Translation exposure is the risk of having changes in foreign exchange rates trigger losses on business transactions or balance sheet holdings. These losses can occur when a firm has assets, liabilities, equity, or revenue denominated in a foreign currency and needs to translate them back into its home currency. Translation is required by the accounting standards when preparing consolidated financial statements.
Translation exposure is most common in two situations. One is when a company has subsidiaries located in other countries, and the other is when a business engages in significant sales transactions in other countries. In both cases, there is a risk that an unfavorable change in the applicable exchange rates could cause a loss on the books of the reporting entity. These businesses can engage in hedging transactions to reduce their translation exposure.