How to start managing currency risk
Every business trading globally, whether you’re selling your goods or services abroad or perhaps buying parts to make products, has to undertake a foreign exchange transaction.
Whether you’re moving money overseas each month, every quarter, or only a few times a year, having a currency strategy can help you to maximise the benefits and minimise the risks you are taking on these transactions. There are ways to reduce that risk which include ‘hedging’ to help limit the risk you take over a period of time.
Intimidated by creating a currency strategy for your business? You’re not alone. There are many misconceptions around risk management. Some businesses see hedging as 'gambling', others take the view that gains and losses even out in the end or that rate fluctuations are only small. Some believe that risk management strategies add to the complexity of accounting.
However, these excuses may not outweigh the fact that adverse rate fluctuations can be the difference between a profit and loss. It’s simpler than you think to put some protection in place, so don’t wait until your business has taken a financial hit to start your currency plan.
Let’s get started.
Know your objectives
To have the best chance of achieving your goals, you must have clear objectives, which is why the initial groundwork needs to be done with the long-term thinking. Not having your objectives laid out in full is like trying to drive to a destination without a road map – you might get there eventually if you’re lucky, but the chances of taking wrong turns along the way is much greater.
One objective might be to have a better idea of expected costs for your business. A better FX strategy should mean that there are fewer surprises that your business has to absorb along the way.
Clear objectives will also help you to avoid making emotional decisions as markets move.
Understand what foreign exchange risk looks like for your business
What proportion of your business results in the need for foreign exchange payments? The higher this amount, the greater your likely exposure.
What countries do you do business with? Some countries suffer much more political instability and therefore are likely to have much higher currency volatility.
How frequently do you make payments? The more often you transact, the more you’ll encounter exchange rate variations.
Consider ways of removing foreign exchange risk from the start
Is there a simple change in process that can help remove or minimise the foreign exchange risk, such as aligning a customer billing cycle with supplier payments?
Are you able to bill in your currency and remove the risk of exchange rate fluctuations? This passes the currency risk onto the local customer/supplier.
Do you have business costs where you have customers? You might consider using local currency accounts to pay taxes and suppliers in foreign currency and avoid unnecessary conversion fees. In some markets, OFX has a Global Currency Account which can help you accept payments in multiple currencies that may be right for your business.
Do you know your break-even exchange rate?
By understanding the ‘target’ level you need to hit as a minimum for your currency transactions, you will have a better understanding of the amount of risk you can take, and whether you need to ‘fix’ at least some of the exposure you have to currency moves.
To analyse your currency sensitivity, you can prepare a table showing how exchange rate movements will affect the selling price of exported goods or potential profit. This may be done by choosing a range of movement in exchange rates (we suggest +/- 10%) or by basing on past history (see our historical rates).
Currency plans are not ‘set and forget’
As you progress through your financial year, all sorts of things can change. Your business may take a hit from an unexpected shock, such as COVID-19 in 2020, or you may be far ahead of where you expected within the first six months. Either way, you will need to constantly rebalance your currency position depending on how things change across the year. Think of it as keeping your hands on the steering wheel rather than letting the car head wherever it wants to go.
Once you have a plan in place, you should continually monitor and review any hedging against your objectives (quarterly, semi-annual or annual). Don’t judge performance solely by the ‘opportunity cost’ of implementing an appropriate risk management framework, which is a very common mistake. You should also beware of being distracted by short-term currency rate movements. Consider any changes within the framework of your business that may need to be reflected in the plan over time.
Speak to a currency specialist
Starting to build your currency strategy might seem intimidating, complex and time-consuming, but with OFX, our OFXperts are available to help you make informed decisions about your money. We can help you create a currency strategy to simplify your global money transfers.