How to Mitigate Foreign Exchange Risk
This industry insight article was provided by an external source.
Currency risk can have a significant effect on the efficiency and profitability of any international business. Each exchange rate movement affects how much you receive from sales and what you pay to suppliers. If it moves in your favour, you stand to gain, but it can have a crippling impact on your operations if the rate goes in the other direction.
Thankfully, your company doesn't have to face currency risk unaided. You can enlist the help of a foreign currency payment provider, such as Clear Currency, to help you manage any fluctuations and stay competitive.
With a solid foreign currency risk mitigation strategy in place, you can build a stronger competitive advantage to propel your multinational business to greater heights.
What are the Risks of Foreign Exchange?
Foreign currency risk is a financial risk brought about by the fluctuations of trading prices between your home currency vs. the local currency of the nation you are doing business in.
It impacts your business in the following ways:
1. Transaction risk
This involves the potential losses arising from each contract that you make. When you sign a contract, make a purchase order or buy from suppliers, your prices are based on the rate at the time of concluding the deal.
It’s impossible to predict what the price will be upon settling the transactions, exposing you to the risk of revenue losses, higher payments to suppliers, or lower margins.
2. Translation risk
When you consolidate the financials of all your foreign subsidiaries, you can incur losses on the balance sheet and income statement due to currency fluctuations.
Even though the values of the assets themselves have not changed, you can face medium to long-term balance sheet problems.
3. Economic risk
In the long term, the value of one currency may continue declining against another, affecting the future value of your business.
Goods and services priced in the declining currency will become cheaper and more competitive. This can slow down business growth if your prices are listed in the stronger currency.
Foreign Exchange Risk Mitigation Techniques
In a survey on risk management trends, 70% of CFOs admitted that their companies fell prey to avoidable currency exposure.
To guard against this, consider exploring a mix of risk minimisation methods such as the following:
1. Matching or Natural Hedging Technique
The matching technique involves paying your liabilities with receipts denominated in the same currency to eliminate net exposures.
Here’s an example. An American company selling goods in Canada would only pay Canadian suppliers with Canadian dollars instead of sending US dollars across the border.
However, the volume of transactions involved would require the finance team to keep up to speed with exposures and manage the multi-currency transactions smoothly.
Clear Currency can help you manage multi-currency transactions. We offer a simple, secure payments platform which allows you to handle multi-currency transactions, allowing your finance team to keep a keen eye on your receipts and payments.
2. Active Hedging with Financial Instruments
FX tools, like forwards, are designed to lock in future exchange rates.
A forward contract is a firm commitment to buy or sell currency at a predetermined exchange rate on a specific date in the future.
It eliminates any uncertainty as you know exactly how much you will pay or receive at that future date.
Hedging Foreign Currency Risk: Main Takeaways
Foreign exchange risks come with the territory for any business operating across borders.
While there's no way to eliminate the risks, creating a solid risk management strategy can help you reduce your exposure.
You can either stick to matching techniques or currency hedging through derivatives.
Protect your Business: Mitigate FX Risk
Understanding the different risk mitigation measures and when you might use them requires guidance.
Consider turning to Clear Currency for help. As a foreign exchange transfer specialist, we can help you:
- Understand the hedging instruments and how to use them for your business.
- Lower your exposure to fluctuating currencies and create stability through a dedicated FX transfer platform that works with over 35 different currencies in more than 130 countries.
- Manage your international payments quickly and securely.
Whether you’re looking to expand your international business or just want to find out ways to protect your bottom line from market volatility, get in touch with Clear Currency today or sign up to get started.
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