Translation risk, also called translation exposure or accounting exposure in foreign exchange, refers to the potential impact on a company's financial statements caused by exchange rate fluctuations when converting foreign subsidiaries' financial data into the parent company's currency.

This occurs because multinational companies keep their accounting records in the local currencies of their overseas operations, which need to be translated into the home currency for consolidated reporting.

Important aspects of translation risk include:

• It affects the reported values in the consolidated financial statements—such as the balance sheet, income statement, and equity—without directly influencing actual cash flows.
• Exchange rate changes can lead to variations in reported asset, liability, and equity values even if the underlying economic values remain unchanged.
• These translation effects are typically recorded as adjustments in equity, often called "cumulative translation adjustment" (CTA).
• Translation risk represents an accounting issue and does not result in immediate operational gains or losses.
• Because it does not affect cash flows directly, companies often choose not to hedge against translation risk, although it can influence financial disclosures and market perceptions.

For instance, when a U.S. company consolidates the financials of a UK subsidiary, assets reported in British Pounds will be converted to U.S. Dollars. Changes in the GBP/USD exchange rate can cause fluctuations in the dollar value of those assets, leading to translation adjustments in the consolidated results.

In summary, translation risk is the exposure a company faces in its reported financial results due to currency exchange rate changes during the process of converting foreign currency financial statements into the parent company’s reporting currency. Recognizing this risk is essential for understanding the financial statements of multinational enterprises.