Whether you have an international or local business, it’s likely you’d still be affected by currency fluctuations. Through the evolution of communication services, businesses have the ability to spread all over the globe, profiting from advantages a global market has to offer. Products can be sourced from a country thousands of miles away, and services can be rendered to the most distant locations on the planet.
But this kind of venture has its difficulties. There is no "one size fits all" solution to settle payments. This creates a new type of challenge for small businesses, as they have to take into consideration the various currency rates and fluctuations of the Foreign Exchange (FX) market. See infographic on how global events impact your forex trades.
After lengthy and exhausting negotiations, the contract is finally signed – just for the profit to evaporate in an unlucky and unforeseen move of the exchange rate. This is the reason that more and more businesses are looking to the treasury departments of various banks. But there are other ways in order to protect oneself from the unknown.
Ways to deal with currency exposure as a small business:
1. Opt for Long Term Relationships
For businesses dealing in import or export, the most favorable setup is to sign long-term contracts. Exporters sell their products or services in a foreign country, usually for a different currency than their own. This means that they are exposed to a high amount of risk as their expenses are in a different currency than their income. If the home currency jumps in value, then their expenses go up compared to the income – a vary bad position to be in. If these businesses sign long-term contracts however, then their cash flow should be relatively stable, allowing for easy implementation of hedging.
Conversely, businesses dealing with imports are interested in a strong home currency, as they pay for the sourced products with their cash from home. And if the home currency is strong, then they can buy more units of product for the same 1 unit of money than they could beforehand.
2. Be Flexible
Another way to reduce the risk is to have an exceptionally flexible pricing policy. This does not work for everyone unfortunately, as businesses who deal with physical products or are dependent on outsourcing some part of their business have to acquire said things for good old cash. They can not go below a certain price without losing money. Businesses whose main profile is providing services are usually much more flexible. Recent surge in "Software as a service, or SAAS" type of businesses confirm this, as they can aggressively price their way in to the market, with usually very low overhead costs associated with providing the services once they are developed and programmed.
If the pricing policy is flexible, then the price of a product or service can be adjusted to the current exchange rate. This is simple to automate in certain cases, so there is no need to involve a treasury department to hedge currency exposure.
Hedging currency exposure in the traditional sense is probably the most effective way to remove the uncertainty of fluctuating exchange rates. The first phase of actively managing currency risk is by monitoring exchange rates. This is very common and usually everybody who does it has some form of exposure to different currencies apart from his home currency. The second phase is to open a brokerage account and selling or buying spot currencies, locking in the exchange rate. If a business knows that it has a contract worth 50,000 Euros for example, then he can just as well call his broker and sell the EUR to buy USD. This removes the risk that a drop in the value of EUR will negatively affect him. This also means that he will not be able to profit if the EUR rises in value. This is usually not a concern however, as the most important thing is to remove risk.
The third phase for actively managing currency exposure is even more sophisticated, as it involves time. Forwards and FX options do not only specify the price for which the EUR can be sold against the USD, but also until when (in case of options) or when (in case of forwards). The last and most sophisticated level is usually reserved for large corporations, as they are uniquely designed to fit the various needs of the business, and require several hours spent in a meeting room with a banker.
As a summary, currency exposure is a real risk and has to be taken seriously. Fortunately there are ways to eliminate this nearly completely, allowing for a much more computable cash flow. If a business owner or manager starts from phase one and works his way to the required level of knowledge regarding hedging, then they will have a very powerful tool to remove the uncertainty. And this is invaluable given the fast paced world we live in.