Doing business overseas presents tantalizing opportunities – a larger target market, low cost sourcing and the moniker of being “international” that can have positive implications for brand and marketing. However, a major pitfall of international business is dealing with foreign currency and the uncertainty it brings in terms of revenue and expenses as well as the potentially heavy costs involved in exchanging currency to make payments or receive funds.
I don’t want to dwell too much on the direct costs of currency exchange that SMEs are exposed through their bank. Suffice to say, it is currently a rip-off, but I am working hard to change this. Unfortunately, 90% of cross currency payments are still conducted through banks. I know businesses that are paying more than 9% in spread (the margin between the rate the bank will buy currency at and sell currency at) and fees to facilitate the exchange. Ridiculous. Instead, I want to focus on managing currency risk.
Volatile currency markets are a threat to every business, whether it is a three-man technology start-up in Hoxton or a global corporation with thousands of employees. Currency fluctuations, particularly acute today, can effect predicted revenue disastrously and lead to difficulties in covering expenses. The pain a business can feel when a currency move goes against it can be mitigated – and almost removed entirely – by implementing a series of risk management procedures.
Forward contracts are a currency risk management tool that enable a business to secure a fixed exchange rate for payments/income scheduled in the future, providing protection against volatility in the currency markets. Settlement of the payment can be defined as flexible or for a fixed date. Businesses typically have the option to draw down (pay-as-you-go) on a fixed date or in an agreed time period. The ability to secure the rate helps mitigate currency risk, protects the company’s margin, and allows them to more reliably predict their cash flow. The ability to fix the rate for up to one year in advance helps businesses to budget and forecast with more precision for the forthcoming year. The risk management tool is also of great benefit to businesses that have to price goods or make purchases now but are not required to pay for them or receive payment until a future date; typical terms most are exposed to are 30 or 60 day payment terms.
Another way businesses can obtain protection against volatile currency markets is by building an income or cost stream in the same foreign currency to set off against costs/income in that currency, thereby removing much of the risk surrounding a major currency move.
Risk can also be managed implicitly through intelligent trade agreements with suppliers and buyers. For example, a business can agree to bear the risk of a certain sterling-euro trading range, but its customer agrees to pay if the moves are larger, in either direction, thereby absorbing the cost or reaping the benefits of a favourable move.
There are also specialist services available to businesses that want to protect themselves from volatility in currency markets. If a business has a target exchange rate, an international payments specialist will monitor the market for them 24 hours a day. This service is particularly useful if a business is happy to wait a little longer to achieve their desired exchange rate. Standing orders can also be valuable because the business knows the market is being monitored, but they do not have to waste their time or human resource to track it themselves. A business will know exactly the price of its payments cost, when its account will be debited and when its suppliers will obtain their funds.
A business that uses a combination of these risk management tools to fit the particular risk profile of their business can all but remove the currency risk without too much effort and reap the benefit of more stable and predictable cash flows.
This article originally appear in the July issue of Entrepreneur Country magazine.