What is Translation Risk?
Whenever a foreign exchange is involved, and the operations are in multiple countries, there is an accounting risk of converting books from one currency to another. The company must book foreign currency gains or losses based on accounting methods. Although they will affect reported earnings, they do not necessarily reflect real economic gain or loss (i.e., no effect on cash flows).
Examples of Translation Risk:
Let’s take an example of a U.S. company that borrows from a Canadian bank. If the CADUSD exchange rate decreases during the year, the USD has appreciated, and the company has incurred a foreign exchange gain. If the CADUSD exchange rate increases, then the appreciation of the CAD means the company has incurred a foreign exchange loss.