In the fourth quarter of 2015, Apple lost a staggering $3.75 billion in revenue due to the strong US dollar impacting on global sales. 5% of its total revenues for Q4.¹
Fortunately for Apple it has the financial clout to withstand such beatings from the currency markets.
But if your company is like most with exposure to foreign currencies, taking a 5% hit on revenues because of exchange rate volatility is simply not an option.
Corporate Currency Risk Management In 10 Steps
While there are no exact figures, approximately 55% of SMEs² in the UK do not actively hedge their exchange rate exposure at all. They just leave their profit margins to the mercy of the constantly fluctuating FX market.
A lot of companies think that it will “even itself out” over time – losses in one quarter, gains in another – and that hedging is complicated and costly. This is an ill-advised approach.
The truth is that it needn’t be costly, if you benchmark and shop around among FX providers. As for being complicated, the hedging products that are the most beneficial are the most simple – forward and options contracts, for instance.
Hedging, like anything, takes a little getting used to but it is not complicated. Understanding it and how to employ an effective hedging strategy are essential in controlling FX risk, keeping your costs down, and stopping any nasty surprises from taking a chunk out of your revenue.
1 – Understand How To Hedge Your Risk. Properly
While there are many companies who neglect to hedge, there is another group who go the other way and overdo it, hedging their entire exchange rate risk without fully understanding what they are doing or how to hedge.
Banks have sales teams whose targets are to make as much profit as possible. In order to do so, their sales reps are given targets to sell complex hedging products simply because they cost a lot more for you than the more simpler products.
And they convince you that your company needs them. Really the only companies that need such complex products are large caps and companies in dozens of markets around the globe. SMEs by and large do not need them. Which brings us to our next point…
2 – Simplify Your Currency Hedging Policy
Something that happens too often in corporate foreign exchange risk management is that companies buy complex hedging products, they don’t fully understand them, and they end up out of pocket and without a full understanding of their own hedging strategy.
Keep it as simple as possible by knowing your needs and how to meet them effectively and as cost-efficiently as possible.
Look for an FX provider who will take the time to analyse your company’s exposure and really explain what kind of simplified hedging product, such as a forward or an options contract, is best under certain circumstances.
3 – Review Your FX Provider Costs With These Questions
Q1 – What is the spread on the exchange rate?
These questions will help you to gauge whether you are with the right FX provider:
The spread – the additional charge added by the bank or broker to the exchange rate – is often between 1% and 3%, sometimes more. If the provider is truly transparent, they will disclose this information to you. If not, it’s a sign that they are not being completely honest and that they are taking a large commission fee from your company in the form of an undisclosed spread.
Q2 – Is there an additional cost for delivery of funds?
There is often an additional fee levied on your company for sending the funds from your bank account to the beneficiary’s. This is a second commission on top of the spread for the exact same transaction. A provider who sends your funds with no additional charge will cut this cost out.
Q3 – Does the spread percentage change on the same currency pair over time?
A trick that is unfortunately common in corporate foreign exchange goes like this: in order to attract your company as a client, many brokers offer an incredibly good opening exchange rate with an unusually small spread.
With time and more transactions, the spread is widened, with no disclosure. This brings us back to question one – always asking what the spread percentage is will stand your company in good stead.
Q4 – Are there any other costs involved?
The traditional finance sector is of course known for applying hidden fees. Ask if there are any, and why. Does it sound like a ploy to get more money from your company? If so, it’s a sign to look elsewhere.
4 – Review Your Currency Service Provider
How fast are the payments? Are same and next day international payments available or do they take more like 4 or 5 business days, or longer?
Are they knowledgeable? Do you have a personally assigned, experienced dealer or do you have to deal with call centres with different tellers every time?
Are they transparent in their pricing and processes? Are they regulated by the relevant body (FCA in the UK)? These are all good questions to ask.
Crucially, you needn’t feel like it is too much to ask these questions – if the bank, broker or alternative provider puts clients before profits, they will be happy to answer these questions and more. And they will have nothing to hide.
5 – Pay In The Local Currency Of Your International Supplier
In order to cover their own foreign exchange risk, many suppliers charge you a premium on top of their typical rate in their own currency.
Ask them for an invoice in their currency, rather than US dollar or another reserve currency you might be using. You can then calculate if there is a difference.
If sizeable and you already have a strong hedging strategy in place, would it make more financial sense to take on the FX risk and lower supplier costs? An additional bonus is that your suppliers will be happier that they receive payment in their own currency.
6 – Don’t Take On The FX Market. Ever
Leaving your company exposed to exchange rate fluctuation, believing that you might benefit from a strengthening of your functional currency for instance, is nothing more than speculation.
The FX market is so volatile with so many factors that influence exchange rate movement that it is simply impossible to call. You might get lucky sometimes, but most of the time you almost certainly won’t and speculating with your company’s money is dangerous.
7 – Don’t Hesitate To Lock In A Loss
Should the exchange rate move against your interests, and often this happens after you have your accounting in order for the period ahead, don’t be afraid to lock in your loss by hoping that your luck will turn. Take out a hedging product – a closed or open forward – to hedge that risk.
If not, that loss can worsen over a longer period of time. Stamp it out by accepting a less detrimental hit.
8 – Forecast Well For Good Business FX Management
Forecasting can include very optimistic views. Of course forecasting is not easy, but many companies make it more difficult than it has to be by including sales and revenue goals in there.
Get a tighter reign on your forecasting, particularly if you have accounts receivable and payable in foreign currencies, which can be trickier to gage.
Better forecasting primes your company for a more realistic view and of how to react to FX volatility should the need arise, and it will arise.
9 – Fully Understand The FX Tools And Processes That Will Save You Time And Company Money
Following market movements, central bank decisions and macroeconomic policy is time-consuming. Time that you likely don’t have.
There are currency providers that offer guidance in managing exposure. Look for a provider with a personalised service and a knowledgeable dealer team.
As for tools, understand how limit orders and stop loss orders work and can be of benefit to maximise gains and minimise loss on the exchange rate, respectively.
FX alerts are also a handy way of automating the process of following exchange rate movement.
10 – Keep Your Eye On The Ball
It’s all well and good getting a good business FX management strategy in place. Essential. But it is easy to let complacency of some degree set in along the way.
To offset this, it is strongly advised to schedule periodic reviews of FX providers – say bi-annually, where you can benchmark your current bank, broker or provider against others; looking at service, pricing and responsiveness, among other points.
With these 10 steps to a good business FX management strategy, your company will be well on the way to lowering its FX costs, reigning in volatility and making your process much smoother and less time-consuming.
It really needn’t be as daunting as it may first appear, and once you get over the first, most difficult hurdle in deciding to overhaul your strategy, it will be much easier.
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