Between Foreign Currency Revenue and TL Costs: Where Does Financial Strategy Address Currency Risk

The Risk Between Foreign Currency Revenue and TL Expenses

In companies that export, provide services abroad or price their sales in foreign currency, a significant share of revenue is earned in foreign currency. In the same companies, most costs are usually incurred in Turkish lira. Staff wages, rent, energy, payments to local suppliers and taxes are the main items. This currency difference between revenue and costs links the company's profitability and cash balance directly to exchange rate movements.

The effect of exchange rate movements is not one-directional. In periods when the exchange rate rises, the TL value of foreign currency revenue increases and the company's margin may widen. In periods when TL costs rise at a pace that differs from the exchange rate, the same foreign currency revenue may produce a different result in terms of covering costs. What these two situations have in common is that the company's results come to depend largely on a variable outside its own control.

Financial strategy offers the company a framework at this point. It is usually not possible to eliminate currency risk entirely; it is, however, possible to measure the size of the risk, decide which part will be carried and which part will be managed, and link these decisions to clear rules. This approach turns exchange rate movements into an element that is built into the company's planning.

This structure is found in many sectors. Textile and apparel exporters, software and technology service providers, tourism businesses, logistics firms and machinery manufacturers earn much of their revenue in foreign currency while bearing their production and service costs in TL in Türkiye. Although the sectors differ, similar questions appear on the financial strategy agenda of these companies: How much of the foreign currency revenue will be converted into TL, and when; against which part of the exchange rate movement will protection be sought; and according to which rules will these decisions be made?

This article looks at how currency risk is defined from a financial strategy perspective, the tools that can be used to manage the foreign currency position and how decisions on currency risk can be linked to clear rules.

Defining Currency Risk from a Financial Strategy Perspective

Addressing currency risk within financial strategy begins with defining the risk correctly. In a company with foreign currency revenue and TL costs, currency risk can arise in three different forms. The first is transaction risk: A change in the exchange rate between the date a foreign currency sale is invoiced and the date it is collected affects the TL value of the amount received.

The second is balance sheet risk: The period-end valuation of foreign currency receivables, payables and cash balances appears in the financial statements as exchange differences. The third is economic risk: The long-term effect of exchange rate movements on the company's competitiveness, pricing capacity and cost structure.

Each of these three types of risk is addressed with different tools. Transaction risk is usually managed with short-term hedging instruments, balance sheet risk by balancing foreign currency assets and liabilities, and economic risk through decisions on pricing policy and cost structure. The first task of financial strategy is to establish the extent to which the company is exposed to each type of risk.

The starting point for this assessment is a table of cash flows by currency and maturity. When expected foreign currency collections, foreign currency payments, TL costs and TL revenue for the next twelve months are shown month by month in a table, the company's net foreign currency position for each period becomes visible. The net foreign currency position is calculated by deducting the amount to be paid in foreign currency in a given period from the foreign currency amount to be received in the same period. In companies with foreign currency revenue, this figure is usually positive, and this amount needs to be converted to cover TL costs.

The company's domestic sales are also shown separately in this table. Revenue earned domestically in TL covers part of the TL costs and therefore reduces the need to convert surplus foreign currency into TL. The share of domestic sales is one of the factors that determine the alignment between the company's TL cost structure and its revenue structure. This information helps link sales strategy with financial strategy and allows market choices to be assessed from a currency risk perspective as well.

The second function of the table is to show timing. Foreign currency collections may be concentrated in certain months while TL costs follow a steady pattern throughout the year. In this case, the company needs to decide on what schedule it will convert the foreign currency it receives in peak collection months into TL. This decision is the first area in which currency risk is consciously managed within the company.

The third function of the table is to measure sensitivity. The effect on operating profit, cash balance and debt service capacity of exchange rate changes of certain magnitudes can be calculated through several scenarios. This calculation turns management's concern about exchange rate movements into a measurable figure. Management can see concretely within which exchange rate range the company achieves its planned results and in which range additional measures are needed.

Collection terms also play an important role in defining currency risk. The payment term granted on foreign currency sales determines the duration of transaction risk. Extending the term raises the likelihood that the exchange rate at the time of sale and the rate at the time of collection will diverge. For this reason, it is appropriate to assess currency risk together with sales terms. We examined how payment term and collateral topics are addressed from the perspective of the company's overall financial position in our article on financial health in setting commercial terms.

Economic risk is a type of risk that is difficult to measure and is usually addressed through long-term decisions. Exchange rate movements also affect the company's price position in foreign markets and the cost structure of its competitors. Movements in the currencies of competitors producing in other countries may be among the factors that determine the company's market share and pricing flexibility. For this reason, the assessment of economic risk takes into account not only the company's own cash flows but also the structure of the markets in which it operates. Diversifying export markets and invoicing currencies is among the strategic options available for managing this risk.

Managing the Foreign Currency Position within Financial Strategy

Once the size of currency risk has been established, financial strategy defines the tools with which this risk will be managed. The tools available to companies with foreign currency revenue and TL costs are not limited to financial products. Decisions taken within the company's own operations can often cover a significant part of currency risk.

→  Natural balance: Aligning foreign currency costs and debt payments with foreign currency collections in the same periods reduces the amount of foreign currency the company needs to convert. In companies that use imported inputs, this balance often forms on its own.

→  Foreign currency financing: For companies with foreign currency revenue, borrowing part of their financing in the same currency as their revenue, within the framework permitted by legislation, matches debt payments with collections. With this method, it is important to keep the debt amount in line with expected foreign currency revenue.

→  Forward sale contracts: The rate at which foreign currency to be received in the future will be sold is fixed today. This method helps the exchange rate used in the budget to be realised and makes the company's margin predictable.

→  Option contracts: These provide protection against the exchange rate falling below a certain level while allowing the company to benefit if the rate rises. A premium is paid in return for this flexibility.

→  Pricing and contract clauses: Price adjustment clauses linked to exchange rate changes in sales contracts, and the choice of currency in supplier contracts, allow part of the currency risk to be balanced through contracts.

→  Foreign currency cash management: Planning the timing of converting foreign currency collections into TL according to the TL payment schedule prevents foreign currency from being converted unnecessarily early or in large single amounts.

Strengthening the natural balance is often a gain that can be achieved without using financial products. When foreign currency payments for raw materials, machinery or services purchased from abroad are scheduled in line with foreign currency collections, the company can make these payments without converting its foreign currency. The timing of investment spending can also be assessed from this perspective. Scheduling a foreign currency machinery investment for the period when foreign currency collections are concentrated limits both currency risk and transaction costs.

Each of these tools responds to a different need, and they are often used together. From a financial strategy perspective, what matters is that the tools are chosen in line with the company's cash flow structure. In a company whose foreign currency collections are regular and predictable, forward sale contracts can be an effective tool. In a company whose collections arrive irregularly on a project basis, natural balance and foreign currency cash management may come to the fore.

The hedge ratio is the main parameter to be defined at this stage. The hedge ratio shows which part of the net foreign currency position will be protected with hedging instruments. For example, a company may choose to protect a high proportion of its net foreign currency position for the next three months and a limited proportion for the period between four and twelve months. This staggered approach makes near-term results predictable while leaving flexibility for the period beyond.

Using hedging instruments also requires planning the relationship with banks. Forward and option contracts are concluded within the limits banks grant to the company and may require collateral in some cases. It is important for these limits to be sized in line with the company's hedging needs so that the policy can be applied in practice. Working with several banks allows different price quotes to be assessed and transactions to be concluded on suitable terms.

Hedging instruments have a cost, and this cost needs to be clearly defined within financial strategy. In forward contracts, this cost is reflected in the rate through the interest rate differential between the two currencies; in options, it appears as the premium paid. It is appropriate to regard this cost as the price of the predictability the company gains against exchange rate movements. When the hedging cost is included in the budget from the outset, results can also be assessed on a sound basis.

Managing the foreign currency position is also closely linked to accounting records. The period-end valuation of foreign currency accounts, exchange difference entries and the accounting method for hedging instruments determine how currency risk appears in the financial statements. Keeping these records accurate and well documented also helps the company in tax processes. We addressed the record-keeping dimension of foreign currency transactions separately in our article on the financial and fiscal check up carried out before a tax audit.

Linking Currency Risk Decisions to Clear Rules within Financial Strategy

Decisions on currency risk are often taken on the spot when market conditions dominate the agenda. In such cases, the decision is shaped by that day's exchange rate expectations and its connection with the company's overall financial strategy may weaken. Linking decisions to predetermined rules allows management to act consistently and predictably in the face of exchange rate movements.

The document in which these rules are set out is usually called a currency risk policy. The first section of the policy defines the company's approach to currency risk. The essence of this approach is that currency risk management aims to protect the company's operating results, not to generate gains. This principle prevents hedging instruments from turning into transactions based on exchange rate expectations.

The second section of the policy is the budget rate. The exchange rate used in preparing the annual budget is the basis of the margin the company plans. Setting the budget rate at a realistic level and making hedging decisions on the basis of this rate helps keep the gap between budget and actual results limited. The conditions under which the budget rate will be updated during the year can also be included in the policy.

The third section of the policy covers hedge ratios and permitted instruments. It defines the hedge ratio for each maturity range, which instruments may be used and which instruments are outside the scope. Setting ratios as a range leaves management room to act according to market conditions.

The fourth section of the policy covers authority and approval. It clearly defines who initiates hedging transactions, which executive approves transactions up to which amount and in which situations the board of directors is informed. This definition ensures that transactions are carried out within an institutional framework rather than depending on the judgement of particular individuals.

The fifth section of the policy is reporting. The net foreign currency position, the hedge ratio, the current value of hedging instruments and the effect of exchange rate movements on operating results are reported to management monthly. This report allows the board of directors to monitor currency risk regularly and to identify in good time the points where the policy needs to be updated.

Another element that can be added to the policy is threshold values. Situations such as the exchange rate falling below a certain level, the net foreign currency position reaching a certain size or a certain change in the value of hedging instruments can be defined as thresholds that require an additional assessment by management. When it is defined in advance which meeting will be held and which options will be assessed once these thresholds are crossed, management can act in a planned way even in volatile market periods.

Keeping reporting simple and regular ensures that the time the board devotes to the subject is used efficiently. A one-page summary table can show the net foreign currency position, the hedge ratio and the gap between the budget rate and the actual rate each month. Presenting this table in the same format every month helps trends to be followed easily and decisions to be taken on time. In this way, currency risk becomes a financial strategy item that is regularly addressed on the board's agenda.

It is also important for the currency risk policy to be linked to the company's overall planning process. When the sales budget, investment plan, financing plan and cash flow forecast are built on the same exchange rate assumptions, all of the company's planning documents become consistent with one another. Carrying out planning and management processes in this integrated way facilitates the inclusion of currency risk in the company's strategic decisions.

It is useful to review the policy at least once a year. The company's export markets, customer base, supplier choices and financing structure may change over time. These changes also affect the size and timing of the net foreign currency position. The review ensures that the policy remains aligned with the company's current structure.

Once this framework is in place, the gap between foreign currency revenue and TL costs becomes a manageable topic for the company. Management responds to exchange rate movements with predefined rules instead of immediate reactions, follows its budget targets with confidence and can turn its attention to the company's growth agenda. In this way, foreign currency revenue becomes a plannable source of value for the company.

At NT Finans Partners, we address the currency risk of companies with foreign currency revenue and TL costs within a financial strategy framework and support management at every stage, from measuring the net foreign currency position to preparing a currency risk policy. To assess your company's currency risk through a planned approach, you can contact us.