One of the risks within a commodity contract is currency fluctuations. Example: As a euro company I’m purchasing a product today in March with an expected delivery in May and 45days payment term leads to a payment in May. The invoice amount is 50.000 USD, the expected forward rate for June is 1,12061 (EUR-USD) which leads to an 44.619 EUR amount. To protect yourself from currency rate fluctuations, you want to fix a rate with a bank or internal FX desk.
Each company is managing this risk differently, e.g. it can be managed on total currency exposure by period or by exposure per contract.
C4C is supporting both, but the last option can give insight within the currency P&L per contract. Below example describes how C4C is managing the currency exposure on contract level.
Managing currency exposure contract level
During purchase contract entry the trader defines purchase price plus all additional cost. The additional cost components are entered manually or via predefined formulas and templates.
In this example the trader has a 50.000 USD exposure. The expect rate (Cur. Rate) comes from a forward rate table which is updated daily via an external data source. The rate period is based on the expected invoice date + plus payment term days of the contract..
The trader and the counterparty sign the contract and a FX requirement is sent to the FX desk of the company.
The FX desk manages the foreign currency exposures. The size of FX desk differs per company from 0.2 FTE to 3+ FTE’s.
At set times, all FX requirements (buy and sell) are collected and grouped by currency and period.
The FX desk decides which FX requirements to hedge. In this example we select only the FX requirement from the example contract. After selection, a bank order is prepared for further processing and interface with an external bank.
The bank order is a forex contract request with a bank, at creation the fields bank reference, sell amount and rates are empty. But after the accepting the FX contract request by the bank, we import the agreed data into the bank order.
The rate of this bank order is updated on the physical contract calculation, so that the trader can view that there is no more exposure on his contract.
If additional cost are expected after FX requirement, the trader can amend his contract and request a FX requirement for the difference.
Moment of absorption
The contract was created in March, and the delivery is in May. The system exchange rates are set-up as following:
If the full quantity of the contract is received the EUR amount of the inventory is 50.000 USD * 0.892 = 44.600EUR in standard F&SCM.
When the FX manager is activated there is a correction created against hedge value. In our example 50.000 USD against a hedge rate (See bank order) of 0.91000 = 45.500 EUR. This is also what the trader wants see as inventory value after receiving the inventory.
Post packing slip, FX hedge correction via misc. charges
In the C4C Financial event overview this is shown as following:
The purpose of the financial event form is to manage all additional cost on orders (PO, TO, SO). It provides information about the status of an accrual versus actual received invoices, and helps to user to release remaining accruals to the P&L. It is not only used for FX but additional cost in general, e.g. freight, duty, THC etc.
Posting goods invoice
Financial inventory value after purchase invoice
The remaining steps: maturity of the bank order, bank settlements, FX closing job, and the financial insight of the hedge result on order level will be explained in part 2 of this blog.
Please contact us if you have question about the FX manager or Cloud4Commodities in general.