By Philippe Gelis, CEO and founder, Kantox
Increasing international trade amongst small and growing businesses is high on the UK government’s agenda, and with good reason — a much cited CBI report recently revealed that businesses are 11% more likely to survive if they export. There is no doubt that trading across borders can bring exciting growth opportunities, driving competitiveness and supporting long term business sustainability. However, exposure to opportunity also brings exposure to risk, particularly in dealings with foreign currencies. Small businesses should enter into international trade with their eyes open, an understanding of the potential risks and a plan for how to mitigate against their potential impact on all-important profit margins.
It goes without saying that small and medium-sized companies don’t have the same tools at their disposal as large international corporates when it comes to understanding and hedging against foreign exchange (FX) risk. They are unlikely to have access to expensive terminals showing live market rates, an in-house FX expert, or benefit from preferential treatment and rates from the banks. That said, with the right risk management techniques, even the smallest company can effectively protect their business from significant financial losses and unnecessary costs.
First things first – take stock of your exposure to risk
You can’t possibly begin to mitigate risk if you don’t know what you’re facing. All companies doing business internationally need to assess their exposure to FX risk as a priority. The amount of risk a business is able to absorb without significantly denting profits will vary depending on a few key factors — profit margins, the profitability of the business in general, and perhaps most importantly, individual appetite and tolerance for risk. When factoring the potential impact of FX movements into a business forecast, SME-owners would be wise to plan based on a ‘worst case scenario’ outcome.
Don’t run before you can walk
Small business owners are advised to stay clear of products that they don’t fully understand. There’s no merit in picking complex and intricate options without a certain level of expertise. Of course it’s important to negotiate, but as with anything, you should always ensure that you understand what you’re buying.
Buying foreign currencies through a bank or broker, you will almost certainly be paying them more in hidden commission fees than you are led to believe. There are three main ways that banks inflate the amount of money they make from an FX transaction. The spread — as the mid-market rate is never disclosed, the client is never fully away of how much money will be caught by the greedy ‘man in the middle’. ‘Dumping’ — that is, offering unbeatable and very attractive initial rates, only to then gradually load charges into the exchange rate to profit from the client (without informing the client of course). Selective Exchange Rate Adjustment — market rates change all the time, virtually to the second. Why then, if the real rates constantly change, do bank or broker quotes not change with them?
A wave of innovation in the financial services industry in recent years means that there is now a huge range of alternative finance providers for all major financial services needed by businesses — including foreign exchange. SME-owners would be wise to research all the available options, to make sure they are truly taking control of their finances.
Take FX risk management seriously
You should plan a regular review of your foreign exchange policy, based on changes within your business and the wider FX market. Keep up to date with new FX market services, and remember that your business’ ability to absorb risk is not a fixed figure.
We have seen a wave of headlines recently, with companies of all sizes falling foul of currency volatility. Hornby reportedly lost £1.2 million in the final quarter of its financial year as sterling strengthened against the Hong Kong dollar, with SAP hit by the climbing Euro in April.
While giants like SAP have deep pockets, and can likely absorb the blow temporarily, it is unlikely that smaller businesses, taking their first steps in international trade, will have this luxury. Expanding overseas is an exciting way to grow a business and with the right risk management techniques, small businesses can avoid significant financial losses and unnecessary costs. Exporting needn’t be a trade-off between opportunity and risk.