How technology can help manage risk

How can technology help overcome cancellations and reconciliations?

Introduction

The travel industry is driven in large part by advance bookings. With this type of purchase, the relationship between cancellations and financial reconciliations is pivotal, especially when it comes to foreign exchange (FX) management and hedging.

Typically, customers book holidays up to a year in advance, which causes financial risk and operational challenges. Cancellations and poor reconciliation processes can disrupt revenue, as well as influence a company’s hedging strategies and overall financial wellbeing. This article provides an overview of these challenges and demonstrates how implementing robust financial strategies helps to ensure resilience and profitability.

Impact of cancellations and poor reconciliation

Cancellations can often have a negative impact on a business’s bottom line. When bookings are cancelled far in advance, businesses are left to grapple with as well as the daunting task of refilling these slots, frequently at reduced rates. This complexity is magnified by flawed reconciliation processes. Inadequate monitoring of bookings, payments and cancellations can result in discrepancies and muddy the bookkeeping waters.

For instance, a report by the Global Business Travel Association (GBTA) shows that travel firms typically confront 5% to 10% in cancellations yearly, inducing significant revenue volatility. Inefficient reconciliation aggravates this and undermines accurate financial forecasting. A travel agency inaccurately reconciling cancellations may erroneously over or underestimate its foreign currency requisites, leading to misguided hedges.

Shoddy reconciliation processes also run the risk of doing reputational damage in the court of public opinion. Thomas Cook’s collapse in 2019 —partly attributed to substantial hedging losses — underscores the criticality of precision in financial strategies within the travel domain. One prominent airline even faced public censure as customers were erroneously billed for canceled flights.

Managing Currency Risk

Navigating the complexities of currency markets is critical for travel businesses that operate on a global scale. Effective currency management safeguards profit margins and minimises exposures resulting from volatility.

Hedging is a strategy employed to counter potential losses stemming from currency rate fluctuations. For example, travel companies often use forward contracts to secure current exchange rates for future transactions, insulating their finances against potential negative currency movements.

However, the erratic pattern of travel cancellations introduces significant challenges to these strategies. TUI Group faced severe financial repercussions in 2020 as pandemic travel restrictions and a surge in cancellations led to ineffective hedging positions. Continuing the list of troubled UK airlines, Flybe went bankrupt in early 2020, partly due to mismanaged hedging strategies amid flight cancellations.

These examples underline the critical need for agile currency management and hedging strategies in the travel industry. These strategies must be adaptable and ready to respond to sudden changes in market conditions or customer behavior.

The knock-on effects

The ripple effects of cancellations in the travel industry extend far into the business. Cancellations, especially those occurring close to the departure date or in large volumes, can dramatically alter a company’s currency needs, undermining the efficacy of previously established hedging strategies. Below are a few examples of how cancellations can affect any business.

• Immediate financial impact Cancellations lead to an immediate loss of revenue, which means businesses must reassess their short-term currency requirements. US airline Delta experienced this during the pandemic, leading to record quarterly losses.
• Hedging strategy disruptions Effective hedging strategies rely on predictable cash flows and stable currency requirements. Cancellations introduce uncertainty, rendering some hedging positions ineffective or even counterproductive.
• Long-term financial planning challenges Recurrent cancellations can have lasting effects on a company’s financial planning.
• Impact on supplier and partner relationships Travel businesses often engage in contracts with suppliers and partners in foreign currencies. Cancellations can disrupt these agreements, leading to renegotiations or even contract breaches, affecting the company’s FX exposure.
• Regulatory and compliance risks Frequent cancellations and the resulting fluctuations in FX requirements can also expose companies to increased regulatory scrutiny, especially in regions with stringent financial reporting requirements.
• Reputational risk and customer confidence The inability to manage FX effectively following cancellations can lead to delayed refunds or additional charges for customers, damaging the company’s reputation and customer trust.
• Operational resilience and strategic shifts Lastly, persistent cancellations necessitate a more resilient operational model, including more flexible FX management and hedging strategies. Southwest Airlines, through its dynamic hedging policies and robust operational model, was able to withstand the industry’s volatility better than many of its competitors during the pandemic.

In conclusion, cancellations have far-reaching effects on currency management and hedging in the travel industry. They not only disrupt immediate revenue streams but also pose long-term strategic, operational, and reputational risks. Travel companies must adopt dynamic, resilient approaches to currency management to navigate these challenges effectively.

Steps for success

So, those are the challenges. But how can a travel business implement a method that will overcome them? We’ve compiled some suggestions of the necessary steps:

Dynamic hedging strategy

• Implement a dynamic hedging strategy that can adjust to the volatile nature of the travel industry. Utilise a combination of products like forward contracts, options and swaps to provide flexibility and protection against currency fluctuations.
• Regularly review and adjust the hedging strategy based on booking patterns, cancellation rates, and market forecasts to ensure it aligns with the current risk profile and financial objectives of the company.

Advanced forecasting and analytics

• Leverage advanced analytics and machine learning algorithms to predict future booking trends and cancellation rates more accurately. This will allow for more informed decision-making regarding currency exposure and hedging needs.
• Integrate real-time data from various sources, including booking systems, market news, and currency rate feeds to continuously refine forecasting models and hedging strategies.

Robust reconciliation and reporting systems

• Implement a reconciliation system that ensures all transactions, including bookings, cancellations and refunds, are accurately captured and reflected in the financial records.
• Utilise automated reconciliation tools to reduce errors and operational inefficiencies, ensuring that the financial position and FX exposure are always accurately represented.

Flexible payment solutions for customers

• Offer flexible payment solutions that allow customers to book in their local currency while enabling the company to manage the FX risk effectively.
• Partner with FX service providers to offer dynamic currency conversion at the point of sale or pre-booking, reducing the FX risk associated with customer refunds and cancellations.

Continuous training and risk management culture

• Foster a risk management culture within the organisation by providing continuous training on FX risk, hedging strategies and the importance of accurate reconciliation.
• Encourage collaboration between different departments (finance, sales, operations) to ensure a holistic approach to managing bookings, cancellations, and currency exposure.

Regulatory compliance and best practices

• Stay abreast of regulatory requirements in all operating regions to ensure that hedging and FX management practices are compliant with local and international laws.
• Adopt industry best practices and benchmark against peers to continuously improve the payment and hedging management processes.

Summary

The travel industries challenges require a strategic approach. Businesses must ensure they actively manage their currency exposures as well as implement a robust reconciliation process.

Travel businesses must adopt both elements to insulate themselves from risk. Being proactive when it comes to currency management provides the blueprint for sustainable growth, ensuring that travel businesses remain robust, responsive, and ready to embrace technological change.

If you think your business could benefit from our integrated fintech solutions, or if you’d like to find our more about the services we provide, give us a call today. Speak to the experts on 020 3949 6821.

To learn more about how Smart Currency Business can help you, give one of our friendly account managers a call on 020 3773 7402 or visit our website for more information.