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ENTERPRISES FACED WITH INFLATION AND DEVALUATION

Economist
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Inflation as well as devaluation bring about a number of implication to the economic system and consequently to people and enterprises. Later on, some specific aspects directly influenced by the mentioned factors will be explained. It is essential that enterprises be ware of the ways in which devaluation and inflation affect them in a positive or negative way.

Effects of inflation

As mentioned before inflation affects economy in different ways: it reduces the purchasing power of money, it may favor creditors if debtors have anticipated a lower inflation, it causes some administrative costs, it distorts decision making process as well as the role that the markets plays as a guide for producers, it affects productive investments as well as the balance of payments. All this not only influences economy as a whole but also the enterprise activity. There is an analysis of some aspects influence by inflation, below.

1. Evaluation of Projects

Inflation influences the capital flows of a project and also the discount-.rate required by the enterprise, in this way inflation distorts decisions when developing the capital budget. The main reason is that depreciation charges are based on the original cost of the asset and not in the replacement cost. Due to inflation profits could increase because some of the costs remain stable or fixed therefore a greater percentage is subject to taxation. Thus, the flows in real terms decrease.

Inflation can affect cash flows to moderate or great extent, depending on the nature of the flows. Thus, inflation could affect to greater extent the selling prices or the costs. Businessmen usually fight against inflation by lowering prices and keep them competitive but they cannot do anything about generalized inflation in economy therefore their cash flows could decrease in real terms due to the reduction of the purchasing power of money. In this way, inflation encourages investments that can be recovered quickly and those investments that require less capital investment.

Therefore, to consider the effect of inflation since the cash flows are calculated in nominal terms and not in real terms, it is necessary to take into account some factor of deflation when calculating the net present value (NPV) of the project. In this sense Van Horne (1988) states that the fundamental factor is: if the criteria for acceptance or in other words, the required rate of return, includes a premium for the inflation anticipated then the estimated cash flows have to reflect the inflation.

It is necessary hen to adjust revenues as well as costs and expenses according to an inflation rate for each of them and their variation estimated. This, the cash flow Ri will be the result of::

Where:

Ii                Revenues corresponding to the time period i

Ci              Costs and expenses corresponding to the time period i

By adjusting the revenues according to a rate of growth related to inflation f and the costs and expenses according to a rate of growth which is the result of the inflation g, then, cash flow will be represented by:

Then it will be necessary to adjust the discount rate t include the effect of inflation. Thus, every factor of discount:

Where K is the required rate of return, it will be represented:

Where pi   Expected Inflation Rate.

Therefore, the real NPV of the investment could be represented:

The enterprise also could previously calculate the discount rate adjusted for inflation, k, as:

As well as the Internal rate of return (IRR), can be adjusted to get the real IIR of the project:

Inflation decreases the real IRR of the project, even when at the beginning it seems that revenues increase more than costs, as it was explained before this happens because some costs are not affected by inflation for example, depreciation that present a constant fiscal hedge, which means that even when the volume of pretax profit increases, the sum of taxes increases as well and even in a greater way. In other words, taxes increases in a greater proportion than flows and finally this decreases Real rate of return of the investment project.

Something similar happens with the work capital, the greater the inflation the greater the required investment in work capital, therefore a lower real rate of return of the investment.

2. Productivity

Inflation not only affects the productive activities but also the productivity of an enterprise. Thus, inflation tends to promote short term and speculative less productive activities and it discourages productive activities.

In addition the enterprise suffers diverse effects according to the combination of different production factors that it applies. In this way the relative variations of the wage costs and the costs of capital goods could bring about variations in the original resource allocation because, due to the new conditions, it may not be the optimal. As the specific prices of the different factors increase in diverse ways, some of the equipments could become obsolete. Equipment considered as the ideal one for certain wage level may not be for a superior wage level. Demand variations can also bring about obsolescence of some machinery equipment because a number of machines could be the best for certain level of production but they may no longer be the best due to the costs increase for a different level of production.

When the prices of equipment and machinery increase it is more difficult to enhance the maximum production capacity of the enterprise. In addition, planning becomes more difficult and the depreciation charges required to be adjusted to the real replacement cost of the asset. Otherwise the production capacity will decrease due to the impossibility of replacing the fixed-asset depreciated at the end of their useful life.

As it is evident, inflation discourages investment because the real benefits decrease as well as the possibilities to increase the productivity of the enterprise.

3. The Enterprise's Accounting

Money as a unit of account brings about many advantages, because it is useful to summarize, control, record and compare economic transactions. All these benefits are affected and therefore reduced when the value of money is not stable in other words when inflation weaken the purchasing power of money. As a result, thought time it would not be a homogenous unit of measurement because in this sense, there is a different unit for each time period. In addition, this distorts the role of accounting as a way to obtain enough and opportune information to appropriate decision making.

In this way it is necessary that financial statements consider these variations in the purchasing power of the currency because otherwise they will not reflect the real condition of the enterprise. It is essential that accounting data be truthful because if this information is false then the decision making process will be affected in a negative way consequently all the goals and objectives set by the board of directors will be changed.

In this way a lot of situations in which the accounting data is slanted by inflation can be mentioned. For example, when setting the selling price of the products depending on their historical cost, re-stocking is at risk when facing a rise in their prices. On the other hand, inflation distorts financial statements thus traditional accounting is no longer significant when it does not consider the erosion of both the net worth and the economic results.

The costs of sales recorded are lower than the real ones when valuing the purchases and the inventories at their historical cost. The problem is bigger in enterprises with low inventory turnover. The fact of showing misleading results in the accounting data can lead to wrong decisions.

On the other hand, traditional accounting does not record the losses generated by keeping monetary assets, since they have lost their purchasing power. In addition, dividend distribution according to conventional accounting, does not assure that the recourses invested by stockholders keep their purchasing power up.

For all these reasons, when experiencing inflation it is essential to adjust conventional accounting, in a way that it be expressed in homogenous terms and therefore comparable throughout time. In other words, the effect of the generalized rise in prices should be eliminated.

In this way some alternative methods have been implemented to conventional or historical accounting. Adolfo Blanco (1983) mentioned three criteria to quantify the effects of inflation:

  • General Price Level Accounting: the quantities that the financial statements show are converted into a common monetary unit, the one that corresponds to the end of the fiscal-year. The accounting adjusted to the general level of prices tries to keep the purchasing power of the stockholder’s investment up.
  • Replacement cost accounting: it seeks to maintain the working capacity of the enterprise for example in income statement, the cost of sold merchandise is recorded at the replacement cost of the merchandise at the time it was sold.
  • Adjusted Replacement cost accounting: It measures the results of a stable or constant monetary unit, which allows monitoring the real growth and progress of the enterprise.

When facing inflation it is more recommendable to use the Last in first out (LIFO) inventory pricing method than the First-in, first-out (FIFO). That is because with LIFO the income-tax is lower when prices rise. Charles Horngren (19910) says that FIFO is criticized because when facing inflation it exaggerates earnings due to the so called inventory profit.

4. Financial situation and analyses

The financial situation of the enterprise is affected by the constant rise in prices, thus an enterprise could be affected to greater or moderate extent according to its solvency, if it owns few resources its continuity will be interfered. In other sense, it could maintain the prices of its products as a decision of the enterprise or as government control which favours a margin reduction, decreasing as well the possibilities to grow and even the enterprise could lack liquidity because of lack of resources. In addition the methods of the country authorities to fight against inflation such as price control, credit restrictions, and increments in the interest rate bring about greater difficulties in the enterprise management.

When facing inflation the enterprise requires greater financing due to several reasons. First, when the cost of raw material increases then the value of inventories increases as well, this implies that greater financing is required. On the other hand, in spite of the normal requirement of financing from the enterprise to grow, when facing inflation more financial resources are required to simply maintain the actual dimension because the mere conservation of capital will require increments in nominal terms because in real terms it becomes deteriorated.

As a result of the expansion of the circulating medium and the erosion of capital, more financing is required in addition to other situations that the enterprise faces such as liquidity reduction, restrictive credit policies, increases in interest rates, etc, which complicate the financial position of producers.

All this leads enterprises to indebtedness when facing inflation, especially if the loans extended to the enterprise are established in monetary terms, because the enterprise will pay back in the depreciated currency obtaining a monetary profit due to the indebtedness.

It is also convenient to the enterprise to reduce the collection periods because the lower the receivables the lower the monetary loss. It is paradoxically convenient to extend the collection periods to suppliers because it could bring about some monetary profit like by the effect of the financial leverage.

In addition, it is necessary to consider that some assets bring about more inflation losses because they increase as monetary assets, inventories and assets whose length of service is longer increases. In this way, to reduce the assets to the minimum and to get into debt to the maximum (of course setting limits) has become an anti inflationary strategy. In other words, this will favour a greater real profitability. However, it is essential to be aware that this greater profitability is reduced by a greater financial risk because of the reduction of liquidity and the increasing indebtedness and a greater flexibility of the e enterprise to face difficult situations.

It is necessary an efficient financial control system that protects enterprises from high instability of prices and production costs in a way that the enterprise can charge these costs to their selling prices or that they can apply any other strategy against inflation for example making use of raw-material whose price is less sensitive to inflation.

The financial ratio analysis is also affected by inflation. There an explanation about how this analysis based on historical accounting is affected:

  • Efficiency: efficiency can be measured in several ways, for example the ratios sales/assets, profits/sales, that measure the efficiency en the use of assets to generate sells in the case of the first ratio, and the other shows the profits which is a measure of the enterprise’s efficiency . In this way because of inflation, it seems that enterprise’s efficiency has increased that is the case of the first ratio mentioned due to the increase of the selling prices (which is the historical cost) but not the assets. It can be perceived that there is a comparison between quantities expressed in different currencies of different purchasing power.
  • Profitability: in general the profitability of an enterprise is measured by two ratios such as profits/assets and profits/net worth, etc. Inflation brings about a slant because when facing inflation the value of sales increases (in nominal terms). Costs also increases but there are fixed costs (that at least are not affected in the short term) and in the other hand, sales are recorded in more recent currency than costs and expenses therefore the profit-margin increases and revenues will be overestimated for awhile. In this way the profitability of the investment calculated based on the historical data will be greater than the real one. The magnitude of the slant will depend on how high inflation rate, the length of service of the assets and the enterprise’s cost-structure are.
  • Solvency: it refers to the capacity that an enterprise has to face responsibilities. It is measured as the number of times that its pretax earnings cover its liabilities. When facing inflation profits increase faster and many liabilities remain stable (in nominal terms) because many of the obligations are not adjusted-according-to-inflation, so solvency seems to improve. Actually, there is no improvement, to keep the volume of production in the long term, the financing must increase.
  • Liquidity: the ratios of liquidity seek to determine the payment capacity of short term liabilities of the enterprise. Normally a current ratio is applied (current asset/current liability) and the acid test or quick ratio (current asset minus inventories divided by current liabilities). In this sense both rations tend to vary inversely to the inflation rate, mainly the acid test which is affected due to the way inventories are recorded. If the enterprise applies a Last in first out (LIFO) inventory pricing method, then the ending inventory is valued in currency before that account period thus when the prices rise, the stock is undervalued and the ratio become more “conservative”. If the first-in, first-out (FIFO) system is applied the inventory is valued in more recent terms and then the compression will be better. It is essential to mention that when facing inflation try to extend their accounts payable which results in more bad accounts and the convertibility of accounts receivable and consequently there is less liquidity.

5. Taxes

As mentioned before, when facing inflation profits taxes increase in a disproportioned way which results in gradual decapitalisation of the enterprise and a reduction of its production capacity as well as problems regarding liquidity. All this happens because the real tax rate is higher than the nominal tax rate consequently an excessive pay of taxes in addition to the excessive distribution of benefits. It could be supposed that the State gets benefits form inflation, when taxing at real rates greater than nominal rates.

6. Decision Making

The businessman should have access to enough and valid data to appropriate decision making, which implies to be ware of the financial, commercial and industrial condition of the enterprise in very moment. All this leads to appropriate planning in order to reach all the goals and objectives and thus to plan efficient policies in all the areas in other words, financial, credit, inventory and policies.

But when facing inflation all these steps become more complex and uncertain. In this sense the must develop the ability to implement methods to fight against inflation and its consequences and to make right decisions even in such unstable and uncertain periods like inflation.

One of the main effects of inflation in the decision making process is the distortion of accounting data that it brings about. The general-balance and the profit and loss statement suffer a huge impact that dramatically affects the strategic decisions of the enterprise, all decisions concerning prices, indebtedness, liquidity, dividends and investments

By misapplying the accounting data provided by conventional accounting leads to uncertainty in the decision making process especially in the decisions concerning, pricing policy, resources, dividends, planning etc. the enterprise must resort to appropriate methods to face inflation and to get unbiased data. General Price Level Accounting and replacement cost accounting represent useful tools in these cases besides, they are complementary to each other and to conventional accounting.

Effects of devaluation

Devaluation of domestic currency influences or has an effect, sometimes positive and sometimes negative, on the activities of an enterprise as well as inflation does. To what extend and in what way depreciation affects economic activities of depend on type of enterprises, their activities and the sensitivity of enterprises to foreign exchange risks. Devaluation brings about instability and uncertainty therefore management becomes difficult and decision making becomes a process in which a number of variables must be anticipated, most of them independent from the enterprise’s control.

1. Devaluation and interest rates

As mentioned before, when the interest rate parity was explained, there is a relation between the interest rate and the current and forward exchange rate. In addition, as Marin and Ketelhohn (1998) state: the intrinsic risk of economy is reflected in the interest rates.

In this way, if there is some capital in dollars

Where:

1 + r ¢            Interest rate in colones

1 + r US$         Interest rate in dollars

f(TC ¢/US$ )     Forward exchange rate ¢/$

S(TC ¢/US$ )    Spot Exchange rate ¢/$

There a prize for investing in colones thus the investment in colones is more profitable since the return in colones minus the devaluation rate is greater than the dollar rate.

2.                   Foreign exchange risk: devaluation risk

When an importer has to wait for awhile until the delivery and payment of the traded goods, the exchange rate can fluctuate. Such fluctuations can bring about profit and loss depending on if they are favourable or not. In some cases businessmen have to plan their negotiations to carry out them during certain terms. To them, exchange rate fluctuations in the exchange rates represent a big problem that could interfere with their calculations in the future, which is a situation out of their control.

The possibility to face losses due to negative fluctuations in the exchange rate is called foreign exchange risk. Facing such a risk it is necessary to be protected from it. In many economies, several methods to eliminate losses that result from exchange rate fluctuations or at least to reduce the possibility to face them have been implemented such as currency futures.

The foreign exchange risk emerged in the 70’s when the currencies’ gold parity was suspended allowing currencies to float. In this way the prices of currencies against other currencies had the possibility to fluctuate depending on the conditions of the currency market and the situation of economy.

To Vives (1984) enterprises’ exposure to foreign exchange risk can be analyzed in three levels:

  • Accounting exposure: It refers to the effects of devaluation on the financial statements of the enterprise especially on the balance sheet. It shows the exposure to devaluation due to the differences between foreign currency denominated assets and liabilities. The author states that not only accounting exposure should be taken into consideration because it would be a completely restrictive and narrow perspective towards foreign exchange risk exposure.
  • Cash Flow exposure: It considers the future exposure to foreign exchange risk, this because of the liabilities acquired or the ones that will be acquired in the future and that are not included in the balance sheet. For these purposes, the cash flows of the enterprise are compared in both ways: taking into consideration devaluation or ignoring it. All this is carry out under the supposition that physical quantities remain constant.
  • Economic exposure: a complete analysis of the exposure to foreign exchange risk should also consider the markets in which the enterprise participates, its characteristics and the possible reactions that can occur. This leads to anticipate the financial situation of the enterprise taking into account the factors already mentioned, which helps to perceive the effect on the enterprise, the market and on the decisions of the management.

In the same way that inflation affects accounting, as explained before, devaluation can also educe the reliability of traditional accounting, by making planning more difficult as well as decision making processes, financial analysis and project evaluation, by increasing the urgency for financing, reducing profitability and productivity, etc. All these factors vary from enterprise to enterprise, in other words; the effect of devaluation is not uniform. It will affect those enterprises that have a stronger relation with the external sector of economy and that have less capacity to react to these situations.

It is worth to mention that the analysis of the devaluation periods usually is more complex because most of the times an inflation precedes it, therefore; management becomes more difficult because the number of variables involved increases as the analysis needs to be more realistic.

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3. –Export and Import- Companies and Enterprises with Debts in Foreign Currency

Different effects of the exchange rate fluctuations on enterprises can be expected depending on the type of enterprise, its operations in foreign currency, and the importance of such operations. There are three basic situations:

  • An enterprise that exports part or its whole production
  • An enterprise that imports part or all its raw material or ended product.
  • An enterprise that enjoys or receives financing in foreign currency.

Thus, there are eight possible situations for example an enterprise that exports a part of its production does not import raw material but it does have foreign financing. Another case would be an enterprise that does not export its production but imports raw material and it has debts in foreign currency, etc. Depending on the situation of the enterprise it can be more or less exposed to foreign exchange risk. The eight possible situations are described below as well as the effects of devaluation in each case.

Situación

Do you export some part of your products?
Do you have dollar incomes?

Do you import some part of your products?
Do you have dollar expenditures and costs?

Do you receive financing in foreign currency?

Devaluation Effect:

1

No

No

No

It is not directly affected. It could suffer some affects due to other enterprises related to it that are affected (competitors, suppliers, customers, etc.)

2

No

No

Si

It is dramatically affected because it does not have incomes in foreign currency and it has liabilities in foreign currency.

3

No

Si

No

It suffers a negative effect because of the rise in costs of the more expensive raw material.

4

No

Si

Si

It is facing a critical situation due to the rise in costs as well as the increasing debt and its interests. This is the worst case of all the eight cases.

5

Si

No

No

It is favourable because it reduces the price of its product abroad which makes the enterprise more competitive.

6

Si

No

Si

It can be favourable or not depending on if its revenues generated by exports allow the enterprise to face its greater financial burden.

7

Si

Si

No

It can be favourable or not depending on if the revenues generated by exports are greater than the costs of imports.

8

Si

Si

Si

It depends, if the revenues generated by exports allow the enterprise to face its greater financial burden in foreign currency and at the same time the higher costs.

The most complex situation is when the enterprise gets into debt in foreign currency mainly if it also imports, because the company is being expose to a greater foreign exchange risk therefore the financial charge and costs could increase. Thus, a company with obligations denominated in foreign currency will have to pay a higher effective rate than the nominal rate of the loan. This rate would be:

Where:

ie      Effective interest rate in other words, real interest rate with devaluation (taking into account devaluation)

r      Nominal interest rate of the loan

d      Devaluation rate of the domestic currency against the foreign currency.

Devaluation also affects decisions when wondering whether a project is convenient or not because it influences the profitability of the project. In this cases, in the same way that with inflation, the real internal rate of return (IRR) of the project may be calculated:

Enterprise could be protected form risk in many ways. First, they could loan an equivalent amount of money in domestic currency and give in guarantee a long dated security in foreign currency. The countries that enjoy of foreign currency futures markets could resort to them as an efficient method to be protected from foreign exchange risk.

As explained before, devaluation brings about a variety of negative consequences to enterprise activities, such as uncertainty which also have a number of adverse effects, the rise in imported raw material costs therefore substitute or alternative inputs may be required (maybe with a better quality/price relation), more restricted foreign credit, etc.

As demonstrated before, the impact of devaluation could be worse in enterprises that have obligations denominated in foreign currency, companies that require imported raw material, that produce non commercial goods, or that have controlled prices, also enterprises that face a very elastic demand to the price. Among other situations that may difficult the enterprise practices when the domestic currency is devaluated.

Some Important Aspects

1. The modern enterprises face an atmosphere that is more and more changing, unstable, and complex in which survival depends on their ability to adapt and to take advantage of benefits and opportunities that will open up.
2. Nowadays, organizations cannot ignore the different events that take place in the political, legal, economic, socio cultural and technological environment nationally and internationally.
3. Even when classical management theories gave little importance to environment, then with the introduction of the systemic approach, other theories and methodologies, the importance of environment to modern management has been recognized.
4. The external environment is composed of a number of elements that are out of the control of the enterprise, the economic environment is one of them. The main aspects that the economic diagnostic requires can be summarized in five areas: 1. Level of economic activity and management of productive resources. 2. The behavior of the foreign economic relations. 3. Public finance behavior. 4. Monetary and financial variables behavior. 5. Diverse price levels behavior.
5. Inflation is basically a phenomenon of economic nature. The pressure of demand and the rise of costs as well as structural causes and expectations may bring about a sustained increase in the general price level only if at the same time the circulating medium increases as well.
6. Inflation brings about a variety of negative consequences to economy in general: it reduces the purchasing power of money, it distorts the financial system, it generates costs and inefficiency, it discourages productive investment, it affects the balance of payments and finally it distorts the role that the market plays as a guide for producers. Inflation does not affect all of us in the same way, some are favoured by it and some other are negatively affected in other words redistribution of wealth takes place.
7. Domestic currency depreciation tends to motivate export sectors and the opposite happens in the case of importers. In addition, there is a relation between inflation and devaluation because when encouraging exports, the aggregate demand is also encouraged and at the same time costs rise due to the rise in the price of raw material. Like inflation, devaluation favours some and negatively affects others.
8. Inflation affects the enterprise capital budget implementation and interpretation because it affects cash flows, it tends to artificially increase profits therefore a part of them is taxed and real flows are reduced. To consider this effect, the enterprise needs to adjust its revenues, costs and expenditures to inflation in order to have adjusted flows for inflation. Then the discount rate, the net present value and the internal rate of return are adjusted to consider inflation and therefore to evaluate projects in a better way.
9. Inflation reduces productivity of enterprises; it varies the combination of resources applied in the production process when the relative prices change. In addition, it interferes with the increases of the maximum production capacity by hindering assets replacement.
10. Traditional accounting data is distorted due to inflation:

• It affects price setting based on historical cost since inventory replacement could be not protected from risk.
• Financial-statements are distorted: economic results and the net worth become eroded and the composition of the balance sheet changes.
• Cost of sales are undervalued
• Looses due possession of monetary-assets are not taken into consideration.
• There is a risk to distribute dividends over real profits.
• The accounting data is not compatible throughout time

11. To have appropriate and enough information for the analysis and decision making process, enterprises need to apply alternative methods as complements to historical accounting. For example, the general price level accounting, the replacement cost accounting and adjusted replacement cost accounting.
12. During periods of inflation, it is more convenient to apply the last in first out (LIFO) method for inventory pricing than the first-in, first-out (FIFO) since the latter exaggerates profits.
13. When facing inflation, the enterprise needs more financing due to the rise in costs and to finance its growth, in other words its production capacity. In addition inflations tends to favour debtors that is why enterprises get into debt, extend payment periods to suppliers, reduce collection periods to customers, and as far as possible to diminish the possession of assets mainly the monetary ones.
14. The financial ratio analysis is strongly affected, since a fictitious increase in efficiency rations, in profitability and finally in solvency takes place, while the opposite happens with efficiency ratios.
15. During periods of inflation the real tax rate is higher than the nominal, which may bring about liquidity problems for the company, decapitalisation and a reduction of production capacity.
16. The decision making process is affected by the distortion of the accounting data and the surrounding uncertainty. Thus, the use of biased data may lead to big mistakes, which stresses the need to use techniques that allow adjusting the information to inflation.
17. Due to the possibility that in the future the domestic currency depreciates, companies could be exposed to exchange risk, which occurs in three basic levels: the accounting, the one of flows and the economic one. When considering the three levels, there is a precise impression of the enterprise’s vulnerability if it faces devaluation.
18. Devaluation also distorts the accounting data and affects the financial analysis, planning and the decision making process basically due to the instability and the uncertainty that it causes.
19. Companies that have debts in foreign currency or import raw material or finished products, are the enterprises most strongly exposed to the exchange risk, mainly if they do not produce exporting goods. On the contrary the export companies would be favoured of such situation mostly if they do not import their raw material and also if they do not have obligations in foreign currency.
20. Companies can adjust the information to measure the impact of devaluation and thus, to make more accurate decisions.
21. The change in price levels and in the exchange rate of change has a significant and irregular impact on the financial data of the company. This effect cannot be ignored, since the management and investors make their decisions based on this information. Thus the financial statements must be corrected, in order to eliminate all these biases and to analyse the situation of the company based on the new data. In order to do so, the company must implement adaptation policies and clearly recognize the relevant variables within the economic system, since these are phenomena on which the company does not have action capacity, it can only adapt its policies to decrease negative effects.

Some Recommendations

After this analysis some recommendations may be suggested.

1. The modern management must take into consideration the different events of the environment. It also must learn to adapt itself to changes and to develop the ability to turn the unfavourable situations into opportunities that provide to it advantages to compete. Thus the company must guide its efforts and resources to study its environment and the different level of such environment. The enterprise must analyze all the elements of the setting that affect it, also their intensity, and how to react to them.
2. The company must recognize the importance of the analysis of the economic environment and it should be aware that the variations in the price levels and in the exchange rate affect it significantly, in the enterprise level as well as in the general level of economy. This is particularly important in a country like Costa Rica that during the last years has experienced sustained inflation and the devaluation.
3. During periods of inflation, the numbers obtained in the capital budgets should be adjusted to consider inflation as well as devaluation, to do so the flows can be deflated, and then the convenience of the accomplishment of a project in real terms should be analyzed, using a net present value (NPV and an internal rate of return (IRR) in a currency on constant purchasing power.
4. During inflationary periods the organizations need to adjust their accountancy to inflation, to provide unbiased data for the decision making process. Suitable techniques, like the one mentioned in this paper, to achieve such goal must be applied.
5. The financial analysis also must be developed applying real terms, since the financial statements become distorted due to the effects of inflation and devaluation. In this way the enterprise will fight against the possibility of drawing false conclusions regarding profitability, efficiency, solvency and the liquidity of the company.
6. Companies can adopt some strategies to mitigate the impact of inflation, such as to increase their level of indebtedness, to extend the periods of payment to suppliers, to diminish the collection periods, among others. In the same way enterprises look for some mechanisms to protect themselves from the exchange risk.
7. The company must carry out a detailed analysis of its exposure to exchange risk and avoid those situations in which this one is higher, such as get into debt in foreign currency or to require importing raw material without having some income in foreign currency or revaluable assets denominated in foreign currency.
8. The ones in charge of the management of the enterprise must be sufficiently skilled or trained to consider the adverse effects of inflation and devaluation, and even be able to anticipate them, at the same time to have the capacity to apply opportune and appropriate mechanisms to face such situations. This requires to be updated and to constantly study the environment and its relations with the company.

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