Do you operate internationally and carry out transactions in foreign currencies? Do you want to protect your margins from daily exchange rate fluctuations? Then this article is for you!
Here are four simple steps to understand how to mitigate currency risk and effectively protect your business without ever falling into speculation.
1. Analyse your exposure to foreign exchange risk
Whether directly or indirectly, every company is exposed to currency risk on the foreign exchange market. However, this doesn't mean all companies are in the same boat. Not all situations require you to implement a currency risk management strategy. A company with a one-time exposure to a foreign currency transaction of a modest amount will not handle currency risk the same way as one that regularly operates internationally. So the first step is to carefully analyse your exposure to foreign exchange risk.
To do this, start with a risk analysis. List your assets in foreign currencies (receivables, bank accounts, financial investments, etc.) and your debts in foreign currencies (accounts payable, loans, etc.) in order to evaluate your exposure to foreign exchange risk.
You should also anticipate the evolution of your foreign currency cash inflows and outflows throughout the year. A budget forecast is your best tool to measure your risk exposure. By preparing an accurate budget forecast and analysing the pricing structure of your products or services, you can identify more subtle foreign exchange risk exposures. This will allow you to define a "budget rate", i.e., a weighted average exchange rate at which you plan to convert your currencies during the year.
2. Choose the currency risk strategy that fits your company's needs
Once the audit phase is over and the various foreign exchange risk exposures are clearly identified, you will have all the elements to hand to define your foreign exchange policy.
You will then be able to choose between several different approaches depending on your commercial margins, the cost of financial products and your degree of risk aversion:
- Immediately lock in the exchange rate of your foreign currency transactions
- Lock in the exchange rates of a portion of your transactions
3. Identify the products best suited to your situation
Within the framework of a risk strategy, there are many financial products available to secure exchange rates. Be particularly vigilant about the quality of the products offered and make sure you understand how they work and the related costs before making any decision, at the risk of ending up with a financial product that does not suit your needs.
Make deliverable fixed, flexible and dynamic forwards your first choice. In most cases, they will prove to be the most suitable tools for your SMB needs.
Your choice will depend on a few key factors: your risk appetite, available cash flow, price budget and exchange rate policy. For example, a company wishing to lock in its exchange rate will prefer traditional forward contracts. On the other hand, a company that wants to leave itself more leeway will tend to use flexible or dynamic forward contracts. Talk to an expert to ensure you understand how these products work and their compatibility with your individual situation before making a commitment.
4. Always keep an eye on your risk exposure and reassess your strategy if necessary
Your business will grow and change over time, and exchange rates are constantly changing, so it's important to regularly monitor your risk exposure. Keep an eye on your weighted average realised exchange rate, compare it to your "budget rate", and assess all exchange rate gains and losses.
When analysing the results of your strategy, always keep in mind that your ultimate goal is to protect the financial health of your company and to cushion the currency fluctuations of the market, not to maximise your gains. This is why you should focus on the stability of your trading margins and not on the foreign exchange gains.
In short, the four main steps of a good strategy are simple: take stock of your international financial situation, choose the strategy best adapted to your company, identify the corresponding financial products, and finally, monitor your strategy in order to modify it if necessary.
Find out which strategies can improve your currency risk management by contacting our experts today!
