We’ve all stood in a bank or outside a foreign exchange and looked at the currency board, calculating internally the ‘price that we buy’ and the ‘price that we sell’. We carefully estimate how much we’re likely to receive for the cash (real or digital) in our hand, and silently begrudge the margin being made on our money.
And that’s before we see the commission fees on our receipt afterwards.
This trade-off is happening countless times every day in global supply chains, and businesses of all shapes and sizes are affected by those margins and commission charges. As well as these fluctuating exchange rates and fees, foreign exchange (FX) risk is something treasury departments have to tackle regularly – what happens if all those euros you’re holding to pay European suppliers suddenly becomes 20% less valuable?
It’s something Apple experienced in recent years, when currency fluctuations in the dollar meant they missed out on $2.83 billion in a single quarter. Those sorts of figures really stand out when we see them at that scale, but any business that does business in a different currency can see their profits shrink just as proportionally as a global giant like Apple.
Protecting your business against FX fluctuations in the Global Supply Chain
1. Identify FX Risks in your Supply Chain
FX risks can be hidden within your supply chain. If you are buying from a supplier in one currency, they could be buying their products in another currency – indirectly exposing you to their risks. If they get hit, they’ll likely pass those costs onto you.
This means that CFOs, Treasury leaders and finance departments need to collaboratively analyse their supply chain and identify where the risks lie, and to what degree.
A 2018 survey of 200 chief financial officers found that 70% of respondents had suffered reduced earnings in the prior two years due to avoidable, unhedged FX risk.
HSBC
While this is no easy task, by simply listing your suppliers and where they may incur FX risk and examining the contracts in place with them, you may be able to add protections (such as agreed refunds if a major swing takes place, or agreements to shorten the payment period) for your business that would minimize damage from currency fluctuations.
2. Have a diverse supplier base
We’ve talked about creating a diversified supply-chain can help mitigate against financial risks before, and it’s no different when it comes to FX calculations. If you’re sourcing all your raw materials from just one country, and that country’s currency strengthens against your own (whether that’s a sudden shift or a gradual one) you’ll find it more difficult to quickly switch suppliers to one in a country with a more favourable currency exchange rate.
It’s therefore imperative to have at least two different potential suppliers for any of the materials or products that you use in your own process, wherever possible.
It must be pointed out though, that this is not always practically possible. Sometimes, one country is far cheaper to source materials than another, so business demands you go there and only there. In this type of case, it’s important to at least investigate other potential suppliers, and go through due diligence in advance.
It’s also important not to simply switch suppliers on a whim – cost savings may only kick in after a couple of months, and by then the currency rates may have returned to more favorable territory.
3. Currency Hedging
A core strategy for many businesses when it came to FX risk is to hedge currency. In simple terms, hedging currency is like an insurance policy where a company enters into a financial agreement with a supplier to lock-in the exchange rate for a future deal (or deals) – known as a ‘forward contract’.
For example, if a car manufacturer in the US agreed to sell $10m worth of cars to a dealer in the UK, the two companies can agree the exchange rate until the payment is due, even if the British £ has gotten weaker or stronger against the dollar in the period in-between. This can even be done at a sliding scale or by sharing the risk – it all depends on the contract agreed.
A series of reports on mid-caps and SMEs found that over 80% of SMEs trading internationally had experienced losses or gains due to currency fluctuations - one-third of them over $1 million.
ACCA (the Association of Chartered
Certified Accountants)
Of course, currency hedging can work both ways – you may lose out on money if the currency fluctuates in one direction. Also, hedging can be time-consuming, intricate, and costly.
4. Simplify Currency Hedging through Modern Payment Systems
With modern payment systems, the currency hedging process can be simplified significantly.
Using local payment rails and banking infrastructure modern platforms (such as TransferMate’s) can now allow businesses to protect against fluctuating FX rates and reduce risk when doing business internationally.
Businesses can book rates on the platform automatically, lock in rates for future transfers, and save on traditional wire fees and FX mark-ups.
5. Buying foreign currency
One way firms try to ‘beat’ the currency markets is to buy foreign currency when rates are favourable, and use that currency when buying supplies or products, therefore removing the exchange rate from the equation.
Of course, there are downsides to this. Firstly, currency speculation is just that – speculation – and a company can get caught holding currency that is not as valuable as they thought it would be when they come to use it. Secondly, it can eat into cash reserves because buying currency is essentially opening a bank account and putting cash into it, rather than investing it for greater returns. Finally, buying foreign currency requires expertise and administrative time, which many companies do not have.
6. Mitigating FX risk as part of an overall, collaborative strategy
As you can see from the broad options outlined above, businesses have lots of ways to mitigate against FX risk. The chosen path needs to be part of a coherent internal strategy that aligns with the overall goals of the business, based on input from Treasury, Procurement, Finance and the leadership team.
The chosen path needs to be part of a coherent internal strategy that aligns with the overall goals of the business, based on input from Treasury, Procurement, Finance and the leadership team.
Each will have their own priorities and roles. Treasury will be primarily concerned with cash flow management, procurement will need to lead in supplier analysis and contracting, while finance will need to deliver that strategic focus and overall execution. The alignment with business goals will come from the leadership team.
By not making mitigating FX risk as ‘someone else’s problem’ within the organization, your FX risk management policies will become a natural extension of your overall strategy.
‘Cross-border supply chains are built on trust. The supplier trusts the buyer to pay them what is owed, FX risk breaks that trust.’ says Stephen Carter, Director of Product Marketing at Ivalua. ‘By paying the supplier exactly what was invoiced, trust grows, and with it the supply chain. Organizations need to have real-time control and visibility of FX, at the invoice level. Ultimately, it’s supply trust that puts a customer first in the delivery queue or guarantees the best possible price.’
Managing FX can have a big impact on the bottom line
As Apple discovered, proactively managing your FX risk can have a significant impact on your bottom line. In the world of international finance and payments, money is made on the margins, so it’s incumbent on businesses to make those margins work for them and not the other way around.
Just like so many of us have learnt to walk away from the airport currency exchange kiosk when on holidays, despite the convenience, businesses need to figure out alternative strategies so they maximize their spending money.
To learn how TransferMate can help you manage your FX risk, click here.
