How to: manage currency differences in overseas markets
When exporting, one of the key risks you are likely to encounter involves working with different currencies to your own. This section outlines some of the issues that companies should keep in mind to protect against exchange rate fluctuations. This will guard against the risk of agreeing a price with a customer, and subsequently having your profit margin reduced – or worse, turned into a loss – by unfavourable movements in foreign currency exchange rates.
When selling to customers in other markets, one of the issues to be negotiated is which currency to invoice in. Many customers naturally prefer to do business in their own currency. This may suit the exporter for strategic reasons – for example, the chance to win a deal with an important customer – but it’s important to be aware of the potential downsides.
There is also the practical matter of your company needing to deal in foreign currencies on an ongoing basis as your exports develop. While the issue of currency is important, it shouldn’t distract you from your main business. There are several practical ways of mitigating the risk. Your business bank should be able to provide facilities such as:
- A foreign currency account with money in a particular currency, allowing you to receive and make payments to customers in that market without needing to convert the currency
- A bank account in your target market’s country
- Forward contracts, whereby the exporter agrees to purchase currency at an agreed rate for a fixed period of time
- Options – similar to forward contracts – but where the exporter is not obliged to go ahead with the currency exchange
- Agreeing a price in your home currency with your customers and suppliers.
Foreign currency and exchange risks (Invest NI)
Case Study: Declan Crowley, Kerry Group
Headquartered in Tralee, Kerry Group (www.kerrygroup.com) comprises two principal business units: Ingredients & Flavours and Consumer Foods. The Group has manufacturing facilities in 23 different countries and sales offices in 20 other countries. It supplies more than 15,000 food, food ingredients and flavour products to customers in over 140 countries worldwide. Group Treasurer and Chartered Accountant Declan Crowley offers advice for SMEs about how to deal with foreign currencies when exporting.
What should a first-time exporter do to manage currency risk?
The first line of defence is to invoice in your home currency and let the customer carry the risk. When you move beyond that, you’re getting into a situation of determining the selling power of the seller versus his customer and competitors, and this applies to an SME as much as a large corporate.
If you must sell in the currency of the customer, try and have a pricing arrangement where you can convert your euro or sterling selling price to the seller’s currency on the day of sale. If you hedge that back to your home currency on the day you issue the invoice you have no currency risk and the buyer is still carrying the risk. But the situation is different if you have to issue a price list or otherwise fix prices forward in foreign currency for the coming 12-month period and you don’t know when, during that time, the buyer is going to buy. In that case, your company is carrying the risk. In that scenario, try and do a good forecasting of what your foreign currency sales are likely to be in the next 12-month period, and hedge out a percentage – say 50 per cent – of your forecast flows. If there is a higher probability of achieving those forecast flows, you could look at setting a higher percentage. Once sales are made, cover out immediately the any amounts for which you have not already taken forward cover.
If you don’t hedge, then your sales will be converted at the rate on the date of collection of the foreign currency sales and you will be vulnerable to whatever the exchange rates might be. This could have a significant impact on your profit. Another issue to consider is, where is your competitor from and what currency are they invoicing in? That can have a big bearing on who carries the risk.
“The first line of defence is to invoice in your home currency and let the customer carry the risk”
What else can an Irish business to facilitate foreign exchange trading?
If the volumes of sales merit it, you should open a foreign currency bank account with your bank, otherwise the bank will apply an exchange rate to your sterling or euro bank account and it may not be as favourable. This way, you’re putting yourself in control of the conversion process, rather than someone else doing it arbitrarily on your behalf. I think for sums under $10,000 or €10,000, the percentage that banks charge can be very high – I call it the tourist rate. If the quantities are bigger, the percentages may diminish a bit it still be significant.
That’s one of the reasons to have a foreign currency account. It means you can control the conversion and can you deliver against your foreign exchange commitment. SMEs should engage with the foreign exchange department of their banks as they can provide advice and assistance in account opening, trading and management of foreign exchange and advice on trading.
Have you any other tips abouT currency-related issues?
When doing a foreign exchange contract, get a couple of foreign exchange prices if you can, to make sure the prices you’re being offered are competitive. In our own situation, we deal all our foreign exchange on an electronic platform which has real-time pricing from a large number of banks and the price differential can be very significant.
I wouldn’t suggest that all SMEs need electronic trading platforms but it might be beneficial to get quotes for more than one bank. There are also very good web pages such as Bloomberg or Reuters which give an indication of current foreign exchange rates as well as currency conversion apps for smartphones. That way, you can see live pricing so you can have a good idea of what the price should be before you go to trade.
Lastly, it’s no good selling something if you can’t collect payment, so you should look at options such as getting credit references or using letters of credit from your customers to facilitate payment.