Foreign exchange risk: A guide to managing your currency exposure
By Dave Dominy
By Dave Dominy
Mar. 8, 2018 – Many manufacturers are operating on increasingly tight margins, with increasing global competition and the need to source raw materials and components from all corners of the globe. As a result, making and receiving cross-border payments in a number of currencies has become an ongoing necessity. And while global currencies have always moved, the fact that we are now so closely linked to the global marketplace, has heightened our exposure to their movements.
Without a currency plan or the in-house expertise to manage the risk of fluctuating currency markets, smaller manufacturers can be very susceptible to their potential negative impact on profit margins. But, managing this risk might not be as hard as you think. With an understanding of where your business is exposed to currency risk and what tactics are available to help you manage these risks, a currency specialist can help you implement a plan so you can spend less time stressing about global payments and more time expanding your markets
What affects exchange rates?
Currency markets react to various influences almost daily. Typically, the drivers of these fluctuations can be summarized by eight key factors:
1. Political and economic conditions
2. Rates of inflation or deflation
3. Interest rates
4. Monetary policies
6. Fiscal policies
7. Commodity prices, particularly oil
8. Unemployment rates
A few recent examples demonstrate these influences in action. For example, uncertainty about the future of the North American Free Trade Agreement (NAFTA) has caused swings in the USD/CAD exchange rate. This will likely have an ongoing effect on currency markets as uncertainty is one of the biggest drivers of currency volatility. Monetary policy, like the US Federal Reserve’s decision to start pulling away the stimulus package, in place since the financial crisis, has been another driver in the USD/CAD rate movement over the last 12 months.
Without the ability to predict the timing and impact of the numerous influences at play, the smart decision is actively managing your currency risk through a specialist firm.
Managing your exposure to currency risk
A good first step is identifying your exposure to currency volatility. If you’re making a capital equipment purchase from an international supplier, you have currency exposure. Or maybe you’re pricing your product for sale to customers in another country. In either case, currencies are at play when it comes to pricing and payments, and should be factored into your budget.
With each exposure to currency risk, establishing a plan to manage it, can help ensure you’re not jeopardizing your transaction’s profitability. Even a 1-cent change in the USD/CAD exchange rate at the time you need to make or receive a payment, can make or break the profitability of a deal.
A personalized concierge-style foreign exchange provider can help you develop a plan and program to ensure you’re not left at the mercy of moving markets. Regardless of which provider you choose, it’s helpful to find a partner that will get to know your unique business needs.
A currency expert might help you hedge your currency risk by locking in a forward contract, ensuring you know the exact exchange rate you’ll receive when it comes time to make or receive a payment. It’s a valuable tool in protecting the profitability of your contracts, and allows you to purchase or sell a predetermined amount of currency at a known rate within a specific timeframe. This ensures you’re not relying on the need for a spot transaction, which might require you to buy or sell the currency at a rate well above your budgeted exchange.
While the downside of establishing a forward contract means that you might not be able to take advantage of market highs, the certainty of knowing your exchange rate in advance, can be critical in maintaining profitability.
In addition to helping you establish a plan and program to manage currency risk, currency specialists can also ensure your international payments are transferred to and from your bank accounts quickly and cost effectively. Perhaps you have a list of international vendors from whom you regularly purchase supplies? If your business is sending a wire transfer to each of those vendors every month, you could be spending a significant amount of money on fees by the year’s end. A foreign currency specialist might be able to help you save money by using another, more cost-effective form of electronic fund transfer, leveraging international banking networks.
In the manufacturing world, missed or late payments can also cause costly delays. Thankfully, most foreign exchange providers can quickly and easily provide transfer confirmations — regardless of the financial vehicle used to send the money. That means your vendor can rest assured that your payment is on its way and won’t hold up your schedules.
Understanding the various economic and political factors that influence currency markets can have a big impact on your business, and working with someone who understands this means you’re not managing this risk on your own. Currency is complicated, but the solutions to manage your risk don’t have to be.
Dave Dominy is CEO of Firma Foreign Exchange, a Canadian foreign exchange and international payments firm. Every day, Firma’s dedicated team of currency specialists work with customers to simplify business across borders, reduce currency risk and make foreign exchange less complex.