Especially when it comes to physical products, there is a time lag between making business decisions and seeing the effects of those decisions on the company’s bank account. During that time gap, the purchase and sales orders are negotiated, materials shipped around the world and goods manufactured, stored and delivered.
In parallel to that physical process, invoices are being sent, reviewed, approved and eventually paid. Meanwhile, currencies are appreciating and depreciating. If the material and manufacturing costs are in a different currency to the sales receipts, those fluctuations in FX rates can easily wipe away the sales margins the company used as the basis for its original decision-making.
Financial instruments can help mitigate this uncertainty that jeopardizes the company’s financial objectives. This is called hedging, and it ensures that the FX rates affecting the company’s bank account balances are not too different from those used in its decision making.