Ideal for

Whether you work with an SME, a large corporation or an institution, this guide is a must-read if:

• you work with a finance team, or
• you’re a part of the accounting or treasury team
• you're a decision-maker of a business with international operations

Introduction

In the FX market, volatility remains a constant challenge for businesses operating internationally. As treasury and finance teams prepare budgets for the upcoming year, they face currency fluctuations, which if left unmanaged, can erode profit margins and disrupt accurate financial forecasting.

The root cause is often the same: no clearly defined budget rate.

A budget rate is the basis for every part of your FX strategy. Set it correctly, and you can achieve predictable margins, reliable forecasts, and the ability to price internationally with confidence. If you set it incorrectly, or don't set one at all, even a strong hedging programme may not fully protect your business.

This guide is written for treasury, finance, and risk managers at high-growth businesses with international operations. Whether you work within an SME or a large multinational, you will get a clear understanding of what a budget rate is, how to set one, and how to build it into a practical hedging policy.

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Hedging is not about predicting where the markets will go; it’s about managing your currency risk. Actually, think of FX hedging as buying an insurance policy to protect your profits from unfavourable currency movements. It helps you worry less about the FX risks and focus more on your business strategy.

Oliver Matts, Head of Product, FX & Risk Management

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What is a budget and why does it matter?

A budget reference rate, commonly abbreviated as budget rate, is a reference exchange rate that a company uses to set prices, costs, or benchmark for a campaign or budget period. One goal of the FX strategy is to protect this budget rate, achieve financial stability, and fortify cash flow forecasts when transacting globally.

• For importers: It represents the exchange rate cost allowed to maintain planned profit margins on foreign currency purchases. For example, if you are a UK importer buying your goods from a supplier in Spain and selling your final product in GBP, you will need to know the cost in GBP to calculate the selling price. 
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• For exporters: It is the benchmark rate required when converting foreign receivables back into local currency to meet targets.

Setting a budget rate is essential for any business with international operations. It enhances financial planning, improves forecasting, provides certainty about the future value of currency exposures, and helps gauge the impact of FX market fluctuations on profit margins.

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Common methodologies to calculate a budget rate

There is no straightforward answer or one-size-fits-all approach to implementing a budget rate in your FX or treasury policy. It should be well-thought, considered within the overall FX strategy, driven by company forecasts and data, and tailored to suit your unique needs and financial goals.

• For an importer, it can be your cost rate plus some buffer to ensure stability. 
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• For an exporter, it is the rate you expect to convert your incoming foreign currency exchange to home currency.

However, the approach to arriving at this rate changes if you are a business that runs more than one campaign within a budget period. Here, you will need to protect the budget rate of an individual campaign rather than the annual budget rate. Different businesses approach this depending on their business situation, including FX flows, historical data, cash flow forecasts, needs, goals, and even risk tolerance levels. It can be:

1. Historical average rate: Using the average spot rate from the previous financial year as a baseline.
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2. Current spot rate: Applying the prevailing market rate at the time of budget preparation (best for short-term planning).
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3. Forward rate/market Consensus: Utilising current forward exchange rates for future dates to lock in or project future rates.
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4. Buffer/adjusted cost rate: Adding a protective margin (buffer) to current rates to cushion against adverse market moves.
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5. Budget rate: Applying the desired target rate you want to achieve
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6. Average of bank forecasts: Calculating the average of previous/current hedges bank forecasts

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Why a one-size-fits-all approach won’t work

Each year, each business, and each goal demands a unique approach. Using last year’s budget rate as a benchmark because the exchange rate favoured you in the previous year may not be the best approach. Similarly, using the current spot rate when budgeting may expose you to future fluctuations. Hence, this approach is best suited when you have a short-term outlook. Depending on your goals, set a budget rate before the start of the financial year, season, period or order and, accordingly, design an FX strategy. 

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Key questions to consider before setting your rate

If you are from the finance or treasury team, here are some of the questions that will help you assess your business circumstances, and FX flows before you set up a budget rate:

• Exposure: What is your exact foreign currency exposure across payables and receivables?
• Forecast accuracy: How accurately can your team forecast global cash flow timings and volumes?
• Margin sensitivity: What are your profit margins, and how sensitive are they to exchange rate movements?
• Pricing models: How far in advance do you fix prices for your end customers? What are the payment terms? 
• Risk appetite: Has your business defined the level of currency risk the business is willing to absorb?
• Budget rate: Have you set a budget rate or prices already? If so, how long is it set for?

Steps to apply a budget rate in your FX or treasury policy

Your budget rate is primarily based on the hedging policy that you employ. However, designing a currency risk management framework doesn’t have to be a complicated process. We recommend using a simple six-step process to build your hedging policy.