A natural hedge is the reduction in risk that can arise from a company's normal operating procedures. A company which has receivables and payables in foreign currency also comes under the profile of natural hedge. A suitable measure of the exchange rate effect on these gaps, as variance from the budgeted numbers, can provide the management with true estimates of the profitability of different operations and businesses.

Most manufacturing companiesindeed even many service companieshave both foreign currency receivables and payables, which in combination provide some degree of natural hedge to their risk profiles. In fact, many domestic inputscertainly commodity type inputs, like non-ferrous metals or petroleum-based products, also have a significant INR/USD link, which can provide some degree of protection against a strengthening rupee.

However, managing this natural hedge requires articulated processes both for identifying the risk and for managing it. Surprisingly, a few companies have such processes in placein fact, some are even unclear about what constitutes a natural hedge, believing that only opposite exposures during the same month (or similar period) provide a set-off. To build a process for managing the natural hedge, for managing the total risk on a company's P&L (or, preferably, a 12-month running P&L)the first step is to define when each risk is to be identified.

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