Translational risk relates to overseas investment and foreign borrowing.
Translational risk affects the values of the balance sheet items and the profit and loss statement when they are translated into the national currency, as well as changes the indicators of the consolidated balance sheet of the group of companies.
Translational risks affect accounting and financial statements.
Its difference from operational risk is that it is not related to cash flows or the amount of payments. The risk of loss or loss of profits arises in the consolidated accounts of a multinational corporation and its foreign subsidiaries.
When consolidated reports on assets, liabilities and profits are prepared in such a corporation, the corresponding indicators of foreign subsidiaries are translated from their national currency into the reporting currency of the entire group. For example, UK-based multinational corporations ICI or BP must estimate all their figures in pounds sterling for reporting.
The risk to such companies lies in changes in the exchange rates during the fiscal year.
The parent company is at translational risk if it has a subsidiary abroad.
As a result, the book value of the group can be reduced in case of unfavourable exchange rate movement or increased in case of favorable exchange rate.
Such loss (or gain) in foreign currency does not affect the cash flow in the group.
However, it is sometimes difficult for large multinational corporations to interest shareholders in investing their enterprises located abroad, hence the translational risk is not only a "paper" loss or profit.