Setting the scene
Exchange rate volatility has contributed significantly to the losses millions of small businesses incurred during the global pandemic. To use an illustrative example, when the lockdown was announced in the UK in March 2020, shortly after the GBP/USD exchange rate fell to a 35-year low, some supplier contracts became unaffordable overnight for UK businesses trading with the US. Many firms at this time scrambled to adjust supply chains and operations to stay viable as a business. But for many, the losses associated with fluctuating exchange rates were unforeseen, and many business’s profits were negatively impacted due to them not being prepared for FX risk.
This example shows, that if business or clientele makes or receives payments in multiple currencies, you may require an FX risk management strategy to reduce exposure to any future instances of exchange rate volatility.
How small businesses can hedge against FX currency risk
All businesses looking to expand to international audiences will eventually need to hedge currency risk in FX markets. Forward contracts can help companies to eliminate volatility in their financial statements and improve their overall creditworthiness.
For example, suppose a UK marketplace seller finds a supplier in the US that offers a great deal on their e-commerce products at a specific time of the year. However, due to currency fluctuation, their prices suddenly become unprofitable for your business model. In this instance, the UK brand could use a forward contract to lock in an agreed exchange rate and simultaneously assure that their companies’ accounts are not recording a loss when the transaction is complete.
There are several tools accounts teams can use to minimise FX risks to small businesses trading internationally. Here, we will run through some key examples of financial tools teams can deploy with the help of a dedicated relationship manager from a money transfer service like WorldFirst.
Forward exchange contracts (FEC)
A forward exchange contract may be a good option for payments due on a future date. Here, you agree on a fixed currency rate on the value of a transaction and effectively lock in the price until the contract reaches its maturity date.
Utilising an FX trader can help you access your transaction’s most competitive exchange rate. However, in instances where the value of your currency falls below a certain amount, you may have to make up the difference in what is known as a margin call.
Advantages of forward exchange contracts
Money transfer services like WorldFirst can offer you flexible forward exchange contract terms. Flexible forward options allow you to buy currency for your international transaction on dates when the exchange rate is weighted in your favour (known as payment windows). Adding windows to your FEC could help you lower the overall cost of your international payment.
Spot contracts for immediate settlement
If you need to make an immediate or urgent international business payment, spot contracts allow you to make payments in an extremely short period of time.
In FX trading, spot contracts utilise third-party FX traders to fix the currency exchange rate for a short-term period of around a few days. If you need to make an international payment straight away, spot options can offer you a live market rate for the transaction. Once you have agreed on a spot price, you can record the exact cost in your financial statements and settle the bill.
If you take advantage of a spot contract, you can hedge against fluctuating currency rates and shop around for the best deal. International payment gateway services like WorldFirst offer affordable money transfer fees – ideal for those looking to make periodic payments to international recipients. Relying on the use of a spot contract without leveraging your exposure with other financial products can however impose a great deal of risk. This is because the rate at which you settle the spot could drastically change – potentially resulting in your products increasing in price.
As an alternative to spot options, it is also possible to look at firm orders. With firm orders, you can keep your preferred exchange rate in mind and enable a transaction to be completed when the markets reach your target FX rate. With the help of a currency exchange service like World First, a dedicated relationship manager can notify you when exchange rates tip in your favour.
Take your business to new heights with growth capital
When you open a WorldFirst account, our lending partner, RITMO, can provide up to £3m funding at a discounted rate within five days. Exclusively for UK-based SMEs, the new WorldFirst Growth Package eliminates the hassle of international payments and collections. With the cost of energy, raw materials, shipping and freights increasing, RITMO offers non-dilutive capital that can help alleviate any cashflow problems you might experience through fast and flexible capital to help you retain control over your business with no provision of guarantees.