Selling into a new market abroad or working with a foreign supplier will create the need for currency conversion - Richard de Meo, managing director at Foenix Partners offers his top tips.
Since the foreign exchange (“FX”) markets are driven by global financial and political events, simply needing to make a euro payment or accept US Dollar (USD) receipts means that your company and your profit margins can be hugely impacted by fluctuations in the currency markets. All of a sudden, wider economic events which you think might not have a direct impact on your business, such as US employment data, or a statement by the Bank of England Governor Mark Carney become directly relevant.
This is not to say that you should necessarily follow every economic event that is happening worldwide, but that as good business practice, you should be mindful of the unique role that FX can play within your company’s financial performance.
The first and most fundamental step is to understand and know the rate of conversion. If foreign payments are being received directly into a GBP account or if international payments are being made in sterling, you are not in control of the conversion, which is almost certainly happening at very wide margins, typically 2-3%. Let’s take the example of a $50,000 payment: you request the payment to be processed and then see a debit on your sterling account of £32,778, reflecting a GBP-USD rate of 1.5254 – this is the rate that your bank or provider would have used on the day. In actual fact, given where GBP-USD was trading, you could have had a fairer price of 1.5650 – the live market rate – if you had used a specialist FX provider to manage the transaction and purchase $50,000 for £31,948: a saving of £830, or 2.5%.
The second step to consider relates to risk management and protecting your company from adverse currency fluctuations. For example, receiving or issuing a foreign currency invoice based on today’s market rates, but where payment is required in 30 or 60 days, means the sterling value of the invoice amount could be dramatically altered. This is solely determined by the movements of that particular currency pair throughout the period defined by the payment terms. Let’s return to the earlier example of the $50,000 payment and assume 60 day payment terms on the invoice. When the invoice is received, the GBP-USD rate is at 1.5650, from which you estimate a cost of £31,948. Over the course of the next two months, the US economic outlook and expectations in relation to interest rate rises undergo a shift, pushing the rate of exchange for GBPUSD down to 1.4950 on the day payment is due. All of a sudden the $50,000 invoice costs £33,444: a rise in cost of £1,496, or 4.7%.
This highlights the impact that not being on top of simple currency payments can have on your profit margin, and the huge costs that can incur if you overlook your company’s FX exposure. With the major currency pairs capable of moving 15% within three months, a lack of caution or awareness can result in huge moves in company’s gross profit margin – in either direction.
In addition to being aware of the relevant currency conversion rates and payment terms, there are several other practices which you should abide by in order to make the most of the FX market.
As a general rule, you should ignore the temptation to ‘trade’ currencies yourself. Although it is possible to make gains from the FX market that can feed directly into your company’s bottom line, this can incur in big losses. Market volatility caused by the devaluation of the Chinese yuan, the Greek crisis, and the imminent US rate hike have a great impact on currencies worldwide. In this environment, the priority should be to protect your company from these risks.
To avoid unnecessary market exposure, you should also ensure that disciplined risk management procedures are implemented. This is a technical process and referring to a specialist FX provider can save you money and time in the long run.
These measures are not arduous and the payoffs of an effective FX strategy can be enormous. Conversely, the costs of ignoring or side-lining FX’s role in your business can be equally as great. The currency markets offer both opportunities and threats, but with some preparation and discipline, you can manage your exposure to currency fluctuations and ensure that your bottom line is maximised.
Top five tips to protect your business from currency fluctuations:
1. Take control of the currency conversion - Ensure you have currency accounts for all currencies you transact in and know the price you are achieving when you convert currencies, even for payments. Particularly with cross-currency and international payments, this is often hidden to avoid revealing poor rates
2. Have a disciplined risk management strategy in place to avoid market exposure - Match your client or supplier obligations with currency deals, ensuring timings and amounts are aligned. FX forwards are a simple and effective way of doing this.
3. Ignore the temptation to ‘trade’ currencies - Gains generated by trading currencies can feed directly into the company’s bottom line and can be tempting, but protecting the gross profit margin has to be priority in what continue to be hugely volatile markets
4. Stay informed - FX shouldn’t become a distraction from the other ‘moving parts’ of the business. Being aware of key market events, major fluctuations and relevant favourable moves all contribute to taking control and improving your conversion rates.
5. Make sure you are getting value for money - Compare the currency rate you receive from your bank or current provider against the live market rate, not just another provider. Make sure your provider is working for the benefit of your business by providing ideas, proactive updates and market monitoring on a daily basis.
Richard de Meo, managing director, Foenix Partners