Budget rate: how to set it, and what to do the day it breaks
The budget rate is the most structuring FX commitment a company makes, and the one set with the least method. How to calibrate it, at what level to protect it, and what procedure to follow when the market goes through it.
Every autumn the same scene plays out: a conversion rate has to be fixed for next year's budget. Three methods circulate — take today's rate, take last year's average, take the banks' consensus — and all three have the same flaw: none links the rate adopted to what the company is actually able to guarantee.
A budget rate is not a forecast. It is an internal commitment. The right question is not « where will EUR/USD be in June » but « what rate am I able to guarantee today, and at what cost ».
The only defensible budget rate is an attainable one
The forward rate can be computed today, for every month of the coming year. It is not an opinion: it follows from the spot rate and the rate differential between the two currencies. It is the rate you can lock in.
The robust method therefore starts there, then applies a prudence haircut:
- 1Take the forward curve over the budget horizon
One rate per month, across the twelve months of the budget. That is the objective base.
- 2Weight it by your flow profile
If 60 % of your dollar revenue falls in the second half, the relevant average is weighted by those volumes, not a simple average.
- 3Apply a prudence margin tied to the hedge ratio
If you hedge 80 % of flows, 20 % remain at the rate of the day. Discounting the budget rate by roughly the annualised volatility multiplied by the unhedged share gives a coherent order of magnitude.
- 4Lock in before, not after
A budget rate announced in November and hedged in March is no longer a budget rate: it is a four-month bet on the market.
A worked example
The reasoning fits in one auditable sentence: « we adopt 1.1050 because we are locking 80 % of the programme at 1.0980 and providing for a reasonable deterioration on the remaining 20 % ».
The day the rate breaks
This is when the absence of a procedure costs most, because decisions are taken under time pressure and commercial pressure. A serious policy defines three thresholds in advance:
| Gap to the budget rate | Status | Planned action |
|---|---|---|
| < 2% | Normal zone | No action. The prudence margin absorbs it. |
| 2 – 5% | Alert | Inform the managing director. Review the ratio on flows not yet hedged. |
| > 5% | Breach | Extraordinary committee. Explicit decision: revise selling prices, renegotiate clauses, or documented acceptance of the margin impact. |
What distinguishes a finance team in control of its FX from another is not the quality of its forecast. It is having a written answer before the question arises.
Three common mistakes
- Taking the spot rate on the day of the budget cut-off: it ignores the rate differential, and therefore the real cost of hedging. On currencies with a wide differential, the error can reach several percent.
- Taking the banks' consensus: it is an average of forecasts, and the dispersion between contributors is usually wider than the gap you are trying to budget for.
- Revising the budget rate mid-year: that erases the variance instead of addressing it, and deprives the company of the signal the budget was meant to produce.
Compute your reference forward rate
The pricer shows the reference forward rate month by month on your pairs, from today's market rates. That is the basis of a defensible budget rate.
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Frequently asked questions
The questions finance departments ask most often on this topic
Should you have one budget rate per currency or a single rate?
One per currency, always. A single rate only makes sense if the company has one significant currency. Interest-rate differentials — and therefore forward points — differ completely from one pair to another: applying the same haircut logic to the dollar and the Swedish krona has no basis.
Can you change the budget rate during the year?
It is possible but rarely advisable. Revising the rate erases the variance instead of documenting it, and removes the warning signal the budget was meant to give. The recommended practice is to keep the original rate and track the variance as an indicator in its own right, commenting on it at each reporting.
What gap between the budget rate and the forward rate is reasonable?
It depends on the unhedged share and the pair's volatility. For a major pair hedged at 80 %, a prudence gap of 0.5 to 1.5 % against the weighted average forward is coherent. Beyond that, the budget rate becomes a disguised commercial cushion, which distorts contract-by-contract margin analysis.
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