As soon as you start doing business using foreign currency, you become vulnerable to currency rate fluctuations. Any change in currency value has an impact on how much you receive or owe. There are many ways to define foreign exchange risk, which is also called currency risk, exchange rate risk and FX risk. But there’s one thing to remember: a company is vulnerable to foreign exchange risk when the value of its transactions and investments, not to mention its viability, are affected by currency rate fluctuations. Here are five tips to help you protect yourself.
Going global means making transactions using foreign currencies. However, currency rates change rapidly. Depending on whether a particular rate is trending upwards or downwards, your invoice may be on the bigger or the smaller side. If a rate is on the rise, you’ll have to pay more to your supplier. If it’s dropping, some of your sales may turn up less of a profit than expected. Yet the cost and the quality of the product or service haven’t changed in the least. “Considering these challenges, it may be difficult to manage your business’s profitability. It’s a reality that all entrepreneurs have to plan for,” acknowledges Salim Laaroussi, director, Risk Management Solutions at the National Bank.
The ups and downs of a currency rate will have an impact on your business’s future worth and its competitiveness in the medium and long term. That’s what we call currency transaction risk. “If you don’t protect yourself from foreign exchange risk, you could leave your company vulnerable to substantial loss,” warns Mr. Laaroussi.
You’ll suffer a dead loss if the currency changes to your disadvantage between the time you complete a sale or accept someone’s currency and when you cash the payment or pay your supplier. Even the slightest change could have major consequences on your profitability.
Foreign exchange risk can also have an economic impact. Currency rate fluctuations can affect the future worth and competitiveness of your business. For example, a Canadian company with assets in the United States faces the risk of foreign currency depreciating. Conversely, a Canadian company with bank financing in the United States runs the risk of foreign currency appreciating. The liabilities they need to reimburse may have a higher value in Canadian dollars.
Currency conversion risk occur when currency rate variations impact the financial state of your international business, pushing you to consolidate the results of your foreign subsidiaries.
Internal and contractual strategies are sometimes possible. Financial solutions are also available to you. These allow you to hedge the risk, partially or fully, at your discretion. A partial hedge – meaning only a portion of the potential currency risk is hedged – is what people select most often. “Choose your strategy based on your risk tolerance and after analysing your business’s standing,” advises Mr. Laaroussi.
Risk management solutions – long-term contracts, swaps, options, collar agreements, and others – are easy to use. They work very well in helping to protect you against foreign exchange risk. Most of them are based, directly or indirectly, on forward exchange rates. This refers to a currency rate provided by a financial institution for the purchase or sale of a specific amount of foreign currency that will take place at a predetermined future date. “The best solution usually consists of a combination of several products, and often requires the advice of an expert,” he adds.
If you make regular transactions using foreign currency, it’s safer to set up guidelines to structure your currency risk management. Creating a foreign exchange risk management policy will force you to conduct an in-depth analysis and to make plans for future operations. “It will also give you the opportunity to ask yourself the right questions and choose the most appropriate solutions in advance. Of course, these will have to be revised regularly,” says Mr. Laaroussi.
Finally, not managing financial risk means speculating on the future of your business and betting that the markets will move in your favour. Making sure you’re protected against foreign exchange risk strategically reduces your company’s exposure to market risks, and can give you a leg up on the competition.
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