Tim Richardson

This is a fairly technical article, but written for a non-accounting audience. I hope to give insight into foreign currency entries you see on the P&L, when to rely on them for useful insights and I also give some ideas about understanding real foreign currency risk and how to deal with it.

Are you interested in knowing when you should hedge currency risk, and when you should manage it as a profit-making business risk?

If so, please see my article here: When hedging currency risk is shooting yourself in the foot

A “real” currency effect is one which affects cash available for the business and for the shareholders. I'm going to assume that the reporting currency is AUD.

“Accounting foreign currency effects” are the effects that foreign currency has on the financial reports. These are not a reliable measure of real foreign currency effects. Instead, they are determined by accounting requirements to balance entries, and to report assets at ‘fair value’. The accounting entries have important differences to real currency results:

• All foreign currency results are reported in the accounts as AUD (since this is the reporting currency), even though the real currency results may be driven by EURO vs USD effects, or some other combination

• The realised gain/loss results are only designed to allow accounting entries to balance.

• In particular, gain/loss entries only happen when there are accrual accounting entries. Businesses like online retail have cash transactions for sales but purchases on credit: they will not get representative foreign currency entries. I refer to this as an asymmetric effect.

As Treasurer for Bellevue Kindergarten, tonight (late) I am working through invoices.We have one from Telsra.

I like to pay by EFT: quick and easy. Usually.

Teltra provides no BPAY or EFT information on the invoice. Amazing, but true. There is a link to a web page where I can advise of my payment details, but visiting the website shows me a page letting me know that the site is down until "July 21". And all links to graphics are broken (or perhaps I am being punished for using Firefox).  No year is mentioned, but today is October. Is Telstra three months late, or do I wait until July 2011? Anyway, I don't want to advise of my payment details, I want to learn how I can pay.

The same section of the invoice invites me to "Pay Online" where I can use "Online Bill to establish up to 1 of 6 Direct Debit payment options". I don't know what Online Bill means: there is no URL, except for the one above where I can advise of my payment details (the one that is down until July 21).

Incredible.

In this article, Exploding Myths, a Yahoo Finance columnist, Julia Lee, seeks to "explode" the myth of index funds. Her recommendation is to buy into value, because index funds only work in a world where the Efficient Market Hypothesis (EMH) is perfectly true. In fact, she holds the EMF to be mythical, and therefore index funds are mythical. She points out that Warren Buffet does not believe in the Efficient Market Hypothesis. He probably doesn't. No one believes the EMH is literally true (I'll get back to this)

One of the more annoying things about Ms Lee's article is that Warren Buffett has consistently recommended that ordinary investors should choose index funds, easily verified by google "Warren Buffet index funds". I did not know that he had endorsed index funds, but he is such a sensible person and index funds are such a sensible idea that his endorsement of them seemed extremely likely. My first google search proved the point very quickly. I don't much of Ms Lee's name dropping; my cross-examination of Mr Buffett would be embarassing for the prosecution, I think.

I'm a commerically focused finance leader rather than a conservative "dot the Is and cross the Ts" accountant. And like many colleagues in Europe and the US, I've spent a lot of time dealing with S404 Sarbanes Oxley compliance, where senior management needs to sign off on the existence of business controls. The consequence is that you need a huge system documenting line managers proving that they have detailed controls at every level of management. Initially, it seemed completely ridiculous. However, it's not all bad.

Firstly, on a personal note: the defining moment that caused me to move into finance was not a turnaround or a big investment. It was basic business controls. I went to Indonesia in the days of the Tiger Economy boom. Business was growing fast, deals were being made, parties were being had and Jakarta was full of expats, money, long nights and gorgeous girls. I was doing post-implementation work with MFG/PRO, reporting to the Finance Director (an austere Dutchman from the northern protestant provinces). He had an internal audit report that was critical about the management of credit risk to our customers, although there were actually no indications of credit problems in an environment of 20% growth. However, we sat down and went through the customers, updating credit ratings, liens, mortgages and bank guarantees necessary. To some customers we said goodbye. Sales management was puzzled.