If your company’s finance director, on receiving a substantial payment in Euros, took that money and put it on a horse running at the 3.30 at Kempton, this would-quite rightly-be frowned upon.
However, many small- and medium-sized enterprises (SMEs) are currently speculating with money in much the same way: they are stockpiling the payments they are receiving in Euros, rather than converting it as soon as possible to Sterling.
The temptation to do this is understandable. The exchange rate now is far from favourable for this conversion. This is down to ongoing uncertainty in the Eurozone – the fear of a Grexit has reduced confidence despite its resolution – and the continuing strength of the UK economy. This, plus other factors, has meant that the Euro has been weak against the pound for some time. So why convert now, when there is a chance that the rate will be more favourable in six months or even two or three?
By hoarding this currency, rather than exchanging it, these SMEs are effectively engaging in currency speculation, something that carries a lot of risk – in much the same way as putting the money on a horse would carry risk. It’s also a distraction small businesses don’t need. Currency markets are unpredictable: you may look at the current situation and assume that, through the simple law of the return to the mean, things will get better for the Euro in the future. Unfortunately, there is simply no guarantee that will be the case.
The hoarding of foreign currency creates another problem for small businesses – it locks away liquidity. The ability of a company to meet its short-term liabilities is a good indicator of how healthy the company is - locking away cash reserves while waiting for a better exchange rate has the potential for disaster. Small businesses already face liquidity problems due to banks restricting credit and the issue of late payments. Hoarding will only exacerbate the problem.
Businesses that receive frequent payments in foreign currency should exchange on a regular basis – at least every month. The rate will rise and fall, but exchanging regularly means that these fluctuations will average out over time, giving you an acceptable rate over a year - without trying to second-guess when the rate will move.
To avoid the worst of currency fluctuations, your bank or currency exchange provider should be able to agree a set reference exchange rate that will remain fixed for a set period. By locking the exchange rate in this way, you avoid the potential losses incurred if there is a sharp change in the exchange rate. This also avoids having to change prices in order to maintain profit margins, and makes financial forecasts more accurate and predictable.
Of course, if the currency rate changes in your favour, you will not be able to take advantage of that. However, I would argue that this chance to make a little extra money is better traded for peace of mind. Some currency exchange providers will offer, rather than a fixed rate, upper and lower limits, so the business can enjoy some of the benefit of a better rate and avoid the consequences if the rate swings the wrong way.
Arranging a fixed rate is also a good opportunity to check that you are getting the best deal when it comes to fees. Overpaying for your currency exchange will cancel out any profit made by timing the exchange just right for the best rate.
“Keep calm and keep converting.” It is best to keep this mantra in mind and leave currency speculation to the currency speculators.
Money Mover is the online business currency exchange and international payments service dedicated to SMEs.