Exchange rate risk is a reality for exporters. And with so many products on offer to help reduce your exposure, a foreign exchange management strategy is ideal for exporters who want to stay one step ahead of foreign currency deals.
All exporters, whether they like it or not, have to deal in the foreign exchange (forex) market, and if there’s one thing that’s certain in foreign exchange, it’s that nothing stays the same.
In a perfect world, though, you’d be able to charge your overseas customers in Aussie dollars and they’d pay you in Aussie dollars, keeping your cash flows and profit margins solid. But in many cases, when you’re exporting goods or services, the people you’re exporting to don’t want to make payments in $A, explains Basil Payn, regional director for foreign exchange at Travelex. “Most exporters will have an objective to sell as much as they can to as many customers as possible, so unless you’re in a position of power where you’ve got a product or service that nobody else provides and the whole world wants, you really want to make it as easy as possible for people in global markets to buy from you.”
David Marshall, Bank of Queensland’s group executive of business financial services, agrees saying if exporters can arrange their business in a way so they don’t incur any currency risk (i.e. only get paid in $A) that’s great, “but I can’t help but think that there’s going to have to be some relative impact in price, because the importer on the other side is still going to want to get a competitively priced, good quality product”.
So, to keep customers happy, many exporters will allow importers to pay for goods or services in their local currency, or the more globally accepted ‘basket’ currencies, such as the $US or the euro. But as currency movements throughout 2007 have indicated, exchange rates are volatile and potentially harmful to exporters, especially as the Aussie dollar continues to rise against the $US.
At the time of writing, we’d seen movements of up to 15 percent in the exchange rates in the preceding two months. “That can easily wipe out your entire profit,” warns Payn.
Strike Group Australia is an inventory solutions provider for major stockholders of mobile phones and accessories around the world. Launched in 2001, the company was a ‘born global’ and now exports into 73 countries around the world with the majority of their business in the US, Hong Kong, Europe and the Middle East. Consequently, general manager Paul Branagan says exchange rates have a significant impact on the business. “It’s very important how we manage those, particularly at the moment when there’s a lot of volatility in certain markets. It’s a very important part of our business and our financial people spend a lot of time tracking the international currency moves.”
While exchange rates can play for you, as much as against you, when it comes to running a business a level of certainty is needed. “You’d rather have as many as your costs fixed as possible to be able to plan for your cash flows,” says Payn. “It’s very difficult to run a business not knowing how much you’re going to receive for something.”
While an ad hoc approach might suit some, Marshall believes this can be extremely risky, especially for those inexperienced in foreign exchange. “There will be plenty of people who’ll be able to show you all sorts of graphs to say that if you do nothing you’ll be better off. But I think it depends on your financial position, your gearing, your length on time in the business, your experience, your research and your technical expertise.”
Consequently, mitigating the level of risk and exposure is crucial for exporters wanting to maintain profit margins, and incorporating a formal forex strategy into your business’s management processes will be your best insurance policy.
“Exporters should have a policy in place that addresses when they’re going to identify their currency risk, how much that currency risk could potentially be, and what action they need to take, or don’t need to take. They should continue to look at and identify where their costs and benefits are, and refine that policy until it’s something that works for them,” advises Payn.
Unlike standard accounting rules and practices, there’s no one-size-fits-all forex strategy for exporters. “Every company is going to have different things they’re going to need to look at,” he adds. Where you export to and the volatility of the currency will be major factors.
“You need to understand the impacts of foreign exchange risk in terms of your revenue and you should also develop some principles that you should try and run the company by,” says Marshall. He’s reluctant to advise a formal forex ‘policy’ as this can sometimes infer something that’s set in stone, but suggests some clear principles around what percentage of your receivables you’ll have hedged, or how often you’ll review your forex exposure are important.
Your forex strategy will also depend on the degree to which you are exporting. “If a company is purely an exporter, that would be a bigger issue than for someone whose revenue is only 20 percent in exporting,” explains Marshall. Pure exporters would need to have those very clear principles in place and stick to them, but if only 20 percent of revenue was derived from exporting you’d have some more flexibility.
Payn believes your strategy will also depend how much value you’re adding to your products. “If you’re just exporting a raw material, you’re probably not adding much value and it might be getting sold in US dollars, so you’re probably up for a pretty big chunk of what you’re receiving is in foreign currency. So, that may hurt you a lot more than someone who’s manufacturing a product that has a high value of sale, and whose profit margin is probably higher.”
Exchange rates will also affect how exporters price their goods. “It’s a very critical area when it comes to the lag between doing a contract, and delivering the goods and getting paid for it,” says Payn. “It’s pretty important you have the information to be able to price out what you’re going to receive in $A when you actually do the contract, and then what you actually do receive in $A when you receive payment, so you can keep track of the cash flows and keep an understanding of what it’s done to your profit margin.”
While information around currency movements and economic forecasts is readily available to businesses through the media and internet these days, many SMEs won’t have the knowledge or even time to come up with their own forex strategy alone. Our experts suggest exporters work closely with their financial advisers (most probably your accountant and maybe your lawyer, depending on the business), and a foreign exchange provider—whether it’s your bank or a foreign exchange specialist—to come up with the best strategy for your business that recognises the problems you might come up against, and how you might go about fixing those.
Having a formal forex strategy is crucial for Strike’s exporting business, says Branagan. “We set the strategy in-house and then the forming of that strategy, in terms of the machinations of it, we work closely with external advisers. There’s really no person or place in the market you can go to, to get the level of advice for your business that you need. It’s so volatile, no-one is going to put their head on the block and say ‘the $US will be this at the end of the week’. They can only offer their opinion, which will differ from someone else’s, so you have to set your own strategy.”
While Strike started out solely using their bank for forex services, as the business grew and the level of expertise has opened up to them, they’ve embraced the opportunity to work with forex specialists as well. “It spreads the load a little bit, and gives us two external voices to listen to or ignore of we decide,” says Branagan. “It’s always good to have a certain element of competition there as well. If you have one institution with whom you do all your transactions, and they know that, then there isn’t necessarily any great reason to remain on the ball.”
Foreign Exchange Strategy
A major part of an exporter’s forex strategy will involve deciding which solutions to use to hedge forex risk. In previous issues of Dynamic Export we’ve revealed the myriad of hedging products available to exporters. The most common of those is a forward exchange contract (forward) whereby exporters can pay to have an exchange rate fixed at a certain price for a future date. “That basically mitigates the foreign exchange risk, and the exporter knows how much $A he’s going to get for the goods or services, and their margins are locked in,” explains Payn.
Other hedging products gaining popularity are currency options. While these come in all shapes and sizes, in their purest form options are essentially currency insurance. “That’s where you would pay a premium and that would give you the right to sell, say, $US and buy $A on a specific date at that rate,” explains Payn. “If the market moves against you, you use the policy and you’ve got protection and if the market moves in your favour, you don’t use the premium but you can still deliver in the market.
“More and more people are realising where the currency is going to go is more of a two-way bid, and that causes a lot of problems. I think now, especially when you see the volatility over the last two months, the cost of insurance is something that’s been more widely accepted as a benefit.”
In deciding the best product, or combination of products, that will work best for your foreign exchange strategy, Payne says a key indicator will be your business timelines. In other words, from the time you sign a contract with an overseas customer, to when you deliver the goods and then receive payment, those time lags will often determine the different hedging product/s you should use.
Marshall believes it also involves weighing risk and reward. “Some foreign exchange hedging products don’t allow you to take the upside, but protect the downside [forwards]. And some foreign currency products will let you get the upside to a particular point [options] and there are all sorts of variations in between.
“But I think this is part of the challenge for business customers—understanding the multitude of different products, the costs of those products, the risks of those products, and the opportunities they can provide, and that’s where the advice of a forex provider will be most valuable.”
Branagan admits Strike takes a fairly conservative approach to foreign exchange. “We try not to ever be in the situation where we’re gambling on the foreign exchange, so we do just about do everything with back-to-back foreign exchange forward contracts.
“The only way you can use foreign exchange to make more money is through taking more risk, and you’re back to gambling on foreign exchange and, at the end of the day, that’s not our business. We provide a service to our customers and we think it’s better to spend our time and focus and expertise on doing that extremely well, and adding value to that process. And then making sure that, through our close management of other areas, we can continue along a steady keel.”
Just as exchange rates can be volatile, so can all aspects of your business, so a forex strategy needs regular assessment to ensure its effectiveness. Again, the frequency and extent of this assessment will differ between exporters, but both Payn and Marshall advise doing a formal review at least every 12 months along with your business plan and financial forecasts. Look at the policy steps you’ve undertaken, and what the outcomes have been.
The degree to which you’re exporting will also determine how strategic you need to be. For example, if the majority of your business is in exports, Marshall says exchange rates will be such a fundamental driver of your income that monitoring your forex data, as well as seeking expert advice, should be done daily.
While Strike also has a strong domestic business, a substantial portion of their business is in exports, so their internal financial team are reassessing the company’s forex strategy on a daily basis. “There’s a daily system our finance people have to go through and, from time to time, we’ll broaden that out and maybe once a week get some external input into that, and we’ll sit down and make sure we are managing that to the expectations we’ve set for ourselves,” says Branagan.
A strategy should also be reassessed whenever there’s any material change in the business, adds Payn, such as if you’re exporting to different countries in different currencies, or if you’ve had some sort of cost change in your business, and you’ve got to pass on your costs.
There are also times when the $A might be getting stronger against one currency but weaker against another, and once you start to understand movement in those currencies and the implications behind them, you can start to look for markets where you can get a better margin on your goods, suggests Payn.
Conversely, you might have had some cost savings in your business, so you might decide that while you’ve traditionally always hedged, do you still need to take out those forward contracts—is the risk still as great?
While for many, dealing in the more widely accepted $US, pound, euro or yen will remain a preference, Payn and Marshall agree that exporters shouldn’t ignore business opportunities simply because a new overseas customer requests they pay you in their more exotic currency. “International markets are pretty sophisticated now and there’s a lot of knowledge and know-how in what might have been considered an exotic currency, such as the Indonesian rupia,” explains Payn. “Before you go ahead into the market, you can go and find out what the Indonesian rupia is against the Aussie dollar, where it’s traded, what it’s done for the last 10 years, where it’s at, at the moment, and if you can lock in your currency, so it’s not something you should really be afraid of.”
Technology has also eased the complexity and time constraints involved in doing multiple payments in multiple currencies. “There’s a lot of help out there now and technology has certainly stepped up in the last two to three years,” says Payn. “Especially thanks to the internet, there is a lot more reporting provided, as well as more detailed accounting and currency knowledge, and the ability to receive payments and invoice and all those sorts of things.”
“The delivery and execution of foreign currency transactions, being online, has made it much easier,” agrees Marshall. “The transparency and availability of information on one hand is a major tool, but what business needs is for that to be simply distilled so they can make informed decisions. It’s really important that the information they act on and get is provided by reputable organisations who are regulated and authorised to talk about it.”
Despite the technology available, Branagan believes there can still be some extremely long lags in currencies going to and from certain countries. Strike encourage their customers to focus on a $US, euro or $A trading platform, but if a customer requires they trade within an exotic currency, Strike wouldn’t walk away from the deal. “We have, from time to time, dealt in the Hong Kong dollar or the variety sterling, but it keeps our cost profile down if we can limit our exposure to those currencies, and the lower we can keep our cost profile, the better value for money we can offer to customers.”