What is balance sheet risk?

Balance sheet risk

Balance sheet risk is driven by non-functional monetary assets and liabilities on any entity’s balance sheet in a currency other than its functional currency. Most often these are line items like A/R, A/P, Cash, and loans. Generally, what happens is each month the change in value of these foreign assets/liabilities has to get reported in local currency and that change gets specifically called out on the income statement in the FX gain/loss line. The extent of the risk is driven by the size of the exposures, the functional currencies of the entities, the availability of data, and whether the organization uses a monthly or a daily activity rate.

For many organizations, balance sheet is a good place to begin for operational FX risk. Here are some typical characteristics of balance sheet risk.

• Although data can always be a challenge, it is usually easier for companies to obtain good balance sheet exposure data because it is mostly based on booked transactions that should be available in the ERP.
• Depending on the organization’s structure risk may be concentrated in a few exposures or entities.
• Accounting is much simpler for balance sheet hedging programs, making them a good way for companies to begin hedging FX.
• Unlike cash flow risk, subsidiary incentive and parent incentives are aligned, removing risk at the subsidiary will also reduce risk for the parent.

Before making a decision on implementing a balance sheet hedging program it is important for the company to do some analysis, determining the amount of risk, discussing their risk appetite, creating a sustainable strategy, and ensure the proper resource exist to run such a program. Chatham has helped hundreds of companies design balance sheet hedging programs design balance sheet hedging programs that effectively reduce risk in an efficient and cost effective manner for the company.

Chatham Financial corporate treasury advisory

Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with organizational objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency, and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate, and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.