If you think currency and exchange rates are something only bankers have to be concerned with, think again. Many business are exposed to currency risk, whether they realise it or not. With the recent wild swings in global currencies, exchange-rate risk is back on the agenda for companies with customers, suppliers or production in other countries.
With the spread of coronavirus, March and April brought dramatic fluctuations in currency rates. Strict regulations to contain the outbreak put the brakes on the global economy, triggering a matching fall in oil prices and stock markets. The market is seeking safe havens, moving towards Japanese Yen, US Dollar and Swiss Franc. Smaller currencies and commodity currencies have suffered, including NOK, SEK, AUD, NZD and emerging market currencies, though some of the fall in value has reversed since April.
The key learning is that if you run a business that earns revenues abroad or has costs in other countries, you most likely have exposure to currency risk. Events outside of your control could eat away at your revenues and increase your costs.
So how big is the problem managing currency risks?
In a survey of 200 chief financial officers and nearly 300 treasurers conducted by HSBC and FT Remark, 70% of CFOs said that their company suffered reduced earnings in the prior two years due to avoidable, unhedged FX risk; 58% of CFOs in larger businesses said that FX risk management is one of the two risks that currently occupy the largest proportion of their time; and 51% said that FX is the risk that their organisation is least well-equipped to deal with.
Currency fluctuations are also a threat to small and mid-sized businesses, but according to Nordea’s study done in late 2020, too many SME’s underestimate their currency risks. Businesses with turnovers above 2M Euro and fair level of imports and exports say that they’ve experienced unexpected financial losses caused by currency fluctuations during the COVID-19 pandemic. However, close to half of the SME’s have not protected themselves against this, and the survey indicates that the biggest barriers for managing the risk have to do with lack of time and know-how.
On the flip side, managing your currency risks can bring your business benefits:
- Protection for your cash flow and profit margins
- Improved financial forecasting & budgeting
- Better understanding of how fluctuations in currencies affect your balance sheet
- Increased borrowing capacity
When currency exchange rates fluctuate, businesses rush to prevent potential losses. What currency risks should they hedge and how?
5 steps to manage your business’s currency risk
Understanding where and how currency fluctuations affect a company’s cash flow is not straightforward. Many different factors, from macroeconomic trends to competitive behaviour within market segments, determine how currency rates affect cash flows in a given business.
Review your operating cycle
Review your business operating cycle to learn where FX risk exists. This will help you determine your profit margin’s sensitivity to currency fluctuations.
Accept that you have unique currency flows
Every business is unique and that is reflected in your currency flows, but also in the structure of your assets and liabilities. It is key to understand that currency fluctuations may have an impact and the decision to hedge or not is not as simple as a roll of the dice. For a business that relies on foreign manufactures or suppliers, Nordea Markets has developed a specific service: Learn more about Exchange at home.
Decide what rules you want to apply to your FX risk management – and stick to them
An effective FX policy begins with a clear understanding of the company’s financial objectives, and the potential effect the changes in FX rates might have on them: If the operative cash inflows and outflows are in different currencies, changes in FX rates might jeopardize the company’s EBITDA target. If the assets and liabilities are in different currencies, remeasuring those assets with new FX rates might jeopardize the P&L bottom line, or the equity ratio targets. The FX risk management policy ensures that whatever the financial objectives are, such FX risks that could jeopardize those objectives are monitored and mitigated, systematically.
Manage your exposure to currency risk
Especially when it comes to physical products, there is a time lag between making business decisions and seeing the effects of those decisions on the company’s bank account. During that time gap, the purchase and sales orders are negotiated, materials shipped around the world and goods manufactured, stored and delivered.
In parallel to that physical process, invoices are being sent, reviewed, approved and eventually paid. Meanwhile, currencies are appreciating and depreciating. If the material and manufacturing costs are in a different currency to the sales receipts, those fluctuations in FX rates can easily wipe away the sales margins the company used as the basis for its original decision-making.
Financial instruments can help mitigate this uncertainty that jeopardizes the company’s financial objectives. This is called hedging, and it ensures that the FX rates affecting the company’s bank account balances are not too different from those used in its decision making.
Automate FX handling to free up your time
Small businesses as well as large corporates can all benefit from automating their FX handling. Nordea’s award-winning AutoFX solution helps businesses free up resources, eliminate manual tasks and minimize operational risk and human errors.
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