D. R. Lessard and J. B. Lightstone
Treasurers are familiar with the impact of changes in exchange rates on the dollar value of assets and liabilities denominated in foreign currencies. The impact of changes in exchange rates on operating profit expressed in home currency, which we will call operating exposure, is often more important to the company but much less understood. Interest in the effects of exchange rates on operating profit has been increased by the growing awareness of global competition, as well as by the ongoing debate over the accounting treatment of exchange gains and losses.
Operating exposure is often the major cause of variability in operating profit from year to year and an understanding of operating exposure is a necessary input into many decisions of the company. In the long term, operating exposure should be considered in setting strategy and world-wide product planning. In the short term, an understanding of operating exposure will often improve operating decisions. At a business unit level, the quality of a business and the effectiveness of its managers should be evaluated after taking into account exchange rate effects on reported performance which are outside management control.
The increased importance of operating exposure has developed in several ways. Exchange rates are volatile in the current world of managed floating rates. Also, markets are becoming increasingly global. For example, the US no longer has a dominant world market ...