades of research, economists have yet to identify a reliable way to forecast exchange rates," says a recent blog post from the Kellogg School of Management at Northwestern University. "The best method, called a 'random walk,' involves using today’s exchange rate to forecast future exchange rates."
But that method is still unreliable, Kellogg finance professor Sergio Rebelo says in the blog.
According to PwC's John Horan, multi-currency accounting brings other challenges, including:
This occurs when monetary assets or liabilities are recorded in currencies other than their functional currency (the currency of the primary economic environment in which the overall enterprise operates.)
This happens when a company expects to purchase goods or sell products in a currency other than its functional currency. Since a business always expects to be buying and selling, it follows that economic exposure is always a consideration for an international business.
Small businesses are especially vulnerable to the whims of the global currency climate.
"The smaller the business, the more sensitive it can be to currency moves," Chris Towner writes in FM magazine.
While an international company has no way of preventing currency volatility, it can minimize its effects.
Smaller businesses would be wise to hedge against exchange rate fluctuations by locking in rates on committed exposures, Towner advises, citing an example of a shoe retailer whose inventory purchase price, because of exchange fluctuations, effectively increases just two days after making an order.
Businesses dealing in multiple currencies should also have a strong FX policy in place and make sure that policy has buy-in across the enterprise, Towner advises.
Multi-currency accounting software can help
Mitigating foreign currency exposures isn't only a matter of policy or even expertise.
“In any type of international business operation, the key issue is to identify the measure of FX exposure," Mathieu Vincent, of global accounting firm Mazars, says in a blog post published by Praxity Global Alliance. "If you don’t have a multi-currency accounting system, there is no way that you can keep track of this FX exposure.”
But while the need for an international business to have multi-currency accounting capabilities is a given, the quality of those capabilities may differ from one software to another.
Gravity Software offers a three-tiered currency model in which you can set a default functional currency for each of your companies but complete transactions, such as invoicing a customer, in other currencies. You can select a consolidation currency so that all companies can be reported in one currency.
Gravity includes automated currency conversion and automatically calculates realized gains and losses that result from FX transactions so there are far fewer surprises at reporting time. You can choose to update exchange rates manually — for example, if you've contracted with a supplier to pay a specific exchange rate on a particular shipment — or use an integrated service to automatically update exchange rates at regular intervals.
A multinational business is, by definition, a multi-entity business because it has multiple offices operating as microcosms of the larger company.
While subsidiaries may operate primarily in their local currencies, according to Praxity, their financial statements must be translated into the larger enterprise's presenting currency.
With Gravity’s unique structure, your company's subsidiaries can operate independently, in their local currencies, even while consolidated reports can be presented in the organization’s reporting currency for the overall enterprise. New entities can easily be added as your company grows.
The best FX policy means little without visibility across the organization to ensure its efficacy. Visibility means little if the information being presented isn't relevant and easy to understand.
Gravity Software, built on the Microsoft Power Platform, integrates with Power BI to provide visually appealing, clear-cut graphic representations of a company's key metrics, including those associated with FX.
Use Power BI to create graphs comparing year-over-year FX losses and gains, or for a side-by-side look at realized versus unrealized losses and gains for the month. You can even create individualized, real-time dashboards for each stakeholder within the company.
Even the best multi-currency accounting solution can’t completely eliminate foreign currency risks, but it can help mitigate them by ensuring up-to-date, accurate FX calculations that will prevent your business from being caught unawares by gains and losses resulting from exchange rate fluctuations.
Coupled with a comprehensive FX policy, Gravity Software can help your business achieve success in the global economy. Learn more and schedule your online demo today.
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