SME currency concerns: cause and FX

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