Creative companies in the UK frequently find themselves doing business across borders, as highlighted in our blog on international expansion.
Trading overseas creates the need to invoice clients and pay suppliers in local currencies – exposing a firm to the vagaries of the foreign exchange (forex) markets.
Forex exposure in action
Let’s take a London-based production business as an example. It lands an assignment to create a programme for an American broadcaster – which wants to pay for the work in US dollars.
The price is agreed before the project starts, but producing the TV programme takes several months. So the UK firm invoices its client, receives payment in dollars, then converts the dollars to sterling, some time after the price was set.
Similarly, a publisher buys creative assets from around the world, to sell on at a fixed price in the UK. Again, there’s a time lag: this time between paying for the assets in foreign currencies, and receiving income for them in sterling.
In both situations, there’s a risk that exchange rates might move in the wrong direction in the interim. The result: they will receive less revenue in sterling than projected, or pay a higher price than budgeted, damaging profitability and cash-flow.
A clear and present danger
Getting forex wrong can cost a creative business thousands of pounds. The bigger the international transaction, the greater the risk. Exchanging currencies at the wrong time can even put a firm’s future at risk.
From a UK perspective, sterling has fallen significantly against the dollar and the euro since the EU referendum, in response to the ongoing uncertainty over Brexit. The currency risks now facing British firms are more serious than they’ve been for a while.
In my experience, creative firms often fail to realise that their business is exposed to forex fluctuations. They may think that they’re too small for it to be a problem; or that as a creative business, the money markets aren’t their concern.
But currency risk affects any business that trades internationally. And doing nothing about it is not an option. Company directors have an obligation to mitigate all significant risks facing their business.
Hedging currency risk
So where does this leave creative firms with international business operations? What can they do to manage their currency risks, and protect their profitability from exchange rate volatility?
A simple solution is to hedge. Hedging against adverse forex fluctuations effectively ‘insures’ a business against the negative effects of changes in currency values.
Currency hedging can be a complex undertaking; but there are two relatively simple mechanisms commonly used in the creative industries:
- Forward contracts
A forward contract fixes the exchange rate received at a specified future date, which can be up to a year ahead.
Let’s assume that a marketing agency needs to pay a supplier a sum of $100,000, three months from today. The firm could take out a forward contract with a bank or FCA-registered forex broker, which will guarantee what exchange rate the agency will get on that day.
With forward contracts, there is no financial gain or loss. If the exchange rate moves in the agency’s favour in the interim, it will lose out on that benefit; but the advantage is that the currency risk is managed.
A further benefit of a forward contract is that you don’t have to use all of your cash-flow upfront, as you would if you simply purchased the currency on the day of the transaction. You may need to pay a deposit upfront, and a commission on the overall amount.
- Participating forward contracts
A participating forward contract works in the same way as a forward contract, but with an important distinction: it allows you to benefit if the exchange rate moves in your favour between when the contract is made, and the time of the actual transaction.
This means that you’re protected from adverse exchange rate movements, but benefit from favourable ones.
Pricing structures of participating forwards can differ from simple forward contracts, as can the amounts required in terms of deposits and commissions.
To a director of a creative business, terminology like hedging and forwards may appear quite technical. But don’t be put off: forwards and participating forwards are tried, trusted and tightly regulated financial transactions. Millions of them are carried out on the international forex markets every day.
Forex hedging isn’t just for large corporates and sophisticated investment professionals; it’s an important tactic for any business with currency exposure.
As trusted advisers to many creative firms, Goodman Jones can help you mitigate currency exposure, and ensure your firm meets its risk management obligations. We can recommend suitable banks and forex brokers, and advise on how to treat your exchange transactions for tax purposes.
We can also help you to report them accurately in your financial statements. Hedging currency risk is simple; but that can’t be said for the relevant international accounting standards. These apply to all firms that use currency markets, not just publicly listed ones. And more companies are now affected by the new UK GAAP FRS 102 regulations, which also have implications for how you account for forex hedging.
Our experts know the accounting rules surrounding forex inside-out. Our support has helped creative businesses save hundreds of thousands of pounds a year as a result.
Get in touch if you’d like to discuss your firm’s currency risks.