By Gavan Smythe, Managing Director, iCompareFX
The foreign exchange market is one of the largest in the world, transacting values in the billions. Many small and medium-sized businesses have the same struggles when it comes to foreign exchange. Most often enter the market blindly.
Not only is this unnecessary, but it can end up with eye-watering fees being paid for even the smallest of transactions.
What are some of the key risks?
There are several key risks associated with foreign exchange, no matter what size a business is with three of the biggest being:
- translation risk
- transaction risk
- economic risk
These can have a significant impact on commercial margins and is particularly hazardous for small business as their banks are less likely to offer currency hedging solutions.
Translation risks occur as businesses with international dealings translate their international assets and liabilities as well as financial statements from foreign currencies to local currencies. This translation exposes them to foreign exchange risk, given that exchange rates remain prone to ongoing fluctuations.
Transaction risks are due to fluctuations in exchange rates from the payment date to the settlement date, which exposes businesses to further potential expenses.
Any unexpected fluctuations in exchange rates expose businesses to economic risk. If a business has invested in international projects, contingency risk enters the picture too.
High upfront fees for making international payments are also part of the issue. Unfortunately, costs are concealed and immersed in the exchange rates offered, making it challenging for small businesses to understand exactly how much they are being charged.
Here, are three key strategies for SMEs to negate these risks and save money on their foreign currency exchange:
Traditional banks don't usually offer the scope of financial payment options or stable global payment technology that FX specialists do. Sometimes there is even a lack of visibility or control over when a transfer happens meaning businesses end up accepting whatever the exchange rate is at the time. Therefore, businesses should consider working with money transfer companies with business account managers and FX experts.
Working with an FX specialist allows for more precise forecasting, better timings, and hedging opportunities, ensuring exchanges and currency moves occur at the right time. This means when a transaction takes place it's more likely to be at a favourable rate, therefore reducing the risk of negatively affecting a company's bottom line.
There are several ways SMEs can negotiate an optimal exchange rate with an FX specialist. For example, businesses can negotiate the FX margin on the exchange rate offered based on the size of the transfer and / or based on the size of future volume of currency exchange and transfers.
Many foreign exchange experts also give the option to buy the currency at a set amount in the future, referred to as a forward exchange contract. By buying it at the forward rate, businesses can manage their risk of currency exchange rate fluctuation more effectively.
These all seem like good options but remember what is best for each unique company will vary. To ensure businesses make the right decisions, they must find the right partner to work with, who not only has the necessary FX expertise but is also willing to take the time to work out which risk management tools are most suited to their industry.
- Bank like a local
Banking like a local can reduce the FX costs that clients may need to absorb when paying a business. By removing foreign exchange costs for clients, a business could improve its pitch for new clients in foreign markets.
Partnering with a money transfer company that offers multicurrency accounts is a good solution. It is often free to collect and hold money from international customers or marketplaces, which means businesses could save on marketplace FX transfer fees and take advantage of more favourable exchange rates at a future date.
Banks don't always have the most advantageous exchange rates, but a foreign currency account located in a foreign market gives the option of keeping money in the currency of the transaction until it is advantageous to convert it. Being able to hold funds can help businesses avoid multiple exchanges where suppliers and customers are in the same foreign currency too.
Economic and political instability, plus other significant global changes like the COVID-19 pandemic can affect currency markets. So, if a business operates in numerous countries, it should try to alleviate possible risks. One way this can be done is through hedging, which offsets money fluctuations in foreign markets. However, it is rare hedging results in a company making money, so it's worth considering a successful hedge as an asset that primarily inhibits losses.
- Get the timings right
It's always useful to see if there are any times, which might be more convenient for business money transfers and, conversely if there are ones which should be avoided.
There are key windows where profitability can go up or down, depending on daily, weekly, and monthly trends. For example, market volumes and prices can go wild first thing in the morning. So, it might be better to avoid doing a foreign exchange transaction during these volatile hours.
Some international money transfer companies don't provide weekend money exchange and transfers when the foreign exchange markets are closed. The FX exchange and transfer specialists that do offer weekend transfers, can and often increase their fees to mitigate their risk exposure to closed FX markets.
So, if a business wants to pay its foreign suppliers on a Saturday their FX company may increase their exchange rate margin offered to mitigate the currency fluctuation risk for booking a trade when the market opens.
If SMEs want to save money in their foreign exchange, it is imperative they understand their current situation and risks, be aware of market fluctuations, and research money transfer providers that suit their particular requirements. It is a strategy that could well pay off!