Management of Assets and Liabilities in Forex

When dealing in Forex, a net asset position may be determined in more than one way. In general, the type of action that may be taken involves the timing of purchase, purchases, or payments, and the utilization of credit by either the payor or the payee. One can examine general types of current assets or liabilities and determine what action may be taken with regard to them.

It might be simplest, first, to consider the possibility of devaluation, and then that of a revaluation. To protect against devaluation, the objective should be to reduce working capital to a minimum or make it negative. Since working capital consists of current assets, less current liabilities, any action that reduces a current asset, and at the same time reduces a current liability, has no effect on the capital position.

In the same fashion, an action that increases both a current liability, and a current asset, has no effect as far as working capital is concerned. We must, therefore, consider actions that change only one or the other, and not both.

Let us start with cash. The first measure of protection would be to turn cash into another currency not exposed to a possible devaluation. To some extent that can be done, but it is inhibited by several factors. The first factor is the operating needs of the business, which are difficult to cover by bank accounts outside the country.

The second factor is that frequent conversions are costly, since there is a differential between the buy and sell rates for a particular currency; third, prior to devaluation, exchange controls are often instituted, and they may prohibit bank accounts abroad. The effect of a cash account in another currency is to reduce the cash in local currency, and it will be remembered that only the working capital in local currency is exposed to devaluation.

What else can be done to reduce cash? As pointed out, there is no change in exposed assets if cash is used to payoff current liabilities, or to purchase current assets, with the possible exception of inventory. Therefore, cash must be used for purposes that do not reduce current liabilities.

It follows, also, that cash must be in excess of the operating needs of the business, so that it is actually available. First of all, excess cash may be used to reduce obligations in other than local currencies, since those obligations are excluded from the working capital calculation. Secondly, cash can be used to pay for the purchase of capital assets, or other assets that have a constant value. That is not quite as simple as it seems, since there is generally a time lag between a decision to purchase a capital asset, and the receipt and payment of the billing.

If the capital asset is translated at the value of the date of receipt, there is no protection until it is received. Cash may be used to repay long-term obligations. That does not give economic protection; because of the usual translation procedures, it does protect against an immediate loss from devaluation.

Finally, cash may be used to repay capital, as in a branch, and for dividend and profit remittances. There are often legal formalities and exchange restrictions that may make it difficult to make such transfers readily, but to some extent they can be planned for, if there is sufficient time.