Does translation exposure affect cash flow?

Not by itself. Restating a subsidiary's results changes reported figures without moving any money. Cash is affected when money crosses the currency boundary: a dividend sent to the parent, a loan repaid across the group, or the sale of the subsidiary. It is also affected if the group hedges a translated number with a contract that settles in cash. So a lender treats translation as non-cash until it can see where a transfer of money is planned.

Where do translation gains and losses go in the accounts?

Under IAS 21-based standards in New Zealand and Australia and under FRS 102 in the UK, differences from translating a foreign operation's results and net assets go to other comprehensive income, and accumulate in equity, often described as a foreign currency translation reserve. They do not appear in profit or loss in the year they arise. Because they bypass reported profit, a reader looking only at EBITDA and net profit will not see them, and needs to read the statement of changes in equity.

How do you hedge translation exposure?

The usual method is to borrow in the subsidiary's currency, so that the debt falls in value when the net assets do. Some groups also use a forward or cross-currency swap documented as a hedge of a net investment. The main caution is that the protection may settle in cash while the exposure it protects does not, so a rate move can produce a cash outflow against a loss that exists only on paper. Some groups leave translation unhedged for that reason.

Which exchange rates are used for translation?

Assets and liabilities are translated at the closing rate on the balance sheet date. Income and expense items use the rates on the transaction dates, or, for practical reasons, an average rate for the period where that approximates them; an average is inappropriate if rates fluctuate significantly. Using two different rates is itself one source of the translation difference recorded in other comprehensive income.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Translation Exposure: a Worked Example

The accounts moved. Now find out whether the cash did.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

Translation exposure matters to a lender mostly as a claim to be tested: management says the numbers fell only because of the exchange rate. Restating an overseas subsidiary's results into the group's reporting currency changes reported profit and equity with no cash moving because of it. A desk splits the movement into the rate and the trading. In the example here, a group's subsidiary EBITDA fell US$2.31m and the currency explains US$0.60m of that. The exposure also becomes real when the subsidiary's cash is what services the group's debt, because a dividend sent home is converted at the rate of the day.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 02 — Aoraki Trade Exports. Paid in USD, costs in NZD, asking for a NZ$6m multi-currency facility. The MD won't say which currencies. Your call first, then the senior banker's.

Read the file →

PART OF Foreign Exchange Facilities

// 01 — WHY RESTATING A SUBSIDIARY MOVES THE NUMBERS

A group that owns a business in another country has to present one set of accounts in one currency. The subsidiary keeps its books in its own currency, and at each reporting date those results are restated. The subsidiary has not earned more or less because of that restatement. It has been measured with a different ruler.

A lender cares for three reasons. A currency move can flatter or depress the figures a lender relies on, and a reader needs to know how much. Leverage and net worth covenants are measured on reported figures, so a translation effect can move a test. And a subsidiary is often a source of cash for the parent's debt, at which point the rate stops being only an accounting matter.

// 02 — HOW THE RESTATEMENT WORKS

Assets and liabilities at the closing rate

Income and expenses at transaction-date rates, or an average that approximates them

Difference to other comprehensive income, not profit or loss

That is the method under AASB 121 in Australia and NZ IAS 21 in New Zealand, both drawn from the international standard. FRS 102 section 30, which most UK mid-market groups apply, works the same way on this point: the differences go to other comprehensive income, though a separate reserve is not required. Because income is taken at an average rate and the net assets at a closing rate, the two do not reconcile without a balancing figure, and that figure accumulates in equity.

Translation is not the same as a transaction exchange difference. Where the parent has lent to the subsidiary or is owed for goods, those balances can produce a real gain or loss on the same page of the notes.

// 03 — THE EXAMPLE

A distributor of pool and spa chemicals, constructed for this page like every figure in it, reports for this page in US dollars and owns a subsidiary whose books are in a local currency, LC. Last year one LC averaged US$0.60 and ended the year at the same rate. This year it averaged US$0.57 and ended the year at US$0.54. Subsidiary EBITDA fell from LC20m to LC17m. Management's note reads: the decline is mainly translation.

Last year: 20 × 0.60 = US$12.00m

This year: 17 × 0.57 = US$ 9.69m

Fall in EBITDA: US$ 2.31m

Rate effect: 20 × (0.57 − 0.60) = US$(0.60)m

Trading effect: (17 − 20) × 0.57 = US$(1.71)m

Total: US$(2.31)m

Nearly three-quarters of the fall is trading, which a currency hedge would not have helped. That answers the lender's first question, and the lender confirms it against operating cash flow in local currency. Now the balance sheet. The subsidiary began with net assets of LC80m and earned LC5m:

Opening net assets: 80 × 0.60 = 48.00

Profit at average: 5 × 0.57 = 2.85

Closing net assets: 85 × 0.54 = 45.90

Translation loss: 45.90 − 48.00 − 2.85 = (4.95) in equity

A US$4.95m loss that no one has paid. It lowers group equity and any net worth test, and that is all it does until something else happens. The group has US$36m of debt at the parent and US$6.0m of EBITDA in its home business.

Reported leverage: 36 ÷ (6.0 + 9.69) = 2.29×

At last year's rate: 36 ÷ (6.0 + 10.20) = 2.22×

LC8m dividend at 0.60: US$4.80m

LC8m dividend at 0.54: US$4.32m

Shortfall against plan: US$0.48m, in cash

Translation has now reached the cash. Just after the year end the subsidiary pays LC8m up to the parent, which had budgeted US$4.80m to help service its debt and receives US$4.32m. On the dividend date, the exposure was a transaction.

// 04 — HOW IT DIFFERS FROM TRANSACTION EXPOSURE

The distinction is what causes the movement. Transaction exposure is fixed by a contract in a foreign currency and settles in cash. Translation arises from the act of restating, whether or not anything is traded or paid across the border that year. The two can move in opposite directions in the same year, as when a weaker foreign currency lowers translated profit and makes cheaper the goods the parent buys in that currency.

A hedge makes the mismatch clearer. A group can borrow in the subsidiary's currency so that the loan falls as the net assets fall, a natural hedge of the balance sheet. A forward sold to protect a translated number is different: it settles in cash, while the thing it protects does not.

DEFINED IN ONE PARAGRAPH → · FINANCIAL REPORTING, READ BY A LENDER → · TANGIBLE NET WORTH →

// 05 — WHERE IT DECIDES A FILE

The desk's test is whether the cash agrees. It asks for the subsidiary's results in its own currency, recalculates at a constant rate, and looks at local cash generation. If management's explanation holds, the local figures will be steady while the group's move. If local EBITDA also fell, the currency explains only part of it.

Covenant drafting decides how much translation reaches the ratios. Debt in a foreign currency is often taken at a closing rate, EBITDA at an average rate, and a net worth test feels the whole of the reserve movement. A borrower with material overseas earnings may negotiate constant-currency tests, and some agreements provide for them. The lender also needs to know how much of the parent's debt service relies on dividends from abroad, and whether those can actually be paid up.

NET DEBT, AS THE DOCUMENT DEFINES IT → · INTERCOMPANY BALANCES → · LOAN COVENANTS, EXPLAINED →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Australian Accounting Standards Board, AASB 121 The Effects of Changes in Foreign Exchange Rates, compiled standard prepared 5 March 2025, for periods beginning on or after 1 January 2025 — paragraphs 39 to 41 — Assets and liabilities at the closing rate, income and expenses at transaction-date rates or an approximating average, and resulting differences in other comprehensive income; NZ IAS 21 carries the same requirement from the same international standard — section 02.
HM Revenue & Customs, Corporate Finance Manual, CFM26220 (foreign operations: closing rate/net investment method) — Under IFRS and New UK GAAP the net investment is translated at the closing rate, with results typically at an average rate and the resulting exchange differences taken through reserves — section 02.
ICAEW, Foreign currency translation under FRS 102, helpsheet — paragraphs 30.17 to 30.23 — Under FRS 102 the resulting exchange differences go to other comprehensive income, and need not be held in a separate reserve — section 02.

// QUESTIONS PEOPLE ASK

Does translation exposure affect cash flow?: Not by itself. Restating a subsidiary's results changes reported figures without moving any money. Cash is affected when money crosses the currency boundary: a dividend sent to the parent, a loan repaid across the group, or the sale of the subsidiary. It is also affected if the group hedges a translated number with a contract that settles in cash. So a lender treats translation as non-cash until it can see where a transfer of money is planned.
Where do translation gains and losses go in the accounts?: Under IAS 21-based standards in New Zealand and Australia and under FRS 102 in the UK, differences from translating a foreign operation's results and net assets go to other comprehensive income, and accumulate in equity, often described as a foreign currency translation reserve. They do not appear in profit or loss in the year they arise. Because they bypass reported profit, a reader looking only at EBITDA and net profit will not see them, and needs to read the statement of changes in equity.
How do you hedge translation exposure?: The usual method is to borrow in the subsidiary's currency, so that the debt falls in value when the net assets do. Some groups also use a forward or cross-currency swap documented as a hedge of a net investment. The main caution is that the protection may settle in cash while the exposure it protects does not, so a rate move can produce a cash outflow against a loss that exists only on paper. Some groups leave translation unhedged for that reason.
Which exchange rates are used for translation?: Assets and liabilities are translated at the closing rate on the balance sheet date. Income and expense items use the rates on the transaction dates, or, for practical reasons, an average rate for the period where that approximates them; an average is inappropriate if rates fluctuate significantly. Using two different rates is itself one source of the translation difference recorded in other comprehensive income.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Markets salespersonSells the bank's markets products — foreign exchange, interest rate hedging, commodities — to corporate and institutional clients.
Treasury analystFunds the bank and manages the interest rate and liquidity risk created by its own balance sheet.
Corporate coverage bankerOwns the bank's relationship with a large corporate or institutional client and orchestrates everything the bank sells into it.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE FIRST QUESTION · THE LOAN · HEDGES

A borrower has a US$10m floating-rate loan and an interest rate swap fixing the rate on US$15m.

What do you ask first?

6 MORE ON THE LOAN · HEDGES →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHTranslation exposure What is translation exposure, and how is it different from transaction exposure?