Financial Planning

How damaging is FX risk exposure for mid-sized businesses?

By Brian Harris – Chief Product Officer, Currencies Direct
Financial Planning
Published: 26 June 2018

For mid-sized companies, fluctuating exchange rates are one of the least hedged variables in terms of risk management. And with many mid-sized firms being heavily exposed to overseas markets, both in terms of importing materials and exporting products, this risk exposure has the potential to hit profit margins hard and turn profit to loss in the blink of an eye.

As we know, the currency market is extremely fluid, with exchange rates moving every minute. It’s impossible to predict on a month-by-month or even a day-by-day basis how much one pound will be worth in comparison to other currencies.

What’s not always considered is the direct impact of this on the stability of a business’s cash flow. There is anecdotal evidence that very few mid-sized companies – those defined as having an annual turnover of between £25m and £500m – have risk management systems or strategies in place for dealing with FX volatility. This is despite an awareness of any risks they may have in other areas. Businesses that have grown to this level generally don’t do so without a firm grasp of variables such as energy and operating costs – why should FX rates be any different?

Compounding this, some UK-based mid-sized enterprises can operate almost exclusively in foreign markets using euros or US dollars, only converting back to sterling in order to pay local fixed costs such as staff wages. These firms may be needlessly endangering their cash flow and bottom line by failing to take into account the variable nature of currency markets.

For UK businesses with an FX exposure, having a risk management strategy that takes account of currency fluctuations has assumed particular importance in the wake of the Brexit vote to leave the EU. Though the debate around Brexit rumbles on in nearly every area there is a growing need for companies to adapt to doing more business internationally – and therefore in foreign currencies.

In the immediate aftermath of the Brexit vote the pound slumped 10% against the US dollar. There is no reason to believe that the likelihood of further shocks occurring has diminished, and any such shock would have the potential to cause cash flow headaches for mid-sized companies with international supply chains. As it stands, many factors remain unknown with regard to the UK leaving the EU and any effect this will have on sterling and the euro.

Impacts on supply chains can be caused by sharp currency movements, with businesses discovering raw materials, components and overseas services have become suddenly costlier. And with many UK-based mid-sized companies relying on buying produce on international markets, these could find themselves exposed in the aftermath of any sharp currency swings.

Instances where firms experience such a currency jolt can lead to an immediate supply chain shock, compromising operations and leading to financial woe. For a business to implement an effective FX hedging strategy only after they have been burned could be viewed a case of bolting the stable door after the horse has fled.

Yet many of the problems experienced by mid-sized companies in relation to FX exposure could be mitigated with the support and tools offered by leading foreign exchange providers.

A range of products are available that allow financial officers at mid-sized companies to hedge against FX risks and minimise any threats to cash flow and profit margins caused by currency market volatility. These include tools that allow the setting of defined exchange rate bands, meaning currency transfers are triggered within specified lower or upper limits.

Other typical risk management tools include forward-looking exchange contracts that allow a business to set an exchange rate up to a year in advance, giving them the security of knowing they are protected against swings in the currency markets. Additionally, FX providers may offer a range of options tailored to the needs of the individual business.

In this politically-charged post-Brexit landscape, FX exposure can be very damaging for mid-sized businesses, but exploring the tools available coud protect profit margins and substantially reduce the risk associated with trading in the global marketplace.

Option products can carry a level of risk and may not be appropriate and/or suitable for everyone. Please take all reasonable steps to understand certain key concepts before transacting in FX derivative products.

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