With all these complexities to navigate, there is one vital element of going global that is often overlooked – the need to manage the risk that comes from increased exposure to the foreign exchange (FX) market.
This can be a tricky area to tackle, particularly for smaller companies which, unlike large multinational corporates (MNCs), are unlikely to have an in-house FX expert to lean on. With a passionate owner-manager, chief executive (CEO) or even generalist chief financial officer (CFO) at the helm, calculating exposure to FX risk and developing a strategy to hedge against this can feel like a daunting challenge.
That said, it’s important to remember that the responsibility for calculating FX risk exposure should not lie solely with the treasurer, but with the entire senior management team. Mitigating against fluctuations in foreign currencies requires continual assessment – at least once a year – of risk exposure, profit margins, business profitability and risk tolerance.
All of these factors will vary over time, though must be taken into consideration to establish a coherent and well-prepared FX policy. This is not a ‘tick it once and it’s done’ exercise. Treasurers should seek to work continually with the CEO and company leadership to protect profit margins from exchange rate fluctuation.
Expecting the Worst
The potential impact of FX movements on company profits means that the likelihood of such a movement must be carefully factored into business and financial forecasting. There’s no room for ‘hopeful optimism’ here; instead, forecasts should be based on a ‘worst-case scenario’ outcome.
Such a scenario might be, for example, that you lose 30% of your revenue due to market volatility. If your profit margin was planned at 50%, you lose some money. If your margin is just 5%, you then have a major problem. Put simply, acceptable risk exposure depends on an individual business’ ability to absorb a potentially large FX movement. The bigger the profit margin, the greater the ‘safety net’.
Recent months have offered no shortage of real-world evidence that businesses regularly fall prey to unexpected FX fluctuations. Earlier this year UK small cap manufacturer Hornby, known for its model train sets, suffered a loss of £1.2m in a single quarter, as sterling strengthened against the Hong Kong dollar. A more unlikely victim was the environmental campaigning group Greenpeace, which dismissed a rogue employee who had lost it €3.8m (US$5.15m) from an ill-fated bet on the international currency market.
Understand Your Buy
FX risk management can be a challenge for companies of all sizes although one that is particularly daunting for smaller businesses, which are often deterred from engaging with the banks around hedging products due to their sheer complexity. While large MNCs likely enjoy access to live market rates in-house, and preferential treatment from the banks, smaller customers have been left in a cloud of FX uncertainty
This is no accident – banks and traditional brokers nurture the confusion, allowing them to push the products that are most profitable for them, often at the expense of the customer.
Our own advice to clients is to ‘run before they can walk’ – although this option is often denied by the banks, which are able to ‘package up’ risky and expensive products into appealing offers. As with anything else, it’s important to understand what you’re buying – the stakes are even higher for those who dabble in complex and intricate hedging options without a certain level of expertise.
Added to this, with banks being required to deleverage following the financial crisis they are tightening up their hedging requirements and making it difficult for smaller businesses to access products at all without significant working capital. For a business already navigating the complex nature of balancing FX risk, the situation can feel overwhelming if they are turned down flat by traditional banks.
The push for transparency across the financial services sector has filtered through to niche business areas including FX management. Alternative providers are now taking advantage of this demand, delivering clarity and simplicity to small and medium-sized companies that want to take back control of their finances.
International expansion is certainly not for the faint-hearted or unprepared. However if navigated correctly and with the right partners on board, it can certainly be rewarding. With effective FX risk management, growth needn’t come at the expense of profits.
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