Whenever a company or an individual enters into an agreement to trade in goods or services that are priced in a foreign currency, immediately there is an exposure to the risk of the volatile foreign exchange market.
Foreign exchange rates in the market change by the second and can fluctuate to unpredictable degrees both in the short and long term. Also, different currencies will fluctuate to varying degrees, depending on the market forces at play nationally and internationally. For example, from February 2013 to date, if you had wanted to buy US dollars the variation between the best and the worst exchange rate was 13% and for the South African rand it was almost 40%.
Such variations may make the difference between a profit and a loss!
So how does a company or individual that is buying or selling abroad manage the risk and safeguard its income and/or profit margin?
Company A contracts to buy leather goods from the Far East at a price of $250,000 for delivery and payment in three months time. At the time of the agreement, the GBP/USD rate was 1.67, but at the time of payment the rate had fallen to 1.59. Consequently, income was reduced by £7,623.
Victoria Smith agrees to buy a new villa abroad at a price of 300,000 when the GBP/ EUR exchange rate is 1.225. On completion, nine months later, the exchange rate has moved back to 1.175 which increases the cost of buying the villa by £10,422.
In both scenarios, unanticipated foreign currency movements have had a significant adverse effect on the outcome. Consequently, for both businesses and individuals obtaining the exchange rate that was assumed when entering the trade contract must be the prime objective in managing their foreign currency requirements.
WHATS THE ANSWER?
There are a number of ways a company or individual can reduce or even eliminate the risk. The simplest being a Forward Trade Contract, where you can order and reserve currency at a fixed exchange rate in advance for an agreed date in the future when you will need the money. Generally, a small deposit is required up-front with the balance being paid on the agreed delivery date.
Company B agrees to buy services from a US supplier at a contracted price of $175,000 for payment in four months time and at the same time enters into a forward trade contract at the prevailing exchange rate of 1.67. This means that, when payment is due, Company B is guaranteed a rate of 1.67 irrespective of the actual market rate, thus protecting budgeted income and profit margin.
So remember, effective foreign currency management means safeguarding your margins, protecting profits and ensuring your peace of mind.
This article was kindly written by Craig Strong. If you would like further information on currency transactions or limiting liability when dealing with foreign clients, get in touch:
7-9 Lonsdale Gardens
Tel: 0800 298 2785