With Sterling declining 7% against the dollar and Euro since the end of May, those trading across borders from the UK are facing a renewed pressure on margins. Equally, these swings can reduce cash-flow certainty when it comes to paying suppliers. As we saw in the lead up to previous Brexit deadline the currency market will become more volatile, reacting to comments by the main players on all sides. Therefore, we will look at how companies can practically manage currency exposure to have greater cashflow certainty and earn the margins expected when initially scoping a contract.
The Natural Hedge
The natural hedge would involve looking ahead at all your likely payments and receipts in the next few months identifying which are being made by overseas suppliers and customers. If you can identify several payments and receipts in the same currency, then it could be worth setting up a foreign currency bank account. Thereby avoiding costs involved in converting currency and providing greater certainty on cashflow. However, this may not be fully effective in eliminating currency exposure, as there could be timing differences in receipts and payments, leading to a need to convert some currency to cover any shortfalls.
This is a tailor-made contract to convert an agreed quantity of currency at an agreed price at a future date. This provides certainty on the cashflow commitment of the transaction and the margin impact to the business. While, you have certainty protecting from any downside movement in exchange rates, it also means should the spot rate move in the businesses favour it will miss out on the upside. Therefore, the value to the business of entering a forward contract, will depend on the amount currency required and the impact of adverse movements on margin. Buying certainty will come at a cost and therefore it can be worth looking at forex broker rather than the company’s bank in order to obtain the best rates.
There are other hedging strategies such as future contracts, however the underlying transaction would need to be of significant scale for these to be considered a practical strategy to manage the business’ exchange rate exposure.
As we enter a period of uncertainty, reviewing the business’ exposure to currency volatility will help assess the impact of adverse swings in exchange rates on cashflow and margin. Once that it is understood, it is possible to identify what would be the appropriate steps to mitigate the risk. Whether, that through adopting a formal hedging strategy such as forward contracts or a looser one such as the one looked above in ‘ the natural hedge’.
Read more at Currency Hedging; A creative imperative