Colin White offers advice on how to protect your business from the impact of foreign exchange rate fluctuations during these challenging times.
If there’s one thing that the current series of events has reminded us of is the fact that unforeseeable events can happen at any time, and with potentially devastating repercussions for any business that relies on transacting in foreign currency or purchases equipment from overseas suppliers.
According to recent findings by specialist banking market research and analysis firm, East and Partners, Australian businesses suffered currency losses of up to AU$3.4bn in the last six months – highlighting just how damaging changing business cycles and volatile financial markets can be.
Despite the current economic uncertainty, the good news is that there are ways you can protect your business from the impact of foreign exchange (FX) rate fluctuations during these turbulent times. The key is to build a risk management strategy around your business, and not just the market, by suitably hedging your FX currency risk.
Why do businesses hedge their FX risk?
FX rate fluctuations can negatively impact any business that:
- imports or exports goods and services from overseas;
- sends or receives funds in foreign currencies; or
- requires greater certainty for cash flow planning and budgeting purposes.
The process of FX hedging includes:
- Identifying your FX risk
FX risk arises when a company engages in financial transactions in a different currency other than that of where the company is based. Any change in the value of the relevant currencies against the other will affect the resulting cash flows of the transaction.
- Setting your objectives
Your FX hedging policy should take into account whether you need to protect or improve margins, your market competitiveness and cash flow requirements. Once these factors are established, it is possible to better determine your hedging requirements.
- Creating a plan
FX hedging can be complex, so it is recommended to speak with an FX specialist about the best FX products available. Some of the most common products and services available include:
Forward Exchange Contract (FECs) – an agreement to buy (or sell) a fixed amount of foreign currency at a fixed exchange rate on an agreed future date (usually chosen to align with a scheduled payment you expect to make or receive). Establishing an FEC gives you certainty over the amount of Australian dollars that you will pay or receive in return for a fixed amount of foreign currency on that future date.
Foreign Currency Options – provides your business with the flexibility to protect against adverse exchange rate fluctuations and also take advantage of any favourable currency movements.
Foreign Currency Accounts and Deposits – whether your business is receiving or sending funds, a foreign currency account can help you manage your cash flows and currency requirements and reduce costs associated with unnecessary conversions. If you have the flexibility, foreign currency deposits can provide a better rate over a fixed term, with a fixed rate of interest.
Unsecured Foreign Exchange – allows small-to-medium businesses to transact FECs without the need to pledge for assets as security; and
Trade Finance – working capital solutions provide your business with end-to-end funding options including short-term trade loans, documentary letters of credit as well as escrow equipment finance. In situations where cross-currency transactions require cash-flow certainty, your business may also have the opportunity to overlay their working capital solutions with FX hedging.
Documentary Letter of Credit (LCs)
One of the most popular financial products to manage risk when importing equipment from overseas suppliers is the documentary letter of credit. This financial instrument protects the buyer as they pay a minimal deposit, coupling this with currency hedging minimises most of the risks in this type of transaction.
Typically, a supplier will require a deposit of 30-50% to be paid prior to shipping, with a further amount payable on shipping usually 90% of the invoice value. Shipping is evidenced by production of original bills of lading. Most suppliers will reduce the deposit requirements when using an LC as the Documentary Letter of Credit is a guarantee of payment if they meet certain milestones.
Most financial institutions will require you to provide security of up to the full amount of the item cost until the asset arrives in the country and has cleared customs.
These facilities can be expensive and tie up additional cash or assets that are then difficult to release.
There are products that allow for deposits of up to 20% to be paid overseas using just the asset as security and do not use any cash or business assets as additional collateral. Progress payments are made in line with agreed trading terms and converts to a simple finance agreement once the goods have arrived.
This allows for the business to preserve cash in the business and not have to go through the lengthy process of providing additional security. The supplier is guaranteed their monies so long as they meet the milestones outlined in the purchase agreement.
In summary there are multiple ways to minimise risk with international trade.
- Investigate foreign exchange hedging products to suit your needs.
- Minimise deposits paid to overseas suppliers.
- Minimise security given your bank for financial transactions.
This is not an offer of finance or financial advice.
Colin White is Director, Interlease Pty Ltd. Interlease can provide you with all these solutions and more. Feel free to discuss all your FX and Equipment import requirements with us. We are here to help.
Ph: 03 9420 0000