This is known as financial exchange risk and is one of the major financial risks affecting businesses (especially global) today. There are three forms of foreign exchange risk: transaction exposure (affects the cash flow of the organization), economic exposure (affects overall effect exchange fluctuations have on the value of the organization) and, accounting exposure (concerned with the effect exchange fluctuations have on accounting reporting of assets and liabilities) ((Fornés, 2009).
Businesses that make payments in the form of foreign currency are exposed to foreign exchange risk in the form of transactional exposure. Take a multinational such as Heineken for example, with operations in more than 70 countries globally, the company often has to import raw materials from foreign suppliers most of whom have to be paid in foreign currency (Fornés, 2009). The financial risk here is that there exists a 50-50 likelihood that exchange rates dynamics could result in the company spending more to pay the suppliers than it had planned. Global companies with foreign subsidiaries often face financial exchange risk in the form of accounting exposure (Fornés, 2009). Again taking the example of Heineken, the company has to convert the value of its subsidiaries' assets and liabilities into one currency for the group's financial accounting records. Depending on the nature of currency exchange rates, at the time of reporting, this conversion could result in foreign exchange losses or profits (Homaifar, 2004). This is due to the fact that a decline in the value of the currency in which your liabilities/assets are represented will result in a lower value of your liabilities/assets when appraise in a different currency compared to the period before decline in value (Homaifar, 2004).
Foreign exchange risk is not solely biased to global companies but can also affect companies that only sell locally.
