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Balance Sheet Hedging 

What is balance sheet hedging?

A company doing business in local (i.e. non-functional) currency will have local currency assets and/or liabilities on its balance sheet. Depending on the firm's cash cycle, local currency items (A/R, A/P, cash) may roll over two or more balance sheet statements.  

These items are initially recorded at the FX accounting rate effective at the time of booking. Thereafter, they are "remeasured" on each balance sheet date, using current rates. The gain/loss resulting from this month to month remeasurement is recorded on the Income Statement.

 

This creates undesirable Income Statement volatility, which in turn adversely affects many corporate metrics. Balance sheet hedging addresses this effect, reducing the net gains/losses and resulting volatility. 

Our balance sheet hedging can be closely integrated with our Cash Flow hedging program. In addition to calculating the required hedges and swaps at each month-end, Balance Sheet hedging provides a comprehensive reporting functionality, including a variance analysis (forward points impact, balance sheet forecasting error and cash flow forecasting error).

Balance Sheet Hedging Process Diagram
Reducing Net Gain/loss from monthly remeasurement chart

Reduced Net Gain/Loss from Monthly Remeasurement 

Hedging the re-measurement of net monetary assets (NMA) reduces the net effect of FX on the balance sheet.

 

The challenge is in forecasting NMA one month ahead, even without knowing the current month’s trial balance. Our methodology provides a robust and accurate NMA, also it manages the required swaps.

Reduce Income Statement Volatility

Under both FASB and IFRS 21, balance sheet re-measurement gains or losses must be posted to the Income Statement. These gains or losses can substantially increase the Income Statement volatility.

 

Thus, minimizing the gains/losses on the balance sheet stabilizes the income statement.

Income statement volatility graph

Want To Learn More About Balance Sheet Hedging?

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