Why do you need to have a risk management strategy?
Fluctuations in currency markets can potentially result in significant financial losses for companies; often eating away at profit margins through their impact on different business costs, for example, by increasing payables or reducing receivables. Companies with robust currency hedging strategies can take steps to mitigate these risks, but selecting an appropriate currency strategy can be fraught with complexities.
SFS works with companies to create tailored currency hedging strategies to manage their foreign exchange (FX) risk, protecting their bottom line by conducting thorough reviews of the potential risks and their different impacts on the business.
Understanding and evaluating the risk
In order to create a comprehensive treasury management and currency strategy, the first step is to understand the different economic and business risks and evaluate their impact.
Currency market risk can be attributed to a number of economic and business factors:
Transactional risk relates to the exposure caused through regular business transactions and day-to-day business, for example, payables to overseas suppliers, receivables from the sale of exported goods and/or services, international intercompany payments, and funding/dividend exposures from overseas assets.
Translation risk arises when companies conducting business in foreign markets need to translate the value of their overseas assets and liabilities into their home currency, in order to consolidate parent and foreign subsidiary financial statements. Fluctuating currency exchange rates can have a significant impact upon shareholders’ investments.
Economic risk arises from the performance of global and domestic markets and their effects on your business.
Why Manage Your Currency Risk?
If your business has dealings in foreign currency, there are some inherent risks that can dramatically affect your budget, margins, profits and bottom line if not managed effectively. In fact, it is difficult to overstate the importance of having strategies in place that can protect you against currency volatility whilst enabling you to take advantage of favourable moves.
By mitigating your business’s exchange rate risk, you can achieve several things simply and effectively:
- Help protect your business’s profit margins
- Effectively manage the impact currency volatility can have on your cash flows
- Secure working capital at budget rates
- Support your balance sheet
- Enable you to accurately forecast your business’s financials
- Retain a competitive edge through consistent pricing irrespective of exchange rates
Business factors contributing to currency risk:
- Your company’s budget rate
Knowing your budget rate can be useful in helping you to make financial projections. In order to set your budget rate, you must assess the risk appetite of your business. This will also help you decide whether the right currency hedging strategy route for you consists of more straightforward currency products, such as spots and forwards, or more complex option solutions, where you can mitigate certain elements of adverse currency fluctuation risks. Your budget rate should be based on a realistic level, close to the current market rate.
Quicker transfer times can allow you to pay for and make purchases on time, strengthening relationships with suppliers.
Is your business subject to large seasonal demands? What time of year is it in relation to your financial year-end and are any key payables/receivables already anticipated or scheduled?
- Which countries your company is regularly trading with and the strength of their currencies
Whether they are suppliers, manufacturers, importers, exporters, retailers or distributors, the countries that are home to your key business relationships and the strength of the corresponding currencies are crucial in assessing your risk.
- The frequency and timing of currency transactions
Your currency strategies will need to be tailored depending on key factors, for example, the frequency of future payments along with the predictability of rates around the dates of these payments. If you only make occasional international payments, a spot contract may suit your needs. If you make regular payments to countries with volatile currencies, it is worth considering forward contracts and potentially more sophisticated hedging strategy.