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Hello Mr Moffat
Just went through the lecture on the topic. There are a few basic doubts I’d like to clear.
1. Invoicing in home currency— how does it remove the risk? It is equally possible that the value of home currency fall and thus the buyer paying lesser than what we expected, right?
2. Netting — I get the logic here but how would I be having enough of the foreign currency to do it? From previous sales?
3. Matching — Why would I buy raw materials from abroad (possibly at a higher price) just to create an expense? Wouldn’t that create me a loss in the first place?
1. If I am a company in the UK and I invoice you 1,000 UK Pounds, then if you are in a different country it is you who has to convert money in order to pay me 1,000 UK Pounds. Whatever happens to the exchange rate, I still receive 1,000 UK pounds and so I am not at risk due to exchange rate movements.
2. Yes. This is only something worth considering if you are receiving foreign currency because of making sales to abroad and also needing to pay in the same foreign currency because you are making purchases from abroad. Instead of converting the receipts and also having to convert the payments, it makes more sense to use the foreign receipts to make the foreign payments. That way it is only the difference that needs converting and you are therefore only at risk on a smaller amount.
3. Again, matching is simply something that would be considered. If you have income in a foreign currency then as the exchange rate changes the receipt when converted to your own currency might be higher or might be lower – there is risk. If you do manage to have a similar expense in the same currency then they both go up and down together, which cancels out the risk. Making purchases in the foreign currency is just one example of what you might consider – maybe they will cost more (although that does not mean you make a loss) and for that reason you might not do it. Alternatively, if you were needed to borrow money then you might decide to borrow it in the foreign currency because then the interest expense will be in that foreign currency.
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