The re-valuation of the Chinese Yuan this month highlights a risk that most small businesses barely acknowledge: the cost and volatility of international money exchange.
If you’re buying raw materials from China, your costs suddenly increased by 4% (enough to wipe out the entire profit margin for some businesses), which makes foreign exchange risk management a problem that you cannot afford to ignore.
How do you protect yourself against these kinds of risks? Any small company dealing in more than one currency should have a comprehensive foreign exchange risk management plan that has four components:
1. Forward Planning: The further into the future you can predict your material needs, sales and cash flows, the further you can plan – and protect – your need for currencies. Keep an account in the foreign currency and trade at known rates now for those future needs. Even if today’s rate is not optimum, use a robust forecasting method to lock in exchange rates so that you can plan (and set prices) accordingly.
2. Allow for Movement: Knowing that international money exchange rates change, be prepared to take advantage of short-term changes that are in your favour. Keep a bit of cash available to play the market when the rates are best.
3. Get the Best Market Price: Exchange rates are generally set by huge markets in the world’s financial capitals… but that does not meant that you will get the market rate from your local bank or trader. Exchange rates are whatever you negotiate, and can include one-time “membership” fees, per month account fees, per-trade fees and of course, additional percentages added to the exchange rate. Compare the total transaction cost for a couple of providers before you lock one in. The best rates are generally from “Mid-Point” plans, but all the ancillary fees will determine which FX team is the most economical.
4. Pick a Long Term Partner: Setting up international banking relationships is time consuming. Do enough due diligence on your vendors to pick one that you can live with for the long-term. Consider the speed of deposits, their regulatory credentials and the markets in which the company specializes. (Verify US companies at the National Futures Association.) A good relationship with a dependable exchange house will pay off when you run into trouble – which in my experience is inevitable in the long-run!
Of course, devaluation by a government, as happened with the Yuan, is an extreme example of currency fluctuation. But almost all currency rates change – and the changes can be constant and volatile.
Any business that deals internationally deserves to have a strong, forward-looking foreign exchange risk management plan that supports the company’s overall financial goals and protects their profit margins.
Dedicated to your (global) profits,
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