Several transactions take place in many different forms through different channels all over the world daily.
It is therefore important for companies that import and export goods to pay close attention to the exchange rates as the value of goods are highly sensitive, chopping and changing with the constant fluctuations.
Similarly, companies that trade domestically must also be aware of changes in exchange rates as they will have an indirect impact by virtue of the wider economy.
There are numerous key risks associated with foreign exchange, no matter what size a business is. Among the notable risk are translation risk, transaction risk and economic risk which have a big impact on commercial margins and are particularly risky for smaller businesses where there is no currency hedging solutions.
Translation risks occur as businesses with international dealings translate their international assets and liabilities as well as financial statements from foreign currencies to local currencies.
This translation exposes them to foreign exchange risk, given that exchange rates remain prone to ongoing fluctuations.
Transaction risks are due to fluctuations in exchange rates from the payment date to the settlement date, which exposes businesses to further potential expenses.
Any unexpected fluctuations in exchange rates can expose companies to economic risk. If a company has invested in international projects, it will also need to consider contingency risk too.
For companies doing business overseas, the uncertainty of the foreign exchange rate between the time a deal is made and when payment is complete comes with a high profit margin risk.
However, using the right combination of payment and cash management strategies means small businesses can improve their cash flow and protect profits.
Here are strategies from researchers to help small businesses looking to manage their funds and be more competitive:
- Opening a foreign currency accounts: This is can be an ideal solution for companies that have many transactions in any particular currency. Therefore, ensuring that there is cash available in that currency can help companies react more quickly and reduce currency risk. It also reduces the need for multiple cross-currency transfers.
- Hedge with a forward contract: A forward contract is a contract where a set amount of currency is bought for settlement at a determined value date in the future, at a predetermined exchange rate. These are ideal for protecting against fluctuations and are useful for budgeting. By fixing prices in advance, small businesses can easily budget and plan knowing exactly what their costs will be.
- Currency option: Like a forward contract, currency options set an exchange rate by a certain date at a certain amount. However, you are under no obligation to exercise an option (hence the name). If the exchange rate moves in your favor, you can forego the option and take the spot rate instead. You pay a premium for this flexibility but currency options are worth considering when demand isn't 100 per cent certain, or if purchasing parameters are partially unknown.
- Use online transfers: They provide easier cash management and increases payment visibility. It also makes settling invoices with overseas vendors more cost effective. Some platform offers businesses a global business payment at any time with Online FX options.
- Use a budgeting tool that gives visibility over exposures: Some providers offer budgeting products that automatically calculate total currency exposures for multiple invoices. This means businesses can go to a single platform to see how much their cross-border incoming and outgoing cash flows are worth in their home currency based on the current market so they can make more informed decisions.
- Purchase a limit order: Limit orders work by purchasing a currency when the rate hits a predetermined target. It's most effective for businesses with some time flexibility before they need to make payments. A limit order can be purchased through an account manager, who will buy the currency once the target rate is hit.
- Settling invoices with overseas vendors in local currency: Overseas vendors often pad invoices in order to mitigate against currency risk. Research from Western Union Business Solutions shows that one in five Chinese suppliers adds roughly 3-4 per cent to USD invoices to cover foreign exchange fluctuations. Making deals with overseas vendors using their local currency gives business owners the opportunity to negotiate a discount.
- Spot payments: Using a spot payment means buying or selling currency at the current exchange rate. Spot rates are recommended for smaller payments that are less regular, or when currency needs to be exchanged rapidly. Look for providers with low fees and competitive spreads between buy and sell rates.
- Build your plan, implement it, then forget about it: Work out what a good position is for your business, implement your plan, and then forget about it. Don't waste any more time worrying about where exchange rates go. Once you have determined a rate that's good for you, it will still be good for you if the rate moves further down the line. Rest easy knowing your business has been de-risked and focus on running your company
Small business owners that want to save money on their foreign exchange need to understand their current situation and risks and make them a priority.
Source: The Globe and Mail