The Impact of Foreign Exchange Gains and Losses

During 2003 Xian Janssen Pharmaceutical Company suffered huge losses of 60 Million Chinese Rmb which represents about 5. 7% decrease in the Operating income of the Company. While during 2004, Xian Janssen Pharmaceutical Company suffered greater losses of 75 Million Chinese Rmb which represents about 6. 9% decrease in the Operating income of the Company.

These losses are not the responsibility of the parent Company Johnson & Johnson; however it’s the responsibility of the Subsidiary Xian Janssen Pharmaceutical, so Johnson and Johnson was generating profits while on the other hand, Xian Janssen Pharmaceutical was losing income. If those reductions of operating income continued, soon this will affect the profitability of Xian Janssen Pharmaceutical, and thus upset its shareholders, and so they might sell their shares till its prices fall, and then the company might suffer from Bankruptcy. This pure use of foreign exchange forwards would be due to some factors including;

The limited availability of other foreign exchange derivatives or risk management alternatives, the restricted policies of Johnson and Jonson, the regulatory restrictions in China on the use of derivatives and currency products, and the unwillingness of Johnson and Johnson to either carry the risk itself or allow more breadth in Management of the foreign exchange exposures of its Chinese subsidiary. The relationship between actual spot exchange rate, the budgeted spot exchange rate, the forward rate, and the expectations for the Chinese subsidiary’s financial results by the U.

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S parent company: Nearly all multinational companies, like all organizations, ordain off of budgets. The Chinese subsidiary of J&J isn’t contradictive. Paul Young must assemble a strategic a business and marketing plan, associated with a budget, for Xian-Janssen’s showing up year. That is the actuality of the situation. The forecast exchange rate for the coming year , the budget rate, Usually generate either exclusively by the companies or in combination with input from the business unit for.

Regardless of the process, the final budgeted rate will be used for planning, purchasing, and atrocious of all--- formation of expectations. As is the case with all forecast, however, it will prove an error. Paul Young just hopes it will not be “too wrong” and that the direction of the error proves in his business unit’s favored. Once the budget was appointed and accepted by the U. S parent, Paul Young and Xian-Janssen’s results for the coming year would be graved on stone. They would then be managing the business to meet the parent company’s expectations, in this case, of 20% growth.

The forward rate is calculated by the financial service providers from the current spot rate and interest differentials. Since the Rmb was fixed to the dollar at this time, and the euro was continuing to appreciate versus to dollar, Xian-Janssen’s financial results were looking at the anemic euro results. The forward rate was costing Xian-Janssen multifarious money. Paul Young would feel increase pressure to forego the hedging in order to reduce the cost. Johnson& Johnson has roughly 200 foreign subsidiaries worldwide.

It has always pursued a highly decentralized organizational structure, in which the individual units are responsible for their own performance from the top to the bottom line of the income statement. Although it is not unusual for a multinational firm to make foreign exchange gains and losses the responsibility of its foreign subsidiaries, it is not typically considered very efficient. The subsidiary business unit is typically just that, a business unit, and does not ordinarily possess the resources of skills sets necessary for good exchange rate risk management Foreign exchange gains and losses have an impact on corporate performance at XJP.

Although many people may first see these as relatively small losses, a reduction in the operating earnings of an individual business unit from foreign exchange changes alone like this would be considered significant. One way to note this is to consider that the average return on sales (ROS) for the Fortune 500 in the second quarter of 2005 was about 7. 7%. If these bottom line profits were chopped an additional 6%-7% on a consolidated basis, a lot of companies – and shareholders – would be considerably upset.

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