How to Avoid Currency Exchange Risk as a Small Business Owner
5 minute read
When you are working with overseas clients and suppliers, your payments are made and received in all sorts of foreign currencies. Currency fluctuations greatly affect how much money you are paying out or receiving into your company’s account. They introduce financial risk into your business’s international financial transactions as they can make your payments and transfers more expensive. Financial losses incurred in an international transaction are what is known as currency exchange risk.
In the long run, if you are constantly being faced with currency exchange risk it will affect the profitability of your business. Fortunately, we offer a broad range of FX solutions that enable you to avoid currency exchange risk as a small business owner.
Using Statrys and Sleek gives you a range of tools and resources to greatly reduce and minimise your business’s exposure to exchange rate risk. Depending on the type and the amount of FX risk, you can use one or multiple of the solutions we recommend below.
How To Reduce Foreign Exchange Risk
There are three methods that you can use to protect your business’s profit margin against foreign exchange risks. All three of these solutions enable you to lock in the rate at which your payment or transfer will transact.
FX spot transfers or spot orders are a foreign exchange agreement whereby two parties decide the terms for an immediate transaction between two currencies. In other words, they agree to purchase one currency by selling another at a price they both agreed on.
When you do a spot transfer, both parties decide on:
- The currencies being exchanged in the transaction
- The amount in value for both respective currencies that will be handled
- The rate at which the transfer will be transacted
The spot transfer rate is set by the exchange rate at the time the currency is exchanged, it can fluctuate by the second. Often referred to as the ‘here and now’ rate, indicating an immediate exchange between two currencies.
Spot transfers are the easiest and most common form of currency exchange. Because they have a fixed spot rate, you know exactly how much the transfer will cost. This sort of transfer is used for simpler transactions like paying clients overseas or buying foreign currency and products.
Forward Exchange Contacts
A forward exchange contract is a foreign exchange agreement between two parties whereby they agree to buy one currency by selling another on a particular date within the next twelve months, at an agreed price, known as the forward rate.
Basically, a forward rate is the exchange rate you agree on today to transfer your currency later. Think of it as a ‘buy now, pay later’ contract. So essentially you can use today’s exchange rate for a later transfer.
Forward contracts lock in rates now for transfers happening in the future, they therefore reduce a business’s exposure to currency fluctuations and changes in exchange rates. This gives you some certainty over the costs of your future transfer and enables you to keep your cash flow both predictable and manageable.
However, there is one major disadvantage to forward exchange contracts. By locking in a forward rate, it means you are completely committed to it. If the exchange rate changes in your favour (implying that you would save money at that rate) then you would not be able to benefit from it as your rate would be locked in. To avoid this happening, it is useful to only use forward contracts for some of your transfers but not all of them, to leave room to possibly benefit from a more advantageous exchange rate.
A limit order enables your business to set a target rate at which you would like to buy or sell currency. In this case, the exchange is done at the limit price or a better one, but it will not be done if the limit price is not met.
The advantage to a limit order is that it guarantees that your transaction is fulfilled at your target rate or a better one. However, the downside to limit orders is that your target rate is not guaranteed, therefore it may never actualise which can lead to missed opportunities to buy or sell in fast paced market conditions.
This FX solution is typically used in association with a reliable forex organisation, which notifies you when the target rate is reached. Depending on the forex organisation you are partnered with, there are likely to be fees associated with deciding to not go ahead with the transaction at the target rate you agreed on.
Which FX Solution Is The Most Appropriate For Small Business Owners?
None of the solutions listed above can be defined as the single best solution for small business owners looking to reduce their currency exchange risk. The reason for this being that each SME has its own business model so each FX tool would impact every business differently.
Usually, the amount a company is willing to spend in a transaction is what determines the FX solution that is most suitable for the exchange being made.
As a general rule, businesses rely on spot orders for quick transactions. In terms of less time-sensitive purchases, businesses favour forward exchange contracts and limited orders.
Why Choose Statrys?
In the end, the decision on which solution best suits your business and your objectives for your international financial transactions comes down to you. But in the interest of limiting the amount of risk your business is exposed to, opt for advanced FX solutions and advice from FX specialists, both of which are offered by Statrys as part of their integrated service.
Their team of experts can help you if you are not sure about your business needs. Leading to better decisions on your international financial transactions, which ultimately can reduce your transaction costs and frees up financial resources that can be invested back into the business. Not to mention it gives you better control over your cash flow and your business’s overall profitability.