A cash flow hedge is a risk management technique used by organizations to stabilize their future cash flows by offsetting potential variability arising from changing market conditions. For example, a company might use a cash flow hedge to protect against the risk associated with variable interest rate loans by entering into a derivative contract such as a swap. By doing so, the company ensures that its payments remain predictable even as market interest rates fluctuate.

The accounting for cash flow hedges involves documenting the hedge relationship and its effectiveness in reducing risk. If a hedge is effective, the gain or loss on the hedging instrument is initially recorded in other comprehensive income and reclassified into earnings in the same period when the hedged transaction affects earnings. For instance, if a company hedges future cash inflows denominated in a foreign currency, the effects of exchange rate changes will impact the income statement upon the execution of the hedged transaction.

Companies employ cash flow hedges as part of their broader financial risk management strategy, aiming to maintain profitability and achieve business stability despite external economic changes. Adopting financial instruments for hedging purposes must comply with accounting principles and meet specific criteria to ensure accurate financial reporting.