ASSIGNMENT | Operating Exposure and Translation Exposure Differences

What do you see as the primary difference between operating exposure and translation exposure? Would this have the same meaning to a private firm as a publicly traded firm? Why or why not?

SAMPLE SOLUTION

Difference Between Operating Exposure and Translation Exposure

Changes in the exchange rate can have detrimental effects to any business. The changes can be felt on prices of products and consequently the profit that a firm derives from its operations. Operating exposure can be defined as the extent to which the future cash flow of a firm are affected as a result of any changes on the foreign exchange rates. Such a substantial change is expected to have a risk on the revenues that a firm derives from its operations (Ito et al., 2016). On the other hand, translation exposure also known as accounting exposure refers to the changes in owners’ equity as a result of translation of foreign currencies to home currency for the purpose of reporting consolidated financial statements. The translation affects the value of owners’ equity, assets, income, as well as the liabilities of the company.

Therefore, the main difference between operating costs and translation exposure is that operating exposure affects firm’s current and future cash flows while translation exposure does not. Operating exposure is as a result of the risk emanating from foreign exchange changes and its implications are felt on the total revenues as well as the market value of the firm. On the other hand, translation exposure is not real and happens when the firm translates assets, liabilities, and other components of books of accounts into home currency (Ni et al., 2016). Another difference is that while translation exposure is narrow in the sense that it deals with specific items of financial statements, operating exposure is broad because it deals with macro aspects of the firm. Therefore, in case of any changes…