The spread of the Coronavirus in 2020 caused currency rates to fluctuate dramatically. Global economies were slowed by strict rules to contain the outbreak, which triggered a drop in oil prices and stock markets. The market is moving towards the Japanese Yen, US Dollar, and Swiss Franc as safe havens.
Whether they realize it or not, many businesses are exposed to currency risk. Since global currencies have seen wild swings in the past couple of months, exchange-rate risk has returned to the agenda for companies with customers, suppliers or production overseas. A key takeaway is that businesses with revenue or costs abroad are more likely to face currency risk. Various uncontrollable factors can erode your revenues and drive up your costs.
What Is The Extent Of The Problem?
In a survey of 200 Chief Financial Officers and nearly 300 Treasurers, 70% of CFOs said their company’s profitability was lowered in the previous two years due to unnecessary, unhedged business foreign exchange risk; business FX risk management is one of the two hazards that 58% of CFOs at larger companies say takes up the majority of their time right now; and 51% said that business FX is the risk that their organization is least prepared to handle. However, over half of SMEs have not defended themselves against this, and the poll suggests that the most significant impediments to risk management are a lack of time and know-how.
On the other hand, managing your currency risks can benefit your business:
- Safeguarding your cash flow and profit margins
- Better financial forecasting and budgeting
- Improved understanding of how currency fluctuations affect your balance sheet
- Increased borrowing capacity
When currency exchange rates fluctuate, firms scramble to avoid potential losses. What currency risks should they hedge, and how?
05 Steps To Manage Your Business’s Currency Risk
It is difficult to understand where and how currency fluctuations affect a company’s cash flow. Currency rates are influenced by a variety of factors, ranging from macroeconomic trends to competitive behaviour within market groups.
- Review your operating cycle
Find out where you are exposed to FX risk by reviewing your business operation cycle. This will help you determine the sensitivity of your profit margins to currency fluctuations.
- Accept that you have unique currency flows
Business entities differ in their currency flows, as well as in their asset and liability structures. It is important to recognize that currency fluctuations may have an impact and that deciding whether to hedge is not as simple as rolling the dice.
- Decide what rules you will follow to manage your FX risk, and adhere to them
A company’s FX policy should start with a clear understanding of its financial objectives and the effect that changes in FX rates may have on them. Changes in FX rates can cause a company’s EBITDA target to be jeopardized if its operative cash inflows and outflows are in different currencies. Any FX risks that may jeopardize the financial objectives are monitored and mitigated systematically, according to the FX risk management policy.
- Manage your exposure to currency risk
The effects of business decisions on the bank account of a company do not often appear immediately, especially when a physical product is involved. Within that time period, materials are shipped around the globe, order and sales contracts are negotiated, and goods are manufactured, stored, and delivered. The physical process is parallel to that of invoices being sent, reviewed, approved, and ultimately paid. Meanwhile, currencies are appreciating or depreciating.
The company’s financial objectives can be jeopardized by this uncertainty, which can be mitigated by financial instruments. Hedging ensures that the foreign exchange rates affecting the company’s bank account balances are not too different from those used in decision making.
- Automate FX handling to free up your time
Automation of foreign exchange handling can benefit small and large companies alike. Solutions such as OpenPayd help companies free up resources, eliminate manual tasks, reduce operational risk, and minimize human error.