How Exchange Rate Fluctuations Affect International Businesses (and Ways to Protect Yourself)
For businesses with overseas exposure, knowing how to deal with currency fluctuations and ways to hedge can go a long way in helping to fight against potential losses.
If you are a business owner with operations, products, or services offered overseas, you should be very aware of the foreign exchange rates when comparing shekels to other currencies.
While many companies do have finance or accounting employees or advisors who may follow these rates, many businesses, and small business owners in particular, are not giving enough heed to the rates and the effects they can have on the business. The rates are moving every few seconds, and in just a few minutes the rate can move in either direction very quickly and without warning. That leaves any business susceptible to potential losses on a number of fronts. Here we will share some tips:
Be on top of the exchange rate
It goes without saying that following exchange rates is extremely important. International business requires having a very good sense of how your local currency is affected by other currencies and how that, in turn, has an impact on your exports, imports, suppliers, clients, etc. We will discuss these topics further on in this post. One site that we suggest checking out for near-real time rates is www.xe.com. They have a very simple interface to and you can easily get alerts for various exchange rates right to your email. You can also download their mobile app on pretty much any device.
Research past historical exchange rates
There is no need to do deep level research here. Simply pull up a chart of the past 6 months for the currency pair you are interested in and see the high and low rates. Keep those in mind as the best and worst case scenarios for your upcoming conversion of funds as the rate will most likely not move past either of those marks in the short term. This can help you decide when to convert funds and when not to.
Know your business
If you are exporting goods out of Israel or offering services internationally, you are going to be happier when the Shekel is weaker (making the exchange rate higher). That way, when you get paid in another currency, let’s say US Dollars, you will have more Shekels in your pocket. The opposite applies if you are an importer. If you understand the way cash is moved in the organization, through third parties, and with clients, you stand the best chance of making the most out of your currency conversions and retaining higher margins. Now that we covered how to get your head into the currency side of your business, let’s look at some of the ways you can actually save money on your currency exchanges and hedge against fluctuations.
Timing your foreign currency purchases
Going back to the examples of an exporter or importer, timing is everything. You may run a business that just has a standing order to purchase or export a certain amount of units of product each month. If this is the case, look into how you can make the order more dynamic so you get the most out of the possible rate fluctuations.
Paying foreign salaries
This is more relevant to business owners who started their businesses in one country and opened a remote office abroad. If you pay foreign salaries and send funds on a certain date each month, think about changing that order. If you choose the day you send the money each month, that one phone call could potentially save you thousands of shekels.
A foreign currency option is a financial instrument that allows the owner of the option the right, but not the obligation to exchange funds from one currency into another at a pre-agreed exchange rate on a specific date in the future. Here is an example of how options work: Company Y is anticipating buying some machinery from Israel in 6 months time. If Company Y continues to expand the business it will need the machinery, however if business slows, it won’t require the machinery. Company Y is a UK based firm, and would need to convert Sterling to purchase the machinery which costs 1,000,000 NIS. The current exchange rate is 5.80, and based on this rate Company Y can afford to purchase the machinery.
However, if the rate were to slip to 5.75 it would become unaffordable. The solution for Company Y is an Option. Company Y purchases an Option to purchase 1,000,000 NIS for 6 months time at a rate of 5.80. In order to do so Company Y pays a premium. This premium is a fee and is non-refundable. Company Y now knows that IF it needs to buy the machinery in 6 months time it can afford to, as they have guaranteed a rate of at least 5.80. The reason company Y has guaranteed a rate of at least 5.80 is as follows: If in 6 months time the exchange rate is 5.40, Company Y will then take up the option of buying the currency at 5.80. If the exchange rate is 6.20 in 6 months time, Company Y does not take up the option of buying at 5.8 and instead buys the 1,000,000 NIS at the rate of 6.20. By taking the option, Company Y would have saved themselves approximately £12,000 taking into consideration the cost of the option.
While a currency option does assist with hedging against exchange rate volatility and does not lock you in on a specific price, you are still required to pay a premium for the option which needs to be considered whether the rate moves in your favor or against you.
Currency Forward Contracts
In short, a forward contract allows you to buy foreign currency at today’s rate, but only actually pay later, so you are locking in the exchange rate of today. If your business is heavily dependent on foreign currencies, this is a pretty good solution to help you lock in a good rate. Forwards can be locked in for up to 2 years. Here is a great example of how this works: Company X is an importer in the US of Israeli machinery. Company X has just agreed to purchase 10 machines from Israel with a value of 4,000,000 NIS. This amount needs to be paid on delivery of the machinery in 6 months time. If the current US Dollar/Israeli Shekel rate is 3.70, Company X will need $1,081,081 if it was to convert funds today.
However, seeing as they don’t need to pay the money for 6 months ,Company X wants to use these dollars for other purposes during this period. If Company X waits until 6 months time to convert Dollars to Shekels, it could cost considerably more or much less depending on the movement of the exchange rate. If Company X does not want to take this risk, a forward contract is the right solution. They can fix a price at the current rate for 6 months time. In order to do this they will need to pay only 10% as a deposit to fix the rate, they will know the exact cost of the machinery now, and don’t have to worry about market fluctuations.
Keep in mind that there are disadvantages to this method. For example, if the rate goes against you, the contract still stands and you are required to purchase the currency at the agreed rate. Options do not have this issue as we have explained.