The recent wild swings in global currencies have placed currency risk ‘ the risk that margins are squeezed or wiped out by detrimental currency moves ‘ back on the agenda for small businesses that have operations abroad or work with international partners and suppliers.
Underestimating uncontrollable events such as these can eat into business revenue and increase costs, and poor choices in this regard could spell disaster. SMEs need to ensure their money works harder for them, especially in the current volatile economic and supply chain environment.
Why is it important to manage currency risk?
Running a small business is tricky at best and trying to keep a tab on goods being sourced from multiple countries complicates matters even more. With supply chains crossing several borders before reaching the business or end customer, business owners often feel they have no control over their supply chain prices and costs in the broader currency markets. Managing logistics is already difficult but under the consideration of protecting business margins, it can be overwhelming.
Whether a business operates in two or ten currencies, the risk remains the same. The swing in currency rates, together with increased shipping or raw material costs, have compressed the margins of many small businesses. Many have lost their competitiveness as they had to raise their prices and the existential threats posed by Brexit and the pandemic make it even more crucial to manage currency risk.
Fortunately, those enterprises that take active control to reduce the impact of currency fluctuations are in a better position to forecast their costs and revenues accurately. They can subsequently develop a longer-term strategy to use a forward contract (hedging) to mitigate risks to their margins.
How can SMEs manage currency fluctuations?
Understanding where and how currency fluctuations affect a company’s cash flow is not all that straightforward. It requires a thorough audit of where and when the risks strike the business and how these pressures affect finances.
The next step after the audit is to determine risk appetite. Deciding how much currency risk is acceptable should be like deciding how much debt is acceptable: it depends on a company’s risk appetite. There are two risk appetite options: gamble on the currencies and trust the rates will be favourable and unfavourable in equal measure, or focus on the business and protect the margins.
Don’t forget, there’s always the option of calling on the experts. Even a brief conversation with a specialist currency provider can help formulate an effective foreign exchange risk management policy to help ease currency pressures.
Depending on a business’ risk appetite, they can also consider hedging and standardisation. Any company that imports, exports, or have foreign subsidiaries faces the threat of currency risk and could benefit from hedging as it ultimately affects profits. It’s a remarkably effective financial instrument to help mitigate the likely constraints on margins and cash flow when a business is setting up, or have found a niche with higher margins to exploit. Business owners must remember, though, that for any international business, making decisions based on unprotected numbers is a gamble on both the outcome and the ensuing margins generated.
Standardising in one currency can help reduce some fluctuations, but it’s not a one-size-fits-all solution ‘ every business’ currency risk will be different. A potential concern with this policy is that invoicing in the home currency will forward the risk to someone else within the supply chain, either as a supplier or customer. This approach could negatively affect the business relationship, causing the business to lose a pricing discount or even a competitive edge. Some businesses may offer better payment terms in local currency, so to protect your cash flow, it’s always better to check first.
As we’ve seen, currency movements can be sudden and large, and businesses that trade internationally must consider the risks that currency fluctuations could have on their bottom line. In a volatile world economy full of uncertainty, addressing currency risks with a well-devised risk strategy is the best thing businesses can do to protect themselves from unpredictable fluctuations.