Today we’re going to talk about things that can sabotage your hedge program.
Really good news for those of you that are hedging interest rates as there's not that many things that sabotage your hedge program. Maybe an early paydown of debt. So some of the forecasting of cash flows into the company, which probably get a lot of attention. So you get a lot of good data on that.
For those of us doing commodity and FX hedging of anticipated transactions, somehow in Treasury, we end up a little bit in the forecasting business where we take what Financial Planning and Analysis has done, and now we have to figure out how much of this could actually be good. The difference is that FP&A gets to talk to all the business units and really like, you know, test back their assumptions. But you and Treasury, we're just going to wave our magic wand and we've got to figure out how much of that forecast could be good. So a lot of times that forecasting can sabotage us.
#2. Existing Balances & Data
But where we really get burned is on the existing balances and data.
And so commodity people: This would be like if you're hedging inventory. Or FX: This is where you're hedging your balance sheet exposure.
And you would expect, you know, how hard can it be? You record a transaction at the transaction rate, you have to revalue to month-end, and then you continue to revalue it until it closes. How much of that could go wrong?
Now, I'm going to tell you, after many, many years, decades of experience, I'm going to tell you that making sure they're booking the transactions in at the right rate is a problem. Making sure it's revaluing to the right rate can be a problem. And making sure that the transactions are closing out at the current rate can be a problem.
So it's really important for you to understand how to dig into your ERP system and understand how transactions are being recorded, especially things like accruals, credit memos – those are kind of some of the big ones, not to mention watching out for shadow balances.
And the other thing is we talk about this on our training all the time. I hope you'll join us, learn more about this.
It Makes Me Crazy…
I'm going to talk to you a little bit about what makes me crazy when we're talking about sabotaging a balance sheet hedge program.
One of the things that really makes me crazy is the accruals at month-end. If you think about what happens in the accounting on the last day of the month, in fact, for the few days after, if you recall, they'll be accruing items as of month-end. They're going to be accruing those items at the month-end rate. Okay. And then at month-end, it sits on the balance sheet as a non-functional currency monetary asset or liability. And it's very likely that that's when you're going to go in and take a snapshot to say, what should my hedge program look like? What should my balances be in each currency?
Well, then what's going to happen on day two, or actually day one of the new month, is they're going to come in and they're going to reverse out all those accruals from the prior month at that prior rate doesn't make very much FX. But oh, my goodness, you have a hedge on that balance and it's just disappeared. And that hedge is going to revalue to month-end, and you're going to have a gain or loss. At the next month then they're going to reaccrue that at the new month-end rate. They're not going to have a gain or loss on that for the period. That is really hard on a balance sheet hedge program.