Are you protected against foreign exchange exposure?

Susan
By Susan October 4, 2011 23:04

Are you protected against foreign exchange exposure?

 

As an exporter who operates outside of the Eurozone you receive payments in another currency than that of your own country: your customers pay you in their own currency. And because of this you have to juggle foreign exchange rates and know how to use them to your advantage

You might have heard complaints against the euro, because it has remained strong and hasn’t weakened compared to the dollar and the pound… at least up until recently anyway! With a strong euro, we haven’t been able to “sell” a weaker currency (in the form of export products) and “buy” a stronger currency (in the form of payments for those products).

On the other hand, the euro has erased the problem of currency fluctuation across 17 countries… So it’s not all bad!

 

Strong vs. Weak currency – what does it mean for exports?

 

So what is currency fluctuation in more detail? A currency is relatively weaker or stronger, compared to another currency. As an exporter, you have to look at your foreign exchange exposure: how is your business affected by currency fluctuation?

Let’s say one euro buys you 1.35 US dollars.

If this rate changes to 1.37, one euro now buys you 1.37 dollars: the dollar has weakened, and you get more dollar for your euro. Conversely, if the rate changes to 1.26, one euro now only buys you 1.26 dollars: the dollar has strengthened. Parity is reached when 1 euro = 1 dollar.

If you export to Great Britain, you will want to look at the exchange rate for pounds. Let’s say you sell your product for €50 a piece. You look at the exchange rate and see that the rate is EUR/GBP 0.89 (one euro buys you 0.89 pound). So you settle on £44.5 (50×0.89) as the price of your product.

If the pound weakens, and the rate becomes EUR/GBP 0.96, you are in trouble: the price you set, £44.5, means you are in fact selling your product for €46.4 (44.5/0.96), instead of €50. You are “losing” €3.6 on every sale.

This means that your margin has been reduced, or even cancelled out. This is why locking your prices is a bad idea, since it doesn’t allow for flexibility in this fluctuating context.

But there are ways to protect your money, by using hedging, for example.

 

Control currency fluctuation with hedging

 

You know what the exchange rate of the pound is today – but how about tomorrow, or in three weeks, when a payment from a British customer is due? If the pound weakens in the meantime, you will have lost money. If the pound strengthens on the other hand, you will have an unexpected windfall. It’s a bit of a gamble, and maybe one your business might not afford to take.

So you enter into a contract with your bank or financial institution: they will buy British pounds from you at a later date, but at the same price that the pound is when you sign the contract. Now you know where you stand. You know that this particular exchange rate you agreed upon actually corresponds to your calculations.

If the pound strengthens, you won’t have the nice surprise of the unexpected bonus. But if the pound weakens, you won’t have to contend with the loss.

 

Bypass the banks: peer-to-peer currency exchange

 

Another thing that could help you save money is peer-to-peer currency exchange. Instead of paying the bank’s fees every time you receive a payment in a foreign currency, you can choose a buyer that offers you a satisfying exchange rate, and do business directly with them.

Imagine you get a $5000 invoice from a US client. If it comes to an Irish bank account, it is automatically changed to euros and you pay charges. That is not ideal. What you can do instead is ask the client to put the amount on your peer-to-peer currency exchange account. This allows you to hold it in dollars and then you can do an exchange with an interested buyer, so that you keep the bank out of the equation.

Let’s say that, on a $5000 transaction, you save €100 in bank fees and a better rate conversion. Over time, that does make an impact. If this US client is a big repeat client that you invoice for a similar amount every month, you can save €100 every month for a year.

That could cover the costs of a whole other project, for example the taxes you’re paying on an employee – and this, just by managing your currency effectively.

There are several companies that allow you to do this securely (for our business we use currencyfair.com  an Irish based company – I am  NOT an affiliate).

 

And a word in conclusion

 

And one last thing to take into account: your export market is another country’s domestic market. When you are thinking of exporting to a certain country, look at the state of their domestic market: is it depressed?

You might not be so successful when exporting there, as you could be if you chose a booming domestic market. Granted, that is not so obvious in a worldwide recession… But it’s worth having a closer look.

 

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Susan
By Susan October 4, 2011 23:04