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A Methodology for Combating Currency Volatility Madness This article describes how companies can transform business system data into actionable intelligence to help them manage foreign currency volatility . The author takes the example of Kennametal, a company which designs and manufactures products for the metalcutting industry, showing how they set about finding ways to automate and streamline the information gathering process, ultimately achieving the protection of corporate value and enabling Treasury to take a more central role in identifying, quantifying and managing financial risks to the organization.

A Methodology for Combating Currency Volatility Madness

by Corey Edens, Chief Operating Officer, FiREapps

In today’s global economy, the stakes for treasurers trying to protect the value of their organizations from foreign currency volatility have never been higher. The world is getting flatter, as Thomas Friedman suggested, leading to increased globalization - but currency markets have only become choppier. With globalization leading to a projected rise in daily corporate FX volume to $1 trillion by 2010, currency volatility is expected to ride the same wave, rising from 10% in 2007 to 13.9% in 2010, according to the British Bankers Association. While market forces have converged to make foreign exchange exposure management more critical than ever, FAS and IAS compliance have added additional levels or scrutiny to the process, and an additional burden in terms of time and effort. As a recent wave of financial restatements in the US suggests, this scrutiny is unlikely to go away any time soon. In 2000, just over 100 US companies were forced to restate earnings; that number is projected to nearly triple, rising above 300 by 2010.

The world is getting flatter, as Thomas Friedman suggested, leading to increased globalization - but currency markets have only become choppier.

All these factors have converged to make managing foreign currency volatility a critical issue for companies today, according to Lawrence Lanza, Vice President and Treasurer for Kennametal. His company has experienced the impacts of those trends first hand.

“Historically, we would see relatively modest movement in our major currencies,” said Lanza. “But in the last year or two significantly greater monthly exchange rate volatility, combined with our geographic diversification strategy, has highlighted the importance of maintaining a robust FX exposure management program. Kennametal already devotes substantial resources to foreign exchange exposure management. The current environment only validates our commitment to understanding and effectively managing the potential risks inherent in foreign currency volatility.”

Over the past six months, Lanza and Assistant Treasurer Mark Olyarnik have been further refining their process of identifying the company’s exposure to foreign currency volatility. The process, as they both described it, is often a challenge.

“Extracting actionable information from our ERP system, and then identifying and hedging those exposures, is a time consuming and frustrating process, but a worthwhile effort consistent with our continuous improvement culture” Lanza says. “Sources of exposure, prevalent in any company with global operations, are numerous and internal data gathering and consolidation is cumbersome. The result is a complex problem with multiple layers that can consume significant manpower resources.”

Reducing complexity

Kennametal’s solution was to look for ways to automate and streamline the information gathering process. Lanza and Olyarnik sought an approach that would continue to meet the company’s high standards while at the same time improving the efficiency of the FX management program and reducing some of the complexity of the current process. Lanza and Olyarnik met with key members of Kennametal’s Finance team to evaluate several alternative approaches - with a goal of enhancing the predictability of the impact of FX fluctuations on the company’s P&L. The methodology that Kennametal employed began with a focus on intercompany balances, which then led to careful scrutiny of other potential sources of exposure, and ultimately to an analysis of the underlying transaction data and accounting processes that produced that information.

“We kept peeling back the layers of the onion because we were focused on better understanding how the underlying potential exposures could impact the income statement versus Treasury’s forecast,” said Lanza.

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