In Finance, what is Translation Exposure?

Translation exposure is a risk associated with converting between currencies. There are a number of settings where currency conversion becomes necessary, exposing a company to risk in the process. Accounting personnel can take some steps to limit translation exposure and to account for it on financial statements. Companies must also consider this risk when making certain types of business decisions so they can weigh it and account for it.

Also known as transaction exposure, accounting exposure, or translation risk, translation exposure happens whenever conversions are made from one currency to another. In the process, it is possible for value to become lost or inflated due to the shift in currencies. This can apply to assets, liabilities, income, and other aspects of accounting statements and may potentially cause a problem.

A common situation where transaction exposure arises is in accounting for foreign subsidiaries. A company with subsidiaries overseas is required to include these subsidiaries on accounting statements. In the process, currency conversion must take place to standardize the accounting statement so that it can be more easily read and understood. Because exchange rates change and shift over time, the conversion may result in an inaccurate reflection of a subsidiary's financial position.

Companies negotiating with business partners overseas can also encounter translation exposure. When a company makes an agreement to do business in a different currency, exchange rate changes can force the company into an unpleasant position if its home currency becomes devalued. For example, if a company in the United States makes a deal in Euros, it might end up needing to spend more United States dollars to buy the right number of Euros to settle the deal, driving expenses up on its end.

The use of numerous different currencies worldwide and their interactions with their home economies can present companies that do business internationally with some substantial challenges. Identifying situations where translation exposure may arise can help companies develop methods for addressing the risk in advance. Being aware of fluctuations in exchange rates is also important.

Exchange rate changes don't always result in a a loss for a company. A company that monitors rate shifts closely might be able to take advantage of changes favorable to itself. In the example above with an American company doing business in Euros, for instance, if the United States dollar is gaining against the Euro, the company might end up spending fewer dollars to conclude the deal if it times the transaction for the right moment.