It’s clearly a global marketplace, and companies are doing whatever they can to expand and thrive in overseas markets. But you can’t just set up shop overseas and start doing business. You need a plan, a strategy.
Foreign exchange strategies are opportunities to increase profits and/or savings from business overseas. Companies doing business internationally may occasionally have the opportunity to transact in a foreign currency. This is an excellent opportunity to experiment with exchange rate risks and rewards. In this way, you create a possible exchange rate gain. And, the strategy works equally well for buyers and sellers.
“A foreign exchange strategy is one that allows a company to both buy and sell foreign currency and also manage foreign exchange risk to help protect against adverse foreign exchange changes,” says Bart Brown Jr., vice president and principal business relationship manager with Wells Fargo Bank. “For example, if a company has foreign payables or receivables, they can hedge against an adverse move of the foreign currency rate against the dollar.”
Smart Business spoke with Brown about foreign exchange strategies, how to implement them and what risks come with them.
How does a company go about implementing a foreign exchange strategy?
A foreign exchange strategy will require three key elements. First, sufficient profit margin (or cost savings) must be built into the transaction to cover any variations in exchange rates and fees. Second, it is necessary to have a financial resource with access to foreign currencies at fair prices. Lastly, with the help of a foreign exchange adviser, determine the timing of currency trades and final payments.
Working with a trusted financial institution that has international capabilities is the best way to implement the strategies. Quality banks will have foreign exchange trading desks and local specialists that work directly with businesses of all sizes to help assess their needs and manage foreign exchange risk.
If I’m the CEO of a company, why should I care about this?
Many overseas customers are all too willing to accept U.S. dollars, as they understand and appreciate the strength of the greenback. So, why not participate in the risk and reward of foreign exchange trading with your customers? Paying for goods and services in foreign currencies is easier than you think, and it may generate additional profits and/or cost savings to your business. At the very least, when conducting business abroad, it is wise to understand the impact of exchange rates to your bottom line.
CEOs should understand and be aware of how foreign exchange rates and translation gains or losses can impact their profit margins. It is important for them to understand how a foreign payable or receivable in a foreign currency can be worth more or less than what they are expecting to potentially affect their bottom lines. For example, if a company is expecting receivables priced in euros and the currency depreciates relative to the dollar, the receivables will be worth less, as the foreign currency will purchase fewer dollars.
What problems or issues can arise from foreign exchanges?
As I said earlier there are risks involved in foreign exchange. The foreign exchange market trades over a trillion dollars daily and rates fluctuate every 24 hours. For these reasons it is highly recommended that a business owner understand his or her costs going into a transaction. In this way, you can design a plan that minimizes risk and maximizes reward. Once a business gains experience making and receiving payments in foreign currencies, then additional tools are available to assist with timing and budgeting strategies. I think the last issue related to foreign exchange trading is the additional accounting expertise required when reporting trading activities.
As I previously mentioned, foreign exchange problems result from companies not anticipating changes that may affect their non-dollar receivables or payables. They may also have an asset that they may need to purchase in a foreign currency at some point in the future. If they don’t lock in the rate today, the cost of the asset may be more than they were initially expecting if the currency strengthens. For example, if a company is purchasing equipment from Germany in euros in six months, they could hedge or lock in the rate today to eliminate any foreign exchange risk of the euro appreciating. If the euro appreciates relative to the dollar, the company will not be affected by the increase in the euro. If they choose not to hedge, then they may end up paying significantly more, as the strong euro will increase the cost in dollars.
What are the consequences a company faces if it doesn’t monitor and/or contain this?
The most significant consequences of ignoring foreign exchange in my opinion are lost opportunities. Very often domestic companies purchase goods overseas for the express purpose of cost savings. By paying in dollars, these companies may be leaving money on the table. Conversely, many American companies sell overseas to find new customers, but with the added risk of doing business abroad should come added rewards in the form of foreign exchanges.
Should a company take this on alone? Where can it turn for assistance?
Again, working with your trusted financial advisers and institutions is key. If you don’t already have one, find a bank with a strong foreign exchange presence and a dedicated local team of experts available to answer questions, assist with planning and execute your trades daily.
Bart Brown Jr. is a vice president and principal relationship manager with Wells Fargo Bank. Reach him at?(713) 319-1764 or firstname.lastname@example.org.