Small business advice: How to mitigate global currency risks

 

 

In today’s global economy, many small businesses are either engaged in cross-border commerce or

plan to be soon.  As a result, complex currency liabilities arise, so managing the value of future payments or receipts grows increasingly important.

 

Before we delve into some basic strategies to protect your business from fluctuating currencies, let’s have a look at some important best practices.

 

First, know your overall currency exposure. Once you know your vulnerabilities, you can employ basic hedges to mitigate currency risk.

 

Second, abandon the “casino mentality” and leave risk-taking to professional currency traders and investors. Devise a hedging strategy, employ it and sleep easy at night.  Don’t fret thinking you could have fared better had you waited a week on a transaction.  You know what rate you’ve bought at and your profit margin isn’t threatened.

 

Third, always maintain a long-term perspective.  The market may initially move against you after locking in a rate but it will just as quickly move back in your favour.  Ignore the noise and regardless of what percentage of exposure you hedge, remind yourself that uncertainty is removed and instead focus on growing your business.

 

Basic hedging tactics

 

Hedging your currency exposure is much easier than it seems once you have the correct mind set.  Here are a couple of commonly used and straightforward tactics to employ.

 

The forward contract is the most commonly utilised hedging strategy among small businesses and has seen an up take of approximately 25 percent in usage since 2008. It’s a basic and sensible strategy for firms with regular payments and receipts, offering a hedge against volatility whilst allowing you to construct fixed and reliable cash flow forecasts.

 

At its core, a forward contract is a contract to buy or sell an asset (in this case a currency) at a specified price at a future date. It locks you in to a rate of exchange for a future payment, for example.  For the majority of small business owners this is as complex an instrument as you’ll need.

 

A forward-extra (sometimes known as a risk-reversal or forward-plus) would offer a protective rate guaranteeing you a price if the base currency weakens.  If the market moves favourably you may also have the opportunity to exploit that shift and buy at a cheaper rate.

 

Again the potential upside is capped but the gain is in guaranteeing a “worst-case” price, while retaining the opportunity for a better rate down the road.

 

Slow and steady wins the race

 

It’s an oft-used cliché, but in this case is a propos.

 

In 2013, several global corporations, including behemoths such as Coca-Cola, took hits to their earnings and revenues due to rapid and violent currency movements which were unforeseen even by their savvy CFOs. If large corporations can be affected by currency volatility, so too can small business owners.

 

Know your currency exposure, lock in a hedge that will provide certainty for your business and don’t worry about short-term ebbs and flows in the currency markets – focus instead on growing your business.

Guido Schulz is Chief Strategy Officer at Associated Foreign Exchange (AFEX), a global payment solutions provider to small and mid-sized companies.

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