When companies do business overseas, they have the added stress of dealing with foreign currencies. And if it’s not done right, what initially appears to be a profit could turn into a loss, says Brian Simonson, senior vice president of foreign exchange trading at Bridge Bank.
“Companies should consult with a banking partner to help them navigate overseas currency markets,” says Simonson. “While you need to understand what you’re doing in that regard, you also want someone who deals in foreign currency markets on a daily basis, someone who’s watching those markets and who understands the nuances of foreign currencies.”
Smart Business spoke with Simonson about how to approach foreign currencies so that what appears to be a win doesn’t turn into a loss.
How should companies approach doing business overseas?
It’s best to have a foreign exchange strategy in place before expanding to a foreign country, even if there’s not going to be a lot of activity initially. As your volume grows and your needs get more sophisticated, you have to make sure that you’re getting a competitive exchange rate on the conversions you’re doing, whether that is sending money to another country or receiving foreign currency payments from customers abroad.
Companies also need to be cognizant of how they invoice for their products. Invoicing in U.S. dollars, for example, can make what was once a competitively priced good not as competitive in foreign markets. So while using the U.S. dollar for invoicing may reduce the burden on accounting, it may also inadvertently reduce demand for your product.
As your business grows, you want to protect your profit margin against adverse exchange rate movements, which you can do through hedging by locking in a rate today for future payment. If you have a subsidiary in another country that you fund every month, you want to make sure that when you go to your board with a budget that you have correctly factored in the amount it’s going to cost (in U.S. dollars) and that that amount isn’t going to be adversely impacted by currency movements.
Conversely, if you have a large receivables base or large contracts in other currencies, make sure that you are protecting your profit margin. If you don’t, you could have a 10 percent profit margin today, for example, but when it’s time to collect that money, you could find the currency has moved against you and reduced your potential profits.
How can a business identify the right banking partner to help it navigate foreign currency markets?
If you’re working with a small bank, make sure it has a SWIFT terminal that allows it to communicate with banks globally. Does it have its own trading desk? A bank with its own trading desk gives you full access to whatever markets tools are available on the foreign exchange side, as well as the most competitive pricing. If that particular service is being outsourced to another bank, you’re more likely to incur an additional layer of fees before the money finally gets to the customer.
A good bank will take a consultative approach to how it does business with you. Many money center banks have international products and services, but they mostly serve Fortune 500 companies. If your business is small, or even mid-sized, you may not be running the volumes to get on their radar screens.
Instead, by partnering with an experienced smaller bank, you’re much more likely to receive a higher level of service so that you can focus on growing your business, not on figuring out the nuances of foreign exchange.
When you’re thinking about expanding your business overseas, at what point should you engage your banker?
You should form that relationship early on as part of a longer-term strategy, before even venturing overseas. An experienced banker can provide advisory services to help get your international business established and can help connect you with other professional service providers such as accountants and lawyers.
You may also need to set up foreign bank accounts, and it can be helpful to have a U.S.-based bank facilitate an introduction to a reputable and experienced institution.
A good guideline for when to consider doing FX hedging for your business is when you begin transacting in foreign currency amounts of more than $100,000 U.S. dollar equivalent. A banking partner can also help you to monitor your firm’s global financial situation. Currency markets inevitably change over time, and what’s appropriate for your firm today might not be advantageous for it in the future. Once you understand your transaction activity, you and your banker can determine whether it might make sense to realign your strategy with your business trends. A good banker will constantly evaluate the success of the program and make corrections as necessary.
What mistakes do companies make when trying to expand overseas?
In the case of foreign exchange, they fail to set up clear risk management objectives. They also tend to focus on trying to capture potential upsides in the market, rather than protecting their bottom line. So, instead of consulting various FX forecasts and allowing a ‘market view to drive strategic hedging decisions, keep risk mitigation your top priority. Companies often reach out to their bankers after taking a significant FX loss. By that time, it’s too late. Be proactive and reach out to your banker before any potential adverse FX rate volatility impacts your bottom line.
Any time a business is venturing overseas, the prospect can be daunting. Each country has its own way of doing business and its own way of banking, and it’s important to consult with a professional who is familiar with the pitfalls of setting up overseas and knows how to avoid them.
Brian Simonson is senior vice president of foreign exchange trading at Bridge Bank. Reach him at (408) 556-8377 or Brian.Simonson@bridgebank.com.
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Volatile exchange rates have become a permanent fixture of the post-2008 financial markets, turning a foray into the global marketplace into a fiscal roller coaster ride. Instead of reducing risk by locking in exchange rates from the outset, companies face uncertain profitability, cash flow and market value when they attempt to time transactions to capitalize on favorable exchange rates.
“You don’t have to put your hard-earned profits at risk to compete in the global marketplace,” says Doug Reichman, corporate foreign exchange advisor for California Bank & Trust. “You can enhance your competitive position and overcome vacillating currency values by utilizing foreign exchange services.”
Smart Business spoke with Reichman about managing currency exchange exposure by utilizing foreign exchange services.
What is foreign exchange exposure and how does it impact profitability?
Companies want to grow their top line by selling products and services overseas, but unless they solidify the currency exchange rate, the price and margin may go up or down each time an invoice is processed. If you buy parts overseas, manufacture in the U.S. and sell finished goods to a company in a foreign country, it’s difficult to forecast sales and profitability given the number of currency exchanges that occur over the course of a transaction. Executives often try to avoid volatility by demanding payment in U.S. dollars, but savvy competitors who deal in foreign currency have a distinct advantage in overseas markets.
How can business leaders identify foreign exchange exposures and opportunities?
You need to forecast sales and profits using a variety of exchange rates and scenarios to recognize and exploit the arbitrage. For example, if you plan to ship $1 million worth of goods to France in three months, you need to look at the current exchange rate and the recent swings to see what you may ultimately collect. In the process of reviewing the best and worst case scenarios, you may recognize an opportunity to manage risk or find that selling products in Asia is more profitable than Europe.
What constitutes an effective hedging strategy?
Effective strategies are customized, mitigate currency exchange risk and help the company achieve its financial goals. The challenge is that most companies don’t have the time or expertise to develop and execute an in-house strategy that relies on precise calculations, great timing and luck to balance gains and losses. For example, some executives try to protect their margins by paying early or late for products, depending on whether they expect the exchange rate to rise or fall in the future. Still others hope that gains and losses balance out over time, but that approach is a gamble in a volatile currency market.
How can a currency advisor help?
Whether your goal is to increase sales, enter new markets, protect profits or improve supplier relationships, a currency advisor has the expertise to help you meet your objectives. First, he’ll review your budget and understand your objectives; then he’ll trace every dollar to expose the risks and opportunities that occur during currency exchanges over the course of the business cycle. Finally, he’ll recommend a hedging strategy and customized suite of services so you can focus on your core business instead of monitoring the hourly swings in the foreign currency market.
Which banking services are most effective for controlling risk and why?
While banks offer many types of foreign exchange services, businesses often use the following products to facilitate profitable global commerce.
? Spot contracts: A simple way to handle payables and receivables in a foreign currency. Currency is converted based on the current rate, funds are wired and your account is credited or debited within two days.
? Forward contracts: Allow you to secure an exchange rate now for a specific settlement date within the next 12 months. Whether you’re buying or selling a piece of equipment, both parties are protected from swings in the exchange rate when the deal is settled.
? Window forward contracts: Essentially the same as a forward contract, except the settlement date is flexible in cases where the manufacturing process or product delivery date hinges on uncertain factors.
? Vanilla currency options: Like insurance, a currency option allows you to exchange currency at a pre-agreed rate on a specific date for a fee, providing protection in case the market moves against you.
? Demand-deposit accounts: Allow you to hold foreign currency and use it to pay employees or bills without exchanging the money to U.S. dollars.
Do you have any other tips for executives venturing into the international marketplace?
First, understand your financial objectives before you engage in international commerce. Develop a forecast and budget and consult with a qualified professional to ensure that your goals are realistic and achievable. Second, understand the exposures and don’t take unnecessary risks, because speculators can get burned in today’s foreign currency market.
Finally, talk to your banker before you make any decisions. Your banker can explain foreign exchange products in simple terms and recommend a strategy and portfolio of services to help you meet your business objectives. There’s no need to put your profits at risk, when your banker has the knowledge and tools to help you succeed in the international marketplace.
Doug Reichman is corporate foreign exchange advisor for California Bank & Trust. Reach him at email@example.com or (213) 593-2113