Case Study: FLIR Optimises FX Exposure Management
FLIR Systems Inc has radically revised and improved the
quality and effectiveness of its foreign exchange (FX) exposure management
process in recent years. Headquartered in the US town of Wilsonville, Oregon,
FLIR is a world leader in the design, manufacture and marketing of sensor
systems that enhance perception and awareness.
With annual
revenues of US$ 1.4bn in 2012, FLIR’s global operations include manufacturing
units in the US, Sweden, France and Estonia. With sales and service operations
in 22 additional countries and international sales comprising approximately 50%
of revenues, FLIR is exposed to a wide range of currency pairs.
At
the time of the first shocks of the global financial crisis in 2008, FLIR’s
treasury team was unable to perform a systematic, dependable analysis of the
company’s global FX exposures. Accordingly, corporate earnings and EPS
(earnings per share) were very vulnerable to the volatility of the FX markets,
since they were continually subject to unpredictable gains and losses. When I
joined FLIR, I was tasked with rectifying this unacceptably high risk
situation, by researching and delivering a structured solution that properly
addressed FX exposure management in a radically changed financial environment.
The Base Situation
The treasury team was
spending too much time and effort in tedious attempts to track down the
organisation’s monthly FX exposure data from FLIR’s global network of operating
units. Before initiating their FX transformation initiative, treasury found
that the general ledger figures they were able to retrieve from enterprise
resource planning (ERP) systems and Excel spread sheets were inaccurate,
incomplete and outdated. They could not be meaningfully analysed, let alone
used to plan and execute the best available FX risk mitigation actions.
The corporation depended on the analysis of historical patterns when
predicting future FX movements, and to adjust the balances of inter-company
accounts based on this approach. This method had worked well enough in an era
of stable currency markets but, post-crisis, such conditions quickly became a
distant and misleading memory. We were tasked with rectifying this situation,
so needed accurate, complete and timely exposure intelligence to understand
what our best internal and external options were, and to plan and execute
approved currency actions. Our internal benchmark was to get and keep our FX
gains and losses under US$0.01 EPS – and that is what we set out to do.
FLIR’s FX Exposure Management Project
The
objectives of FLIR’s FX exposure management project were to:
The first step we took was to
analyse the volatile FX gains and losses that were occurring, by researching
the realities of the underlying exposures. It seemed at the time that the
obvious way to achieve this was through SAP’s software solutions, via
examination of the underlying multi-currency payables and receivables. FLIR’s
major subsidiaries were using a single instance of SAP as their ERP system, so
it seemed feasible to seek an enterprise-wide view of the exposures through SAP
reporting.
In practice, this approach did not yield the desired
result. Our in-house IT team members were SAP experts, but the technologists
were not sufficiently expert in the complexities of FX exposure management. The
reporting that was produced was not sufficiently detailed to be effectively
usable by treasury for FX exposure management. Also, there were a number of
FLIR field offices running on non-SAP ERP systems, and we found it necessary to
integrate their exposure information to perform an effective enterprise-wide
exposure analysis.
Additionally, our corporate structural
environment was liable to change and become more complex through acquisitions,
each of which would impose new demands on the flexibility of whatever FX
exposure management solution we were to put in place. Accordingly, we decided
to seek an outside solution- having first considered developing a solution
internally, but finding that the issues and complexities already mentioned
ruled out this approach. It would have required a very substantial IT
investment, plus the development of in-house staff to gain the necessary high
level of FX management expertise, so evidently this would have been a risky and
expensive path to follow.
Solution Selection and Proof of
Concept
Having reviewed the option of building an in-house
solution, FLIR’s treasury selected FiREapps to provide both a technology
platform and FX exposure management advisory services. A major reason for doing
so was their cloud-based service delivery model. This would enable us to adapt
swiftly to changing situations, such as corporate acquisitions and
reorganisations, without impacting scarce internal IT resources. The essential
reason for this is that the vendor is responsible for the maintenance and
support of the technology, including making the configuration changes needed to
accommodate new corporate organisational structures.
FLIR ran a
pilot project to validate that the chosen software could actually deliver the
results required. The team working on this consisted of the author and one
internal IT resource, collaborating with the vendor’s FX and technical experts.
While it took us about 30 days to fully validate FLIR’s total FX exposure based
on complete and accurate monetary asset and liability data from SAP, it took
our IT person less than three hours to enrol in FiREapps’ service. ‘Enrolment’
is the term used to describe the configuration and set-up functions needed to
use the software in our environment. We then successfully validated the pilot
results by comparing them with verified manually-derived exposure data. The
pilot proved that dependably and accurately revealing FLIR’s corporate FX
exposure position was no longer an elusive goal.
Exposure
Management
The next step was to identify and exploit
natural offsets that resulted from the company’s commercial activities,
previously obscured as FLIR had collected and analysed exposures at a
divisional level only. Having achieved that advance, treasury could then
progress to design and implement an external hedging programme to manage the
range of currency pairs to which FLIR was still significantly exposed.
This was accomplished using FiREapps Cost and Risk Efficiency (CoRE)
analysis. The objective was to benchmark the hedging programme from a cost/risk
perspective, select the right currency pairs for its expansion and to highlight
the most cost-effective external hedging strategies. The result of this
analysis was the identification of more than 30 currency pairs, which together
amounted to a gross exposure of approximately US$97m with a value at risk (VaR)
of about US$16m spread across a portfolio of currency pairs including euro/US
dollar (EUR/USD), Swedish kroner (SEK)/USD, SEK/euro (EUR), British pound
(GBP)/EUR, GBP/USD and USD/Brazilian real (BRL).
FLIR leverages
our vendor’s patented analytics to optimise the cost/benefit of various
external hedging strategies. CoRE analysis takes into account the underlying
volatility and interest rate differential for all our currency pairs. This
directs our hedging actions towards the real sources of high risk in some of
the more exotic currencies to which we are exposed – not just towards the
largest nominal exposures such as the USD/SEK.
Over a year’s
operation, the solution resulted in a 50% VaR reduction, and a virtually
risk-free quarterly interest income increase of about US$20,000. The
combination of the software and expert consulting services provide both the
tools and specialised knowledge FLIR needs to keep FX gains and losses within
the industry benchmark of US$ 0.01 EPS. The software actually does what it
claims, giving me the understanding necessary to make the best hedging
decisions possible and to work with subsidiaries and controllers to
troubleshoot FX issues by currency pair. Moreover, the people behind the
technology are truly there to support me. I can phone and ask a question I’ve
asked three times already, or ask how to do a specialised analysis for my chief
financial officer (CFO) and I know they’re going to help me.
System Operations
The application easily
aggregates and then validates monetary assets and liabilities from multiple
source systems within the enterprise – one of the IT complexities that prompted
us to seek an external solution. We use this process to harmonise data from
SAP and other ERP systems around the organisation, and then to generate an
accurate, complete and timely multi-currency position analysis based on
payables (AP), receivables (AR) and cash on demand.
Our new process
has proved invaluable for integrating new subsidiaries after an acquisition
transaction has closed. It now takes only a few weeks to understand and add the
new set of exposures into our FX management process. We can do this without
making significant demands on scarce in-house IT staff, saving substantial time
and effort in the management of each similar corporate event. This helps us to
harmonise the subsidiary’s exposure management processes with the rest of the
corporation quickly and effectively.
It’s important to stress
that the analytical framework we now use is fully aligned with FLIR’s corporate
risk management policies. This means that we are completely confident in the
analysis so we can do much more than simply take external hedging decisions.
With a trusted, on-demand view of our full portfolio of exposures, we’re much
better positioned to take advantage of natural offsets that eliminate exposure
organically and save us the associated transaction costs.
This
process improves corporate profitability by providing additional working
capital to the business, as well as optimising interest income management.
FLIR’s commercial operations receive the benefit of more plentiful low-cost
liquidity, and the corporation enjoys increased revenue from investment of the
redeployed cash. As necessary, we can call on the vendor’s FX management and
technical experts to provide us with prompt and effective support for resolving
any questions and issues that arise.
Real Benefits
Achieved
FLIR has experienced real, tangible reduction in
FX-related earnings volatility as it has rolled out the FiREapps solution
across the enterprise.
The key benefits that we continue to enjoy
include:
Conclusion
Today, we are
fully confident that we know our enterprise risk position with at least 95%
accuracy. We see the cost of this programme as an insurance premium we are
happy to pay because of the tangible benefits that FLIR continues to realise
through best practice management of FX exposures. The effective elimination of
the potential for large, unexpected FX losses that could hit us in any quarter
fully justifies the investment in securing FLIR’s international revenues and
profitability.
Considering how much FX market volatility has hurt
us in the past, the cost of this service is ridiculously small – and the FLIR
FX exposure management project has, in practice, paid for itself many times
over. There’s nothing worse than blindly entering into FX hedging contracts
without properly understanding your exposure. You will inevitably compound the
problem and it will not end well. Understanding our exposures and their
magnitude tells us when, where and how to attack FX volatility.