Well, 2012 is done and dusted. We survived the fiscal cliff, the end of the world, and currency volatility continued to be the norm. During the Christmas and New Year period alone, currency markets rode a roller coaster up and down a 200 point range.
A turbulent currency market means more businesses want help to minimise the impact of fluctuation on their bottom lines. Currency hedging is one way to achieve this and while the concept can be daunting to some, the reality is it doesn’t have to be complicated, nor is it the best fit for every business. With some planning and consideration it can be an effective way to combat volatility.
The real challenge is that no one can predict the exact movements of a currency. As businesses increase their focus on risk management and hedging strategies they are turning to knowledgeable professionals for support and industry insight to make educated decisions about their international payments.
Don’t ride out volatility, take control
Currency hedging and risk management strategies can help you avoid currency swings that can shrink margins and detract from bottom lines. It can also help with cash flow and budget planning by providing a base level of certainty.
There is a misconception that currency hedging is best suited to large corporates, but there are actually a range of tools to suit businesses of all sizes. A solid hedging strategy accommodates the needs of individual businesses and leverages the most appropriate tools, so you can stop trying to predict market movements and get back to running your business.
Not sure where to start? Here are five steps that a business should consider when developing a hedging strategy.
1. Identify your foreign exchange exposure.
Start by confirming the total of your payments, the required currency and the date your payments have to be made. These sound like obvious steps, but as the foundation of your strategy they are critical in dictating which hedging tools will meet your needs.
2. What do you want to achieve?
It’s important to be clear about the outcome you want from your strategy, as this will also determine the tools you employ. Is your sole objective to protect yourself from currency risk? Then you might consider a simple Forward Contract which lets you lock in the current exchange rate for a set amount which you can draw down on over a set period of time. If your goal is to manage the impact of currency fluctuation on your business then an Options Contract, which protects you from adverse currency movements but also lets you take advantage of positive moves, could be a better fit for you.
You might also be looking to secure costs, maintain margins or manage cash flow; however it’s essential that you keep your objectives focused and realistic. A solid strategy does not predict currency moves. It expects volatility, provides the business with clear instruction and aims for outcomes that are not necessarily price specific.
3. Consider your hedging alternatives
After assessing the financial risks, costs and potential operational impacts of implementing a hedging strategy, it’s time to consider the best approach to achieving your objectives. Forward and Options Contracts, mentioned in the previous point, are reliable choices.
However, you should also consider alternatives such as holding on to any foreign currency you have received, to pay a foreign invoice at a later date. This is called Natural Hedging. Or, perhaps the due date for your payment is in the near future and the current exchange rate is in your favour – which means a Spot Payment might be most beneficial for you. Opening a foreign currency account can also be an advantage, although fees and resourcing could be problematic.
4. Implement your hedging strategy
Once you have worked through the above it’s time to put your strategy into action. At this stage, if you haven’t already, now is a good time to engage the services of a specialist foreign exchange and international payments provider who can help refine your approach and ensure you get the most out of your strategy.
5. Monitor and review
Most importantly, don’t ‘set and forget’ your hedging strategy. It should be reviewed on a monthly or quarterly basis and refined to match the constant flux of currency markets. Are you satisfied with how the hedge is working? How has the market affected your objectives? Is there anything that could be changed to help meet your objectives? Constant reassessment will help achieve the best outcomes from a business, financial and operational perspective.
Take the reins and navigate risk
Successful businesses develop and follow good hedging procedures that are easily understood and executed by the business, reduce risk and aim for cash-flow certainty.
By applying the right techniques businesses can estimate future costs and budget effectively for the future, and in today’s dynamic business environment who doesn’t want to protect their profits and improve their bottom line performance?