Coping with Currency - Managing Fluctuations

Every business struggles with uncertainty at one time or another. A large amount of management time is spent dealing with “what if” scenarios in order to have a plan for unexpected contingencies.

In international trade, the continued absence of a universal currency means that business has to face an additional risk factor known as currency fluctuations. There was a time when movements between currencies in the developed world were thought to have been minimised, but political and economic events in recent years have put an end to that notion.

The British pound has fallen sharply against leading currencies in the last year, following the EU referendum. A pound would have bought 1.50 US Dollars or 1.40 Euros early in 2016. As I write this, the published exchange rates have dropped to 1.30 and 1.12 respectively.

While the fall in the value of the British pound has rightly been presented as an opportunity for exporters, it nevertheless causes headaches and consternation. The biggest issue for most international traders is the uncertainty.

Some people think that they can avoid the risk by always invoicing their customers in UK pounds. They are wrong. What’s more, they are likely to be making life difficult for their customers and possibly losing business because of it.

Let’s illustrate this with an example of a manufacturing company selling to a customer in the Eurozone. If they ask their customer to pay in pounds, and the value of the pound falls, the customer is happy because he gets a lower price. But as we can see from the news, a lower value pound causes inflation, and eventually the exporter has to review his prices upwards if he is to protect his margins.

If the same exporter had invoiced in Euros, the customer would have seen no difference, but the exporter would have benefitted from the fall in the value of the pound by getting more for his Euros. So he would have been better placed to absorb the increases in his costs that would have come later, without having to change his prices.

Naturally, the exact opposite applies if the pound increases in value.

Many exporters will not have the luxury of a choice about which currency they invoice in. Particularly in the United States and the Eurozone, most consumers and smaller businesses will be more comfortable dealing in their own currency, although some larger businesses, particularly those that have substantial international trade, may well take a different view.

A traditional way of avoiding these risks is by passing it on to a third party such as a bank, by the use of forward exchange rates. This is a rate that a bank will offer to exchange the expected payment at a given date. Unfortunately, as markets have become more turbulent, banks have also sought to minimise their own exposure to risk, and where these facilities are available, they tend to offer very pessimistic rates.

There are much simpler ways for small businesses to seek to avoid, or at least minimise their risks. The company that exports products is very likely to source some supplies, such as raw materials, components or equipment, from other countries. Asking to be invoiced in Euros or US Dollars can enable the exporter to play off their costs against their revenue. The Euro has made this particularly useful, as many countries accept the currency, even countries such as Poland and Denmark that have not actually adopted the Euro. The smart thing to do is to set up a Euro currency account, which is usually very straightforward. Allow customers to make payments into this account, and keep sufficient funds in the account to pay suppliers. Not only does this avoid bank charges on exchanging the money, it at least partly negates the effect of currency fluctuations.

Where a company is actively pursuing business in such markets, it’s likely that staff will be travelling on a regular basis, and incurring hotel, travel and living expenses while there. So why not make the funds in the Euro account available to them, rather than incurring more bank charges?

A related problem for many exporters is that many customers are seeking longer payment terms. This is a very difficult trend to resist, and in itself it causes stress for many exporters. But of course, the longer the exporter has to wait for payment, the greater the chance of currencies moving against him before the payment is made. It’s important to bear this in mind when negotiating payment terms. Many exporters offer a prompt payment discount, usually about 2-4%, which is applicable if payment is made in advance or perhaps within 10 days of invoicing. Some European companies will consider this normal practice and may even make such a reduction of their own accord! It’s good to be wary of this, and to factor in an amount in pricing if the practice is expected, but many exporters will consider it to be worth applying the discount to avoid any risk of being hit by an adverse currency fluctuation.

Most importantly, exporting businesses need to keep a careful watch on their margins, and should be ready to act when rates move significantly. It’s worth monitoring the key rates on a weekly basis, and analysing the effect on revenues and margins.

Article written by Tim Hiscock - Associate of Strong & Herd LLP

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