Exchange rates cause budgeting problems

Peter Crawford had learned from long experience that control of a growing company was impossible without accurate, up-to-date financial planning. Peter left most of the planning to Stan Waterman, AP's controller. Stan reviewed the company's sales forecasts and projected expenditures product by product, and by geographic region. He then assembled all the information into an overall consolidated budget for the corporation as a whole.

Normally Peter would not be involved in the details of the process. But today Stan had a problem, and he wanted Peter's advice. The problem concerned the exchange rate of the British pound and how to allow for it in the financial plan.

Although export sales represented 16% of AP's total volume, 60% of all exports went to England. In recent years economic difficulties and inflation in England had resulted in a steady decline in the value of the pound. Each decrease in the value of the pound amounted to a corresponding increase in the price of goods imported into England.

As the price of incoming products rose, domestic goods in England became more competitive. In the past the steadily falling value of the pound usually resulted in serious reductions in AP's exports to that country.

Recently, however, the British government had announced it was about to take measures to control inflation, which led many to believe that the situation might stabilize. The problem now facing Waterman was how to take this into account in preparing the budget.

The prevailing exchange rate was $1.30 to the pound. "In the past the weakening pound has caused sales in England to decline steadily. But I'm not sure what's going to happen this year," Waterman said. "The pound might even start rising before year-end. On the other hand, further declines can't be ruled out either. I'm not sure which assumption to base the plan on".

Peter thought the problem over. He decided the best thing to do would be to assume the current rate would hold through the entire year. "We'll be reforecasting the budget on a quarterly basis, in any case. So we can keep an eye on the situation and make adjustments later for whatever happens in the meantime."

Stan agreed and told him the consolidated plan for the following year was almost complete. "It's going to be a busy year," he said. "If your estimates are accurate, we might see the largest single sales volume increase in the history of the company," he added.

"What about profits?" asked Peter.

"That's less certain, but I'm optimistic. We're breaking a lot of new ground, and that's expensive. Any dramatic profit results may not be felt until a year or more from now."

"I only hope the Board sees it that way," thought Peter.

Questions about the story

1. Who is in charge of financial planning at Audio Performance?

2. What information does he need to prepare the budget?

3. What matter did Stan want to consult Peter about?

4. How much does AP export to England?

5. What had been happening to the value of the pound?

6. What was the cause of this decline?

7. How did the exchange rate affect the price of AP's exports to England?

8. What had been happening to AP's export sales as a result?

9. What announcement had the British government made?

10. What effect might the new government have on the exchange rate?

11. How had the exchange rate been anticipated in previous budgets?

12. How did Peter tell Stan to handle the problem in the financial plan?

13. How often would the budget be reforecast?

14. What did Stan think would happen to sales volume in the following year?

15. Why would the effect on profits probably be less immediate?

For discussion

1. How can fluctuating exchange rates be used to the advantage of a company?

2. What action can governments take to affect exchange rates?

3. Describe several examples of companies (or countries) that are presently benefiting from rising (or falling) exchange rates?

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