Transaction exposure impacts a forex transaction’s cash flow, whereas translation exposure impacts the valuation of assets, liabilities, etc., shown in the balance sheet.
Multi-national enterprises are posed with both transaction exposure and translation exposure as a part of international financial management decisions. Any company with international operations has to deal with foreign exchange risk. Resulting in different positions on cash flows and balance sheets. Comparing transaction exposure vs translation exposure is equivalent to comparing cash flow accounting treatment vs. book accounting treatment or managing cash flow risk vs. balance sheet risk.
Transaction vs Translation Exposure
Let us understand the difference between Transaction and Translation exposure covering the following points of difference.
|Points of Difference||Transaction Exposure||Translation Exposure|
|Transaction exposure impacts the cash flow movement and arises while conducting purchase and sale transactions in different currencies.||Translation exposure is not a cash flow change and arises as a result of consolidating the results of a foreign subsidiary. Translation exposure is usually driven by legal requirements asking the parent company to consolidate financials.|
Need of Foreign Affiliates
|For a transaction exposure to arise, the parent company doesn’t necessarily need to have a foreign affiliate or a subsidiary.||Translation exposure can arise only when a parent company is consolidating the financials of a foreign affiliate or subsidiary.|
Gain / Loss
|Transaction exposure results in realized gains or losses||Translation exposure results in notional / book gain or losses|
|Transaction exposure arises when a company enters into a transaction involving foreign currency and commits to make or receive payment in a currency other than its domestic currency.||Translation exposure arises on the balance sheet consolidation date and is at the end of a given financial period (quarter or year)|
Firm Value Impact
|Because a transaction exposure has an actual cash flow impact, it impacts the value of a company.||Since the translation exposure doesn’t create any cash flow impact, the company’s value doesn’t change due to this type of exposure.|
|Transaction exposure measures gain or loss to the cash flow on account of forex movements. In case of loss, the cash flows reduce, and hence you get tax benefit on the loss and vice versa.||Translation exposure is a measurement concept rather than dealing with actual cash flow impact on a forex account. Hence, no tax exemption or benefit is available on losses due to translation exposure.|
Also, read – Transaction vs Economic Exposure.
Quiz on Transaction vs Translation Exposure
Let’s take a quick test on the topic you have read here.