Foreign Currency Effects

The foreign exchange variance analysis earlier inside the chapter assumes that local managers are accountable for domestic operating outcomes. Ideally, the local manager’s responsibility for exchange variances should be in line with the ability to react to exchange rate alterations.

The financial impact of changes in exchange rates on efficiency is often much more profound than might be seen by means of accounting measures alone. To far more totally assess the impact of inflation and currency volatility, and gauge their very own potential to react, companies need to analyze their competitive industry position along with the impact of currency adjustments on their fees and revenues and those of their competition. To shed much more light on this issue, we return to ICI’s handling of exchange rates and budgetary manage. Like many MNCs, ICI uses a forecasted rate of exchange to set budgets as well as the actual end-of-period rate to measure performance. Unlike lots of MNCs, ICI believes that the variance that results when the actual exchange rate differs from the spending budget rate is just not meaningful by itself. As an example, the organization may possibly have budgeted a rate for the euro for its subsidiary in France as well as the end-of-the-month exchange rate turns out to be identi al for the forecasted rate. There is no arithmetic variance, but ICI may well have lost some sales volume in France. The cause may possibly be that its competitors are exporters from Canada and also the Canadian dollar has weakened against the euro. As a result, the Canadians may have a margin advantage against ICI and can lower their prices in euros to sustain exactly the same amount of income when converting to Canadian dollars. Therefore, ICI believes that exchange rate adjustments have additional impact than accounting measures convey. It finds that further analysis is required to decide the actual impact of currency fluctuations on efficiency, to arrive at efficient reactions, and to establish how far the local manager will be to be held accountable for guarding his budgeted profit in pounds sterling.

To obtain these objectives, ICI looks in the currencies in which its expenses and revenues arise in relation to those of its competitors. Here is actually a view from within the provider: We invest in oil and oil-related goods, that are basically dollar denominated, and we're not a price-maker but are in competitors with other producers in Europe. Our oil fees are dollar denominated and our revenues are denominated in other European currencies. If the pound appreciates against all other currencies, then revenues arising from foreign sales, and also those from U.K. sales topic to competitive pressures, will be reduced. As partial compensation, raw materials expenses (dollar-denominated oil) will be lower, but on balance ICI is worse off since the lower in raw material fees is less than the reduce in sales income in absolute terms. The figure may be substantial simply because ICI would be the U.K.’s largest single exporter. Currency movements in the opposite path are, obviously, achievable and the truth is have not too long ago occurred. An appreciation of the U.S. dollar against all other currencies puts the same raw materials expense pressures on our European competitors as on U.K. manufacturing operations so we will not suffer a comparative disadvantage. The comparative disadvantage would arise if there was a depreciation of the pound versus the dollar coupled with a depreciation of other European currencies against the pound. This would each decrease our revenue and improve our expenses.

This strategy to analyzing the financial impact of currency movements affects ICI’s evaluation of its managers, whose freedom to react to such external circumstances is limited. In measuring the manager’s performance, the business takes into account the extent to which he has been affected by factors beyond his manage and also his reaction to them.