Whether your business trades internationally or is part of a global supply chain, managing currency fluctuations is an essential skill that is now more important than ever for every small enterprise to master.
Smaller businesses can often feel they have no control over their supply chain prices and their costs across the broader currency markets. The reality is that small business owners can take control to at least reduce the impact currency fluctuations have on their enterprise's profitability.
The international currency markets can often seem highly complex. With over $5 trillion US dollars traded every day — much of this trading taking place in London — how these trades impact a small business's supply chain is the foreign exchange (FX) rate, which central banks set. The country's GDP, the current and forecast economic climate and political pressure all influence the exchanges rate the banks set.
Laurent Descout, Co-Founder and CEO of Neo — an FX corporate risk management and payments for SMEs service provider, explained: "EUR/USD went from 1.17 to 1.22 over the last 12 months and that is enough to be of great concern to most companies. There are also meaningful macro changes on the horizon, such as the potential end or softening of quantitative easing policies and higher interest rates, ongoing issues in the global supply chain and a shortage of drivers for goods transportation in some countries. FX hedging and risk management should remain at the top of the agenda for most treasurers.”
Managing the changes in FX should be part of your business’s risk strategy. Whether your business holds foreign currencies, uses spot trading to buy and sell currencies, or has a longer-term strategy to use a forward contract (usually known as hedging) that secures future currency sales at a fixed time and date, should be assessed carefully to reduce the impact FX has on your company.
Hedge your bets
We spoke with Jeremy Thomson-Cook, Chief Economist at business payments specialist, Equals Money.
What are the main challenges facing small businesses when managing multiple currencies across their supply chains?
“Currency risk, the risk that your margins are squeezed or wiped out by detrimental currency moves, is alive and well regardless of whether you operate in two currencies or 10. The businesses that handle it best are able to forecast their costs and revenues accurately and then take steps to mitigate risks to those margins by hedging via a forward contract.”
Has Brexit and the pandemic had an impact on how currency risk can be managed?
“Not so much how it can be managed, but more why it must be. Brexit and the pandemic represent two of the most significant existential threats to how businesses operate, especially those who have either international suppliers or customers. For many small businesses, the move in currency rates — combined with increased shipping or raw material costs — has meant that margins are compressed, or competitiveness is lost as prices have to rise.”
Are there practical steps small enterprises can take to reduce the impact of currency fluctuations?
“Firstly, you have to know where and when the risks hit your business. You can gain this knowledge by thoroughly examining how these pressures affect your business and finances.
“Secondly, decide your risk appetite. Are you prepared to gamble on currencies and hope that rates go in your favour as much as they go against you? Or would you prefer to focus on your business and ensure that margins are protected?
“Lastly, speak to an expert. Even a half-hour conversation with a specialist currency provider is enough to put in place a simple policy that can alleviate currency pressures on your business.”
Is hedging a practical option for small businesses?
“Absolutely it is. In fact, one could say that it is more important than ever for a small business given likely constraints on margins and cash flow when a company is setting up or when higher margins are available for businesses that have found a niche to exploit. Making decisions based on numbers that cannot be protected is gambling on the end outcome and the margins the business eventually makes for any international business.”
Is standardising on one currency (the US Dollar, for example) one way to reduce currency fluctuation risks?
“You can reduce some of the fluctuations by attempting to standardise in one currency, but this is not a one-size-fits-all policy. Every business's currency risk will be different.
“An issue with this policy is that you will be passing the risk on to someone else within the supply chain if your invoice is in your home currency, either as a supplier or a customer. The relationship may change as a result, and you may lose competitiveness or a pricing discount for paying in a foreign currency. It's always worth asking the question: some businesses may offer better payment terms in local currency, further helping small businesses' cash flow.
“It’s never been easier or more important to protect your business when trading internationally. There isn’t much that can bring peace of mind right now but hedging currency risk is one thing that will outweigh the time spent sorting it out many times over.”
The risks associated with a volatile FX and the impact this could have on your business's supply chain can be managed by taking appropriate action. Hedging is certainly an option but take small steps first to see how this approach helps your business prevent the peaks and troughs in the currency markets.
Also, take a close look at the charges your bank makes for FX transactions on your multi-currency account. You may be surprised at the costs. Assessing these costs regularly should be part of your FX management strategy.
Also, hand-in-hand with this strategy are your payment options and also how your current pricing to your customers is presented. According to the Cross-Border Payments and Commerce Report 2019 – 2020, 70% of consumers will abandon a purchase if the price is confusing. Ibid also concludes that an astonishing 92% of B2C customers prefer to buy in their local currency. E-commerce businesses that have yet to move to multi-currency pricing on their websites should make this a priority.
Neo’s Laurent Descout concluded that paying close attention to FX and indeed your business’s whole approach to managing multiple currencies should be a top priority: “It is crucial to identify where the currency risks are in your business. It could be related to cash on your balance sheet, payables, receivables, or a specific contract with a new supplier. Once you have pinpointed the most significant areas of risk, set your priorities.”
Descout concluded: “For a small business, it is difficult to mitigate all of the currency risks all of the time — especially if you’re implementing a corporate hedging strategy for the first time. Fortunately, recent advancements in fintech mean it is possible to access all the key services SMEs need for their corporate hedging strategy — multiple currency accounts, automated payments, and collections, forecasting tools, FX hedging and risk management — at an affordable cost.”
The arrival of Brexit has, in many cases, laid bare the currency risk businesses now face. Managing currency fluctuations with the EU is essential as the region continues to be the UK’s largest trading partner. However, business is now global. Having a strategy that manages the FX risk is critical to the long-term profitability of every business.