Foreign Exchange Risk Management at Nestle SA

Introduction

This report is intended to offer substantive coverage about treasury-level issues and foreign exchange exposures applicable for the concerned organisation Nestle SA. Fundamental aspects of this report will cover discussion and explanation of underlying theories relating to foreign exchange risks. Question 2 of this report will discuss foreign exchange risk management approaches followed by Nestle. Simultaneously, question 3 will critically evaluate approaches undertaken by Nestle which would emphasise on noting potential advantages and disadvantages.

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Question 1: Explanation of underlying foreign exchange risk theories

The foreign exchange risk theoretical types are categorised into three parts which include jurisdiction, transaction and translation risks for Nestle SA. Following is the detailed and individual coverage of foreign exchange risk theoretical types identified.

1.1: Jurisdiction risks

Jurisdiction risks are identified as the first foreign exchange risk type where volatility in currencies is experienced due to sudden changes in trading policies and norms initiated by a country and its respective government. As per opinions of Chaboud et al. (2023), jurisdiction risks are mainly visible for unstable countries and this is bound to create difficulties for companies to initiate progressive export trading volumes. The probability of experiencing jurisdiction risks by Nestle SA is perhaps minimal since its major operations are initiated from Switzerland which is deemed as a stable economy.

1.2: Transaction risks

Transaction risks are identified as the second foreign exchange risks where volatility in foreign exchange valuation is experienced due to sudden appreciation or depreciation faced for currencies. The appreciation or depreciation can occur in the home or foreign country concerned with Nestle SA and its impacts are mostly felt by the buying or purchasing country. Syadali et al. (2023), stated that transaction risks also account for time lags between countries experienced from invoicing to delivery stages which could lead to upscaling of necessary costs.

1.3: Translation risks

Translation risks are recognised as the third foreign exchange risks where Nestle SA experiences volatility when currency fluctuation of its foreign subsidiaries are witnessed. The nature of translation risks mostly impact internal facets of Nestle SA due to which its financial reporting in income statement and balance sheet is jeopardised. As Hassan et al. (2023), idealised that translation risks also account for reporting financial performances of subsidiary foreign companies in the principal company due to which risks are encountered when the currency exchange process is initiated for recording transactions.

Figure 1: Theoretical Types of Foreign Exchange Risks

Question 2: Analysis and description of foreign exchange risk management approaches undertaken by Nestle

Foreign exchange risk management approaches undertaken by Nestle SA are exercised by adopting two techniques including internal and external techniques. The following is an individual discussion about internal and external techniques implemented by Nestle SA.

2.1: Internal techniques adopted

The internal techniques adopted by Nestle SA are identified as enactment of matching and offshore settlements, reporting to board of directors and implementation of a treasury policy. All of these techniques are predominantly exercised to minimise expense bearing capacity of Nestle SA to manage and effectively counter foreign exchange risks and the following is an individual elaboration of the identified internal techniques.

2.1.1: Matching and offshore settlements

Matching and offshore settlements are identified as the primary internal technique implemented by Nestle SA to implement foreign exchange risk management where a unique group entity is conceptualised as part of reciprocal agreement between parent and subsidiary companies. The reciprocal agreement conceptualised as part of matching and offshore settlements are mostly performed to limit currency fluctuations arising due to loans taken from creditors. As a result of matching and offshore settlements Nestle SA has experienced favourable cash flow movements in 2023 where gains of EUR 58,301,000 have been realised (nestle.com, 2023). Hence, it can be observed that favourable foreign exchange outcomes have been experienced by Nestle SA in recent times due to initiation of matching and offshore settlements and hence a better business progression is established for future concerns.

Figure 2: Foreign Exchange Gains of Nestle SA

2.1.2: Reporting to board of directors

Reporting to the board of directors is the second internal technique adopted by Nestle SA where foreign exchange risk management is initiated on the back of reducing sharing capital funding by a margin of 5 million. This arrangement is widely recognised as the share buyback program which aids to generate surpluses in shares and stock prices which can compensate for fluctuations in currency exchanges if and when experienced. The reporting to the board of directors has been beneficial for Nestle SA in FY 2023-24 as it has witnessed a 7.5% growth in currency pricing from total group annual performances (nestle.com, 2023a).

2.1.3: Implementation of a treasury policy

Implementation of a treasury policy is identified as the third internal technique adopted by Nestle SA in which guidelines relating to holding assets under management are prescribed for mitigating imminent foreign exchange risks. The implementation of this technique is deemed beneficial from Nestle SA’s perspective since a higher and reliable credit quality could be achieved due to limited expected exposures arising from return funds. As viewed by Menand and Younger (2023), implementation of a reliable treasury policy also benefits a company's foreign exchange risk management competency by regularly following current currency market trends and appropriately projected future trends likely to be encountered. Consideration of regular audits at specific intervals can also be complemented by Nestle SA due to existence of a reliable treasury policy. The impacts of implementing a favourable treasury policy by Nestle SA can be recognised in its financial annual performances of 2023 where an operating profit margin of 17.3% is observed in comparison to 17.1% observed for 2022.

Figure 3: Operating Profit Margin of Nestle SA

2.2: External techniques adopted

The external techniques adopted by Nestle SA are located as forward contracts, swaps and adopting currency hedging techniques. These techniques are mainly exercised by Nestle SA to boost its business credentials in the external environment as well as simultaneously to propagate effective strategies implemented for managing foreign exchange risks. Following is the detailed and individual analysis of the identified external techniques applied by Nestle SA. 

2.2.1: Forward contracts

Forward contracts are identified as the primary external techniques in which hire purchasing agreements are initiated by Nestle SA with a foreign company in exchange of mortgaging company assets. As per statements of Drehmann and Sushko (2022), forward contracts are deemed inclusive of delivering assets at a predefined specified date and hence are considered as a type of derivative. The consideration and implementation of forward contracts as an effective technique for foreign exchange management is characterised on the basis of allowing higher flexibility to the buyer for making periodic settlements to the seller. The implementation and exercise of forward contracts is also deemed beneficial on part of Nestle SA to implement a temporary hedge where contract prices cannot be changed by either the seller or the buyer. This is also an effective strategy to nullify external market and economic influences due to which currency fluctuation in markets is witnessed.

2.2.2: Swaps

Swaps are identified as the second external technique initiated by Nestle SA in which financial instruments or cash flow reserves are mortgaged to purchase foreign currencies or assets. The swaps are also considered as integral parts of a derivative system in which a fixed and variable swap exists between parties and the variable swap accounts for changes in index price and interest rates. The characteristics of swaps are deemed to be proactive from Nestle SA’s perspective since an intermediary mode of currency exchange facilitation can be exercised while it also has the flexibility among parties to conduct mutual termination if and when necessary. The implementation of swaps by Nestle SA is deemed effective to actively manage credit risk facilities and thus encouraging availability of a higher financial liquidity. The effects of initiating swaps by Nestle SA can be observed in its financial statements where the company has achieved an organic financial growth of 7.2% in 2023 (nestle.com, 2023a).

2.2.3: Currency hedging

Currency hedging is identified as the third technique undertaken by Nestle SA where fixing of foreign exchange rates is initiated with overseas parties to safeguard its financial interests from external volatilities. This technique is identified as a proactive strategy where companies intend to exercise financial damage control and limit risk of high losses (Opie and Riddiough, 2020). The effects of currency hedging can be viewed for Nestle SA in favourable terms as the company has witnessed a drastic reduction in hedging financial debt value in 2023 which is numerically represented as EUR 248 million (netsle.com, 2023).

Figure 4: Currency Hedging by Nestle SA

Question 3: Critical evaluation of approaches

The critical evaluation of approaches adopted by Nestle SA can be observed in terms of techniques used and their corresponding advantages and disadvantages.

3.1: Advantages

The following is an individual discussion about advantages relating to internal and external foreign exchange risk management approaches and practices followed by Nestle SA.

3.1.1: Matching and offshore settlements

The advantages of exercising matching and offshore settlements by Nestle SA allows the company to minimise currency fluctuation risk exposures as well as provides the scope of minimising transaction costs. The minimisation of currency fluctuation risk exposures is deemed beneficial on part of an organisation to conduct free foreign trade and offset any losses with gains obtained from currency exchange risk reduction. Scope of minimising transaction costs helps Nestle SA to merge and record currency exchange transactions due to which more financial reserves can be secured for other activities.

3.1.2: Reporting to board of directors

Implementation of a healthy currency exchange decision making as well as higher organisational credibility is identified as the major advantages available to Nestle SA when internal foreign exchange risk management techniques are followed. According to Challoumis (2024), a healthy currency exchange decision making is important for an organisation to identify what potential overseas markets should be targeted to enable organisational progression. Higher organisational credibility is beneficial from Nestle’s perspective to conduct future prospects of Financing and asset distribution in a resounding manner.

3.1.3: Implementation of a treasury policy

Ability to promote cash optimisation and forecasting as well as reduction in borrowing costs are identified as the key advantages associated with implementation of a treasury policy by Nestle SA. Both advantages of cash optimisation and reduction in borrowing costs is beneficial on part of Nestle SA to enable a competitive cash flow planning as well as to encourage more debt infusion to conduct future activities associated with foreign investments. 

3.1.4: Forward contracts

The advantages and benefits of exercising forward contracts as part of external techniques by Nestle SA include ability to lock an optimum exchange rate as well as to empower future cash flow growth. As explained by Beckmann et al. (2020), the locking of an optimum exchange rate is beneficial for organisations to safeguard itself from overseas market currency fluctuations. Similarly, empowerment of future cash flow growth is achieved due to forward contracts as certain and near guaranteed liquidity estimation can be made by Nestle SA.

3.1.5: Swaps

Availability of financial and currency exchange flexibility as well as minimal transaction costs are identified as key advantages of swaps. As Kirkby (2023), expressed that both of these advantages are beneficial from an organisation’s perspective to place currency exchange rates as per individual convenience due to which financial suitability can be gained.

3.1.6: Currency hedging

Minimisation of foreign exchange trading losses as well as Forex portfolio diversification opportunities are identified as key advantages associated with currency hedging. Both of these advantages are deemed fruitful for an organisation to promote healthy foreign currency trading practices due to which financial sustainability can be guaranteed for a prolonged period (Harasztosi and Kátay, 2020).

3.2: Disadvantages

An individual discussion about disadvantages relating to internal and external foreign exchange risk management approaches followed by Nestle SA is mentioned below as follows.

3.2.1: Matching and offshore settlements

Higher time considerations and lack of tax benefits available to Nestle SA are identified as key disadvantages of exercising matching and offshore settlements to empower foreign exchange risk management. As critically opined by Vissing-Jorgensen (2021), higher time considerations for matching and offshore settlements is expected to provide a higher input from an organisation due to which productivity on other facets gradually decreases. Lack of tax benefits further increase the likelihood of currency exchange losses due to which international trading becomes jeopardised.

3.2.2: Reporting to board of directors

Disadvantages of this technique predominantly include higher possibilities of conflict among board members as well as potential loopholes visible in terms of transparency. Both of these disadvantages are likely to relegate foreign exchange management in a reliable and competent manner for Nestle SA due to which the company is expected to face challenges in terms of initiating foreign trading.

3.2.3: Implementation of a treasury policy

Disadvantages or challenges associated with implementation of a treasury policy by Nestle SA involve likelihood of third-party frauds as well as lack of higher control to fix and modulate currency exchange rates. Zhang et al. (2019), critically illustrated that the likelihood of third-party frauds is impactful for an organisation due to which disclosure breaches for foreign exchange contracts are experienced. Lack of higher control to fix and modulate currency exchange rates further disables Nestle SA to dominate overseas companies and markets in terms of maintaining a linear trading pricing strategy. 

3.2.4: Forward contracts

Absence of mutual termination and lack of opportunities to capitalise on a prosperous exchange rate are identified as key disadvantages of forward contracts. Both of these disadvantages do not pose the ability to generate incremental cash flows for Nestle SA due to which the company is dependent upon its foreign collaborators to ensure better currency exchange management available in the long run.

3.2.5: Swaps

Potential disadvantages of swaps by Nestle SA include higher possibilities of credit risks and improper matching and estimation of interest rates. As critically stated by Alfaro et al. (2021), both of these disadvantages are expected to make foreign exchange prospects more volatile for an organisation due to which continual difficulty is experienced in future.

3.1.6: Currency hedging

Inaccurate market predictions and lack of generating higher opportunity costs are identified as potential disadvantages of currency hedging techniques adopted by Nestle SA. As critically explained by Naveed et al. (2024), inaccurate predictions and lack of generating higher opportunity costs could nullify the purpose of currency hedging due to which foreign currency reserves of a company reduces.

Conclusion

In this report, the main financial risks are classified in terms of jurisdiction, transaction and translation risks due to which impacts on financial reporting and changes in governmental legislatures is witnessed by Nestle SA thereby affecting foreign exchange management. Foreign exchange risk management is conducted through key internal and external techniques involving offshore settlements and swaps by Nestle SA due to which it can maintain a dominating overseas presence. Advantages and disadvantages of techniques have been covered in this report which includes guaranteed cash flows and lack of transparency and financial prosperity by Nestle SA. 

Reference List

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