Any business that makes international payments needs to be aware of currency fluctuations. Unfortunately, it is all too common for the profitability of an overseas deal to be negatively affected by unexpected movements in the currency market.

All the careful planning in the world is worth nothing if one vital element of the process is overlooked, and in the current climate, making sure that you buy and sell at the best exchange rate possible has become more critical.
With increasing globalisation, there have never been more UK businesses involved in international trade.

But it is estimated that between 600,000 to 850,000 UK SMEs still pay no real attention to this essential part of the business and without knowing it are leaving themselves open to currency movements that can rapidly erode profits.

Turmoil in the currency markets is having serious consequences for many businesses, not least German car manufacturer VW, who, as was reported in the media recently, is likely to remain loss-making in the US as long as the dollar remains at its current level against the increasingly strong euro.

But it is not only large corporations that need to be aware of foreign exchange exposure. Anyone from small sole traders to PLCs have some kind of FX exposure, which is usually treated as an afterthought and transacted via their bank, incurring transaction costs and large currency spreads.

It’s not unusual for the high street banks to take anything up to 6% by way of commission and charge in the region of £40.00 for an international transfer. That, of course, is big business for the banks but painful and expensive for the client. The global sell off in the US dollar and the British pound in the past 18 months has forced finance directors to seriously consider translation risk, where a budget figure at the beginning of the year can be out by as much as 20% by year end, ensuring a nasty blow the bottom line.

In more stable economic times currencies fluctuate less and this translation risk has been a great deal narrower. Today however, it’s a consideration that should be at the forefront of FDs’ minds.

With the US on the brink of recession, the concern for many businesses is that the strong euro will only make exported goods a less attractive proposition.
High value items such as cars will become even more expensive to US consumers, as dealers are forced into passing on the significant cost of currency exchange to consumers.

Part of the problem is that many SMEs still use their traditional banking arrangements to service all their business requirements: including the purchase of foreign exchange.

This is despite the fact that the margins banks impose and the extra charges levied when using their facilities to make international payments are unacceptable in today’s business environment.

Currency movements are an accepted risk when making international payments and can have a real and significant impact on profitability and cash flow. These risks necessitate pro-active management, which in turn requires a certain level of expertise. The largest institutions have the scale to employ their own economists, analysts and dealers, and resources to invest heavily in market information, data, and risk management systems.

But it is unrealistic to expect SMEs to have access to such resources and this is where the knowledge and expertise of a foreign exchange specialist comes in to play – allowing SMEs to concentrate on their core business.

High street banks also do not provide free specialist services such as the ‘forward contract’, which can protect against a company’s exposure to foreign exchange risk. The ‘forward contract’ ensures that a rate is agreed at the time of the contract for a delivery date in the future, as stipulated by the client, effectively protecting against fluctuations that could seriously impinge on the profitability of an otherwise successful overseas deal.

While it is possible to agree a rate option with your bank to fix an exchange rate it can be a costly service, with charges of anything up to £20,000 being the norm. For example, one high-street bank charges 2% of the transfer sum for three-month currency protection and lets customers choose between the guaranteed rate and the daily rate.

However, most exchange specialists do not charge a fee to fix a rate meaning that huge savings can be driven straight back to the bottom line.

By looking beyond the banks, businesses can benefit from a proactive service and the provision of a dedicated currency specialist, who will watch the markets on your behalf, advising of advantageous rates and currency movements that might work against you. While not the only concern for banks, international payments are the sole focus for specialists in this field.

At a time when businesses are feeling the dual squeeze of the credit crunch and rising costs, such as the increasing price of energy, the need to examine every option to manage costs whilst increasing profit is critical. In this respect the pricing of international payments is of paramount importance, as they have a direct bearing on the bottom line profits of a company.

Proactively managing risk and protecting against the vagaries of the currency market, has never been more relevant in today’s economic climate. So make sure that when the transaction is finally undertaken, you are left with an exchange rate that will have you laughing all the way to the bank.

Left exposed?

It’s not only large corporates that have exposure to currency markets. With international trade now key to the growth of any company the skill set and understanding of FX markets is becoming more of a necessity than a chore, especially when it comes to the negotiating of contracts. In the past 12 months any company involved in worldwide trade would have seen the value of sterling drop by over 20% against a basket of currencies and this can have dire consequences if the underlying exposure is not accounted for.

Example

A UK company has employed the services of a Canadian IT firm and at the outset of the contract a fee of CAD$ 250,000 is agreed with 20% payable at outset balance on completion of work 6 months later.

At the outset the FD of the UK company has used a £/CAD$ exchange rate of $2.20, and costed the contract at CAD$ 250,000/ $ 2.20 = £ 113,636.

However at the end of the contract the rate of £/Cad$ has dropped to 1.98, meaning the remaining 80 % balance ($200,000) will now cost £ 101,010.00.
So the total cost of the project that was originally costed at £113,636.36 has now risen to:

20% 50,000 $2.20 £22,727
80% 200,000 $1.98 £101,010
New total = £123,737.

It’s vital in the current markets to hedge your underlying exposure as contracts are signed and agreed.

Mark O’Sullivan is director at Currencies Direct