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In Finance, what is Translation Exposure?

Mary McMahon
By
Updated May 16, 2024
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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.

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Mary McMahon
By Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

Discussion Comments
By burcidi — On Jul 01, 2011

Businesses could also predetermine the exchange rate at which they will be doing business. That way, each business would pay or receive the amount that they expected to all along. There won't be any surprises.

This is probably the best way to avoid translation exposure and to make sure that the deal is happening fairly. Otherwise, a business can even go bankrupt from translation exposure. I've read about it before.

By ysmina — On Jun 30, 2011

As far as I know, firms don't necessarily have to accept translation exposure and pay up the difference. They can include it as a cost in their agreement with the other firm before any payments are made.

So if a company can predict that there is a chance of translation exposure, it can estimate it's losses and include it as a cost in the agreement which would cover for the translation exposure if it happens.

By fify — On Jun 29, 2011

As individuals, we also lose or gain when we go abroad and exchange our currency for that country's. Based on the rates for that day, the value of our money might go up or down and we might have to spend more or less on vacation to control for that.

But I can see how problematic it can be for businesses who are working with a weaker currency if there is a translation exposure. The business that has the stronger currency is not going to suffer, they are getting the better end of the deal either way. But if you have the weaker currency, like the dollar against the euro, it really can tip the balance.

I really don't know how businesses can control for this. We never know what the exchange rates are going to be like, it's really not something that can be predicted. I guess it's a bit of a gamble; definitely a risk for businesses.

I had never thought of this before, but buying parts of a product or raw materials from another country might not always be as easy and profitable as it seems if there is translation exposure.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a...

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