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How currency hedging can protect your profits

January 19, 2018

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How currency hedging can protect your profits

Brian Harris – Chief Product Officer, Currencies Direct

For many small and medium-sized business, there comes a point where their next step is to expand overseas. Online trading has made foreign expansion easier than ever. Indeed, for many SMEs, their first step into doing business abroad may be to offer international delivery options on online orders – a comparatively simple process.

SMEs are well aware of these benefits. A recent survey by Currencies Direct and Tamebay found that 91% of SMEs considered international sales to be important to the growth of their business. However, despite the fact it’s now easier than ever to start buying or selling overseas, a number of risks often come to light.

One such risk is a volatile currency market. Since the Brexit referendum and ongoing political uncertainty, both in the UK and across the world, the currency market has remained increasingly unstable – a trend that shows every sign of continuing into the near future. This can result in issues for businesses unprepared for trading overseas, making it incredibly difficult for a small business to protect its bottom line. 

Take the example of a UK manufacturer supplying a business in Europe. The customer in question may order a few thousand pounds worth of stock but may not pay the outstanding invoice for a number of weeks. By this time, the value of the Euro against the pound may have increased, meaning that the UK manufacturer loses out. Shifts in currency values may appear small, but even losing a few pence in every pound can add up to a considerable loss, which can run well into the thousands across the course of a year.

Uncertain cash flow can be detrimental to small businesses. Around half of all small businesses suffer from ineffective management of cash flow, ultimately hampering their ability to grow and expand overseas.

The reality is that SMEs don’t need to be vulnerable to fluctuating foreign exchange rates. A risk management strategy allows SMEs to plan ahead and consider implementing a budget rate for their overseas business, which in turn allows them to track their outgoings with certainty and control costs in the long run.

There are a number of hedging products available to help SMEs manage risk. Among the most commonly utilised is a forward contract –  an agreement that an SME can buy foreign currency at a pre-determined amount for the duration of the contract. This product allows businesses to make payments at a set rate and avoid unpleasant surprises if currency values shift. A currency expert works with businesses on an individual basis to discuss a tailored approach to risk management and how best to avoid any nasty surprises. 

The process of hedging against foreign exchange rates is an alien one to the majority of SMEs. 63% of small businesses across the UK say they do not hedge against currency risk. Of that, 51% believe they are too small to benefit from the risk management, 17% don’t see the value and 10% didn’t know such services existed.

Notably, UK businesses lag behind others around the world in their implementation of risk management strategies. Less than 40% of UK SMEs use risk management tools like FX options and forward contracts, a small proportion compared to the likes of Australia (where more than 50% of business use FX options and/or forwards) and New Zealand (where 40% use FX options and an impressive 78% use forwards). With this in mind, it is evident British businesses are not as well informed on what services are available to them.

The landscape for small and medium-sized businesses in the UK has shifted dramatically in the last 24 months. If Brexit goes ahead as planned, it will become more important than ever for SMEs to find new overseas markets to ensure their growth and long-term stability.  As a result of this, organisations are conducting business in multiple currencies and have to be prepared to manage the risks associated with a fluctuating currency market.

Many small businesses would be prudent to identify their risk exposure to foreign currencies and take steps to mitigate this risk. Awareness of the dangers posed by volatile currency markets remains low, but making small businesses conscious of these challenges and encouraging them to protect themselves will mean that they are able to trade internationally with more certainty and security.

Option products can carry a high 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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