5 Ways to Manage Currency Risk Within a Global Marketplace
We are living in an era where it is becoming a more attractive proposition for SME businesses to become involved in international trade. Government is actively encouraging companies towards export markets to improve economic performance and commercial forces make sourcing products abroad a more viable option financially. Both importing and exporting are fantastic opportunities to either expand your business or improve your profitability, but unfortunately some businesses can still be reluctant to become involved due to the potential hazards of trading abroad.
Once the initial research is undertaken and suppliers/customers sourced the most important factor is money. Making or receiving payments in a different currency can, quite easily, present your business with significant exposure to sudden and drastic unfavourable fluctuations in the exchange rates which can potentially not only affect your profitability but also your company’s cash flow. But with the right help, advice and provision of risk management solutions business owners can mitigate the hazards and reduce the risk of significant financial loss, avoid unnecessary costs and become more profitable through international trade.
Understand the risk
Proper planning is the first step to risk management. Understand the risks as a whole and on an individual basis. Ensure that you set an internal exchange rate for the year for budgetary purposes and monitor your performance against this closely. This rate should take into account how much currency you expect to trade and realistically reflect current and future rates. This may sound daunting but you can get advice to aid you in this process and it will be an invaluable tool for such instances as working out if the markets are moving in your favour etc. Before any transaction ensure your business is fully prepared for any outcome and changes in exchange rate. Remember unless a hedging strategy is implemented any changes in the exchange rate will affect how much profit you receive or how much you pay. For example, if you sell a product to a client who elects to pay you in US Dollars (USD) and you offer your clients 60 days payment terms, whatever the change to the USD/GBP exchange rate at the time of payment will affect your profit, so if it falls 15% during that period, your profit will also fall 15%. The same can be said for making payments abroad, if the market moves against you it can potentially wipe out any sell on profit.
Understand the solution
The foreign exchange market can be complex. The products can be intricate so fully appreciate what you are signing up to and if you don’t fully understand – don’t sign. A good dealer will ensure you are fully conversant with the product prior to agreeing a contract and work with you to increase your knowledge of the FX market.
Choose currency wisely
Wherever possible, trade in mainstream currencies i.e. U.S dollar, Sterling, etc. The reason being, the exchange rates tend to be more favourable and transactions tend to be faster if not instantaneous, whereby less used currencies which are less frequently traded and are lower in demand tend to be less favourable and can take much longer to clear.
Choose a strategy that meets your needs
As opposed to just dealing in the current “spot” rate there are various products within the marketplace to manage your FX risk. Products such as forward contracts and market options can be employed to give a greater degree of certainty through a pre-agreed rate range. They give the client a greater amount of flexibility to either target a specific rate or set a lowest acceptable limit and can be tailored individually or in conjunction to depending on your needs and exposure. Depending how much your business can afford to risk or lose may make certain options more suitable than others, but again a good advisor can offer expert guidance in this area.
Many business owners see the FX market as a bit of a gamble, take a “punt” and live with the consequences, but it doesn’t have to be like that. The majority of good brokers will seek understanding of your specific needs in order to provide a tailored and transparent solution, but always be prepared to ask questions – not only of your specific broker but from other sources. Gaining basic knowledge of the market and an idea of the current exchange rates will help you not only gain confidence but also to ensure that you do not succumb to any unnecessary charges or unreasonable price increases from either banks or brokers looking to increase their profits at your expense.
Simple steps and basic knowledge can help reduce your exposure in the FX market, expert advice is always recommended in order to offer guidance and peace of mind. It is also important to remember the principal function of FX risk management is not to increase your profit margin but to protect your business from significant financial loss and give you greater certainty in a potentially unpredictable market.
"....fully appreciate what you are signing up to and if you don’t fully understand – don’t sign. A good dealer will ensure you are fully conversant with the product prior to agreeing a contract...."