As a small business involved in overseas trading, there lies a high risk due to fluctuating currency. More specifically, the volatile nature of the marketplace and mitigating factors which directly impact the value of selected currencies, both at home and the trading country. As a small limited company or an overseas contractor, it is vital to actively measure the risk and equip your business against changing exchange rates. Failure to do so could tip your business towards financial difficulty, disrupting company cash flow and the overall profitability of the company, writes Keith Tully of Real Business Rescue.
Larger businesses are typically better equipped against FX risks due to higher levels of exposure, the geographical scope of their customer base and longstanding relationships with foreign suppliers. Small businesses should equally note the importance of such trading factors as this directly impacts the health of the business.
SME considerations when trading abroad
Currency fluctuations, also known as currency or exchange rate risk, applies to businesses of any size if trading overseas. Businesses of this nature may come into contact with FX risks if they resort to employing the skills of overseas workers and trading with long distance suppliers. Many SMEs decide to turn their gazes abroad for the following reasons:
- Workers are highly skilled and reflect better standards
- Workers have a stronger appetite
- Rates of pay are affordable
Trading overseas can be beneficial for smaller businesses as this helps attract a wider client base and raw equipment can typically be purchased at a cheaper rate, cutting costs for the business. When foreign currency enters the business, effective measures should be put into place prior to this to ensure cost efficiency and to minimise risks associated with depreciation.
Small businesses should take consideration of the following aspects when trading abroad:
- Currency and exchange rate trends
- Forecasts and budgets as these could change depending on higher or lower exchange rates
- Fluctuating costs of exports and imports
- Cash flow as higher exchange rates could result in a shortfall of cash
- Notable events such as elections, political rallies, economic or financial crisis and natural disasters
Putting it into perspective, the referendum vote which supported the UK’s exit from the European Union resulted in the value of the British pound (GBP) to drop to a 31-year low. Following the unexpected outcome, uncertain investors withdrew support on selected projects and the future of once-lucrative trade deals no longer had a definite future.
If small businesses depend on overseas trading bodies, they will either function as the importer or the exporter. Each role has its own set of considerations and as a result, different measures should be put into place to safeguard the business.
SMEs functioning as the importer
If you work with businesses outside of the UK, such as to import materials into the country, you should keep a close watch on the value of your home currency. If the value of sterling drops by 10 per cent, you may find that you are paying more. This could decrease the amount of money in the business as production costs can easily increase, tightening profit and loss margins. You may consider distributing the risk between the business and customers, but it’s worth noting that this may appear unfavourable to the end customer or client.
SMEs functioning as the exporter
As an exporter, the key consideration will be whether you are paid in foreign rates by overseas customers, or if the customer makes payment in GBP, saving you time and money. If you are paid in a foreign rate which is worthless when converted into your home currency, this could directly impact your financial forecast and budget.
It is also vital to note that from an accounting perspective, you will be required to record your foreign exchange losses and foreign exchange gains in order to correctly calculate your tax contributions to HMRC.
FX risk protection measures for SMEs
By actively analysing exchange rates, you will be able to work in a cost-efficient manner and spot the right time to strike. Entering into an agreement which incorporates a fixed exchange rate will enable you to accurately make budget forecasts, measure cash flow and futureproof the business.
Forward contracts:
Forwarding a contract is essentially making an agreement to pay the current exchange rate on the date of execution. This is typically a written contract which confirms a fixed price for a future date, protecting against fluctuations in rates. This secures financial stability for the business as they will know what to expect in terms of payments. This measure is appropriate when you aren’t quite ready to make a transfer yet.
Specialist currency brokers:
Currency brokers can ‘lock-in’ exchange rates, allowing you to establish what payments you will be required to make, removing ambiguity from the process and disqualifying any significant differences in exchange rates. Specialist and complex exchange rate products can be purchased through currency brokerages which allow you standardise rates, often used by larger enterprises.
Data tracking and analysis:
Intelligent exchange rate trackers can help you measure trends in exchange rates and pinpoint the most lucrative rates. By setting alerts, you will be able to take advantage of record low exchange rates and predict future trends. Brexit related trackers such as Finder tracks the value of the pound in accordance with key Brexit events and notes upcoming key Brexit dates which could have an effect on the pound.
Currency account:
A multiple currency account is suitable for small businesses working with multiple currencies, allowing for borderless trading. The account offers lower transactional fees, allowing you to save on foreign exchange charges. This saves you opening several accounts in different locations, and limits the level of organisation and communication required to manage multi-currency funds.
By planning for fluctuations in currency and anticipating the impact of upcoming events on currency, you will be able to keep your business safe from significant fluctuations and maintain financial stability. Taking the business to the next level of overseas trading can reap rewards. If conducted without protections in place, this could hurt your track record due to unforeseen exchange rate fluctuations and unexpected shortfalls in cash. There are a variety of tools, products and measures which can be put into place to help your business reach the next level of productivity and protect against currency fluctuations.
More on taking your business international and how politics affect international markets.
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