FX volatility - is your SME exposed

FOREX volatility continues – Is your SME exposed?

Foreign exchange volatility can impact many companies, some of whom may be ill-prepared for outcomes, and so they should have in place the proper processes and procedures that mitigate against FX risk.

Although each organisation is different, all may experience similar problems with currency procurement and management. Analysing currency exposure and putting in place effective risk management structures are key to the success of international operations.

However, this can be a complex task for many SMEs and can distract focus from the day-to-day activities. On the other hand, ignoring the issue of currency can seriously affect the commercial success of any business working or dealing with overseas.

So what can small companies do to reduce the risk of foreign exchange volatility?

Here we identify some of the most important aspects a business without a treasury resource can implement. Any strategy should ideally be stress tested with various “what- if” scenarios.

The first obvious option is to increase prices and for some that is the answer. However, is it sustainable in the longer term and does the business have sufficient pricing power to cover all the risk?

Agreeing with customers/suppliers that the price changes if a currency moves beyond certain levels is another option to investigate.

The safest strategy is to try to organise your business by creating a “natural hedge” so that the business is protected. So, for example, if a UK company has £2m turnover in Euros it may be able to alter the company’s organisation, supply chain or procurement so that it also has around £2m of cost in Euros. This can be achieved by setting up a subsidiary in Europe that pays its staff in Euros or just looking to source components from Europe or use European contractors to carry out services in Europe. All of these actions would reduce the net exposure.

Renegotiating with overseas customers/suppliers to pay in Sterling may be achievable. First and foremost, most businesses want to continue with successful operations and it is about finding an agreement that works for both parties.

Setting contracts to have relatively short payment terms, limits the amount of time that businesses are exposed to the currency market and hopefully means funds are collected before the exchange rate changes too much.

Planning and budgeting activities are crucial for all organisations and allow better management of cash flow. This may allow timing of currency transactions in order to trade at the most preferential time in the market.

Companies are able to hedge against currency exposure. These contracts fix exchange rates against fluctuations. You might not be able to benefit from positive swings, but you won’t get hurt by a negative swing. The downside to these contracts is that you have to pay for them, but it mitigates the risk and allows businesses to focus on what they are good at. One mistake for companies to avoid is to think they are FX analysts and to start taking a position on the direction of currencies. Exchange rates are notoriously difficult to predict and subject to bouts of extreme volatility.

A hedging programme may be terminated because it’s “going the wrong way”, only to then start to move back and provide the hedging cover that was originally being sought.

Depending on the risk involved, it may be advisable to enlist the help of a specialised FX organisation so that together you can identify the risks posed and avoid unwanted and unforeseen negative impacts on your bottom line. To benefit from this, currency transactions should be tracked in order to assess outcomes in the level and timings of trades, compare pricing and decide which currency services would be most appropriate for the organisation.

FX volatility is hard to manage. Even the likes of Apple have their results impacted. But the smallest company can still take some actions to reduce the risk.

FD4 has a team that can help address the currency challenge and has contacts specialising in FX strategy.

About the author

This was written by Brian Kilcullen, a Commercial FD with over 30 years’ experience in business.

Brian is a member of FD4, which is a network of experienced commercial Finance Directors that are passionate about adding value to Companies. They are engaged Part Time (on an hourly or daily basis) to do the work of a full time Finance Director, but at a fraction of the cost. They specialise in driving extra profit, controlling risk & cash, enabling growth and business planning - see more at www.fd4.co.uk