Foreign Currency Risk Management

November 30, 2012 Published by
Post Categories: Risk Management

Once your business has committed to conducting a foreign currency transaction, you are exposed to exchange risk.  There is a potential gain or loss that may occur as a result of currency rate fluctuations. For entrepreneurs who are involved in international trade, currency volatility has always been a concern. One example is the strengthening of the Canadian dollar against the U.S. dollar in the last couple of years.

How can you protect and even improve your bottom line when faced with any kind of currency swing?

Here are some short-term options that may help protect you against currency exposure:

  • Do nothing.  This may not be a bad choice if you receive foreign currency from your customers and your payments are also made in that same currency.
  • Use forward contracts to buy or sell funds, in other words hedging.  It guarantees the future price of a currency. For example, you purchase a contract for the payment of goods to be acquired in the future thereby setting the future cost of funds. The fixed rate allows you to budget effectively without currency fluctuation eroding profit margins.
  • Monitor foreign exchange markets to execute orders when favourable opportunities arise.  This requires a time commitment and experienced personnel.
  • Engage a foreign exchange broker.  Their business is to be informed for their clients and trade foreign currencies on hopefully beneficial terms.

These solutions may help you reduce your risk for certain transactions, but they may not fundamentally prepare you to counter the risk in the long-term. What if the current run-up of the Canadian dollar is permanent?  This new environment may force or encourage you to re-examine your cost structure and way of doing business.  For example, you may need to:

  • Diversify your supplier sources for import markets and customers for export markets to reduce your dependency on the U.S. dollar.  It’s easier said than done, but it should be one element of your long-term growth strategy. Other markets do exist in Europe, Asia and South America.
  • Increase your sales volume to protect your profit margin.  When you operate in a low margin environment, the volume may generate the necessary cushion against unfavourable fluctuations in the exchange rate.
  • Become more efficient at everything you do.  This should reduce your direct and indirect costs for better margins.  It is another effective way to deal with exchange risk.  Review your internal processes, be innovative and you should find processes to reduce spending while improving your level of customer service.

If you are not in the business of speculating on foreign exchange rates, you should consider refraining from actively managing currency risk as the exposure could jeopardize the financial health of your business. Be mindful of such a risk, and take concerted steps to lessen the currency impact.