Start with a currency cash flow forecast
A currency cash flow forecast lists expected receipts and payments in each currency, by month or week. It is the basis for every other decision in this guide. It shows the net position in each currency, when surpluses and shortfalls occur, and how much of the exposure is offset internally before any hedge is considered. It should be updated as orders, invoices and supplier terms change, and compared with actual flows so its reliability is known.
Payment scheduling and settlement timing
Every conversion and payment has a value date, and both currencies have to be in place on it. A few practical points cause most timing problems:
- Settlement cycles. Spot trades settle one or two business days after they are agreed, depending on the currencies; payments add their own processing time.
- Holidays. A holiday in either currency's country moves the value date.
- Cut off times. Instructions received after a provider's or bank's cut off move to the next business day.
- Forward maturities. A forward that matures before the customer pays has to be extended or settled from other funds.
Matching receipts and payments
A business that both receives and pays the same foreign currency has a natural hedge on the overlapping amount. Using receipts to make payments directly, instead of converting both ways, reduces conversions and leaves only the net amount exposed.
A Canadian company receives about $800,000 USD a month from US customers, around the 25th, and pays about $500,000 USD a month to US suppliers, around the 10th.
- Converted each month if every flow is converted$1,300,000 USD
- Converted each month if receipts pay suppliers first$300,000 USD
- Spread cost at an illustrative 0.0020 per US dollar, converting everything$2,600 CAD a month
- Spread cost converting only the net surplus$600 CAD a month
Matching saves about $24,000 CAD a year in this example, and it reduces the exposure to the $300,000 USD surplus each month, which is what needs hedging. But the timing does not line up: suppliers are paid on the 10th and customers pay on the 25th. To use receipts for payments, the company has to hold enough US dollars from one month to pay suppliers early in the next, or arrange a forward that delivers US dollars on the 10th.
Netting
Netting extends matching across a group. Instead of each entity converting and paying separately, intercompany balances in each currency are offset and only the net amounts are settled. That reduces the number and size of conversions and payments.
Netting does not remove the net exposure. A group with more US dollar receipts than payments still has a surplus to convert, and it remains exposed until it does. Netting also depends on flows lining up in time, still needs liquidity for the net settlements, and between entities in different countries may be subject to legal, tax or regulatory constraints that need advice.
Liquidity and the cost of mismatched flows
Every approach to currency management needs cash in the right currency on the right day. Forwards settle on their maturity date whether or not the customer has paid. Credit facilities can require margin if hedges move against the business. A held foreign currency balance is itself an open position until it is used.
When flows are mismatched, the consequences are operational before they are financial: payments made late, overdrafts in one currency while another sits idle, or spot conversions forced on a day the business did not choose. A forecast that shows when each currency is short avoids most of them.
When natural offsets reduce the need to hedge
Where receipts and payments in a currency are reliably similar in size and timing, only the net needs hedging, and sometimes not even that. The offset is only as good as the forecast behind it. If a large supplier contract ends or moves to another currency, the net position can change quickly. Natural hedges should be monitored like any other hedge, and the net position reviewed whenever either side changes.
Timing and payments in Vantry ATI
For clients of Vantry Capital Inc. in Canada, payments sit in Vantry ATI alongside trading and analysis. A forward can be drawn down against an invoice as it falls due and paid to an approved supplier by wire or EFT, and trades can be funded by wire, pre-authorized debit or a holding account, under the approval rules the business sets. More in treasury services.
This article is general information about managing currency risk. It is not investment advice or a recommendation to use any instrument, and examples use illustrative rates and amounts, not quotations. Products are offered in Canada by Vantry Capital Inc., subject to eligibility and credit approval.