In fact any company that sells overseas, or imports stock, raw materials or services will be acutely affected by swings in the value of the Pound.
And such swings aren’t in short supply at present. The Sterling has begun 2016 in wretched fashion – losing four per cent of its value against a basket of foreign currencies since the start of the year. And while a weakening Pound is great news for British exporters – as it makes goods and services cheaper for overseas customers – it is gradually increasing costs for importers.
Astute business owners will notice and adapt to these long-term shifts in exchange rates, but far fewer prepare for the sudden, surprise shocks that can be triggered by jittery markets. The impact can be dramatic – for example, Sterling slumped over five per cent against the Euro in just one torrid week in August 2015.
With many SMEs operating on extremely tight margins, such unexpected swings in exchange rate can be the difference between making a profit and or a loss on a deal. In the most extreme cases, falling foul of exchange rate volatility can tip a struggling business over the edge.
Don’t be a hostage to exchange rate fortune
Unless you specify otherwise, when you buy foreign currency (ie send funds overseas to pay a supplier), the conversion will be made at the rate of the time and day. This exchange rate can go up or down, meaning that each time you make the same transaction, it could cost you more or less.
Read more about exchange rates and foreign money:
- Why problems in China and fluctuating forex can effect your UK business
- Don’t hoard, hedge: Why holding onto your Euros is risky
- Export to grow: How SMEs can manage foreign exchange costs
Whatever you’re doing – importing materials or renting an office overseas – you need to hedge against this risk. But too few companies properly account for the volatility of the currency markets – and fewer still make use of the various strategies that exist to limit the risk. These include:
With forward contracts, you buy a currency now with a small deposit – typically five per cent – that enables you to lock into a specific rate. However, you only pay the remainder when you actually need the money. The fixed rate protects you from the potential for a sharp move against you when you eventually make the payment. Forward contracts can usually be fixed for up to a year.
This is where you set a target exchange rate, at which, if achieved in the markets, you will buy your currency. Limit orders are useful if you have upcoming payments but you are not restricted by tight deadlines and therefore have time to try and achieve a better exchange rate than what’s available at the current time. This tool provides assurance to businesses that should the ultimate exchange rate be achieved, even if that occurs in the middle of the night, their trade will be triggered automatically.
Stop loss orders
This is where you set a minimum exchange rate, which, if achieved in the markets, you will buy your currency. Stop loss orders are often used where there is a high risk or concern of adverse movement in exchange rates, enabling clients to protect their bottom line and reduce the risk of exposure to such negative movements.
By locking into an exchange rate, a company could miss out if the currency movements go in its favour, but that risk is surely more than outweighed by the benefit of being protected if the exchange rate movement goes against it.
Small and medium-sized firms are unlikely to have the cash reserves to bail out if an overseas deal goes wrong because of currency fluctuations.
More than anyone else, bosses should use hedging strategies to ensure that when they expose themselves to overseas markets, they’re not also exposing themselves to unnecessary currency risks.
Elsewhere, Kevin Grant, managing director of corporate international payments at Moneycorp, discusses how the pound’s exchange rate can impact importing and exporting businesses.
David Lamb is head of dealing at foreign exchange specialists FEXCO.
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