Budgeting for International Operations: Impact on and Integration with Strategic Planning

Foreign currency exchange rates, interest rates, and inflation are the three major external factors that affect multinationals' budgets. Chief financial officers know they have no influence or control over this Bermuda Triangle of outside forces. Nonetheless, these elements must be estimated, evaluated, and examined as part of a multi national's strategic plan. Although these variables are interrelated (for example, higher inflation in a specific country tends to drive down the value of its currency, which impacts the exchange rate, and price inflation would drive up interest rates), the changes in currency exchange rates have the most direct effect on the budgeting process for a multinational corporation. We will show you 19 company examples so you can see the broad range of issues involved. (Some of the company names are hypothetical.) Example 1 The uncertainty introduced by the volatility of foreign currency exchange rates has been evident in recent years. In the span of one year, the value of the euro went from $1.48 on February 25, 2008, to $1.27 exactly a year later, a decrease of 14%. A similar significant change was observed in other major currencies (e.g., the value of the British pound went from $1.97 to $1.42, and the Canadian dollar depreciated from $1.00 to $0.80 during the 12 months ending on February 25, 2009). The general strengthening of the U.S. dollar was expected to negatively impact the already weak trading position of U.S. exporters. (2) On the other hand, the June 2010 decision of the Chinese government to allow more flexibility to the yuan did provide export opportunities for U.S. companies. (3) Changes in these three external factors stem from several sources, including economic conditions, government policies, monetary systems, and political risks. Each factor is a significant external variable affecting areas such as policy decisions, organizational procedures, and budget control. To minimize the possible negative impact of these factors, multinational corporate management must establish and implement policies and practices that recognize and respond to them. Other external forces exist, such as political turmoil, competition, labor quality, and cultural or religious orientation of the local populace, but they tend to be related specifically to one country or particular region of the world. For example, the events of September 11, 2001, have been significant to U.S.-based multinational corporations. Since 9/11, the strategic plans of many international entities have focused on security measures, employee counseling, and other special training that they had not paid much attention to in the past. All of these efforts must be addressed in budgeting for an international operation. FOREIGN CURRENCY EXCHANGE RATES Of all factors influencing international budgeting, foreign exchange rates have the most significant and pervasive effect. Changes in foreign exchange rates are explained by different theories, but essentially they are based on the underlying demand for assets denominated in a particular currency. Foreign exchange rate fluctuations affect a multinational through translation exposure, transaction exposure, and economic exposure. Each of these exposures has a different effect on the entire budgeting process and on the strategic marketing and operating decisions. Translation Exposure Translation exposure influences financial statements during the development of a budget and/or while the budget is being used for control purposes. Specific exchange rates, usually based on forecasted values, must be determined and applied when preparing the budgeted financial statements from the applicable operations budgets. (4) Throughout the budgetary period, the actual exchange rates likely will vary from the anticipated exchange rates. The differences can generate unpredictable--often uncontrollable--results during interim and final budget performance reviews. …

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