Are exchange rates hurting your bottom line?

In this guest article, global money transfer experts, OFX, explain how putting a currency plan in place could help protect your business from moving FX rates.

In early 2022 the market exchange rate for pounds to US dollars was $1.37. By June it had dropped below $1.2.

Uncertainty generally spells bad news for the pound and 2022 has brought plenty. Record high inflation post the Covid-19 pandemic, supply chain issues, and the Russia-Ukraine war have all put pressure on the UK economy. On the other hand, the US dollar is considered a safe haven currency by investors. This means in uncertain climates investors tend to buy US dollars versus riskier currencies such as the pound.

As a result, the pound reached a two-year low against the US dollar in June, swinging in value by more than 12% in less than six months. So, if you’re a UK importer or exporter, managing your budget is especially tricky. Foreign revenue can change in value over time, and overseas invoices can cost you more or less.

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.

What is hedging?

Have you ever purchased a foreign currency at a favourable exchange rate before an international holiday? If so, you’ve already used a hedging strategy.

Hedging is the process of protecting yourself, whether you are a consumer or business, from a future change in price. In foreign exchange, it works by taking a position that prevents you from losing out if the currency market moves against you, but you could also miss out on some benefits if the exchange rate for the currency pair you need to trade changes in your favour.

Work with an OFXpert

Intimidated by creating a currency strategy for your business? You’re not alone. At OFX, we talk to a lot of businesses. 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 reasons 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.

Our currency experts (we like to call them OFXperts) are here to help.

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What is the market rate?

Also known as the “interbank rate” or the “mid-market rate,” this is essentially a ‘wholesale’ rate that is available only to large financial institutions or those who purchase large volumes of currency. Generally, people wishing to exchange currency will not be offered the market rate but instead will be provided with a ‘retail’ rate. Similar to the sale of goods and services, the retail rate typically is the market rate plus a mark-up added by the provider. The OFX customer rate of exchange includes a margin.

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 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 chance 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 conduct business with? Some countries suffer more political instability and therefore are likely to have higher currency volatility.

How frequently do you make payments? Regular transactions can mean more 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 a 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 it 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.

Beware of the risks

If you decide to ‘hedge’ and fix a rate for some of your currency exposure, you could also be preventing your business from taking advantage if the rate moves in your favour. Remember, exchange rates are constantly moving, every day of the working week. To continue to take advantage of exchange rate movements, it can be worth ‘hedging’ only part of your currency requirement as a way to partially hedge against volatility.

Talk to an OFXpert

Managing your money globally doesn’t have to be complicated. Our OFXperts can help you navigate issues and complexity, breaking foreign exchange down so it’s simple and easy to understand. We specialise in managing foreign exchange for SMEs and have a highly experienced team of currency experts ready to help. With eight offices around the world including London, Dublin, San Francisco, Hong Kong, and Sydney, our business day follows the sun. So call us 24/7. +44 207 614 4195