By Gavan Smythe, Managing Director, iCompareFX
The foreign exchange market is one of the largest in the world.
Transactions take place in many different forms, 24 hours a day, through different channels all over the world. While the FX market is becoming more accessible to smaller and medium-sized businesses, most often enter the market blindly.
Not only is this not needed, but it usually means eye-watering fees are paid for even the smallest of transactions.
The top three foreign exchange risks
There are several key risks connected with foreign exchange, no matter what size a business is with three of the most noteworthy being:
- translation risk
- transaction risk
- economic risk
These have a big impact on commercial margins and are particularly risky for smaller businesses as their banks are less likely to offer currency hedging solutions.
Translation risks occur as businesses with international dealings translate their international assets and liabilities as well as financial statements from foreign currencies to local currencies. This translation exposes them to foreign exchange risk, given that exchange rates remain prone to ongoing fluctuations.
Transaction risks are due to fluctuations in exchange rates from the payment date to the settlement date, which exposes businesses to further potential expenses.
Any unexpected fluctuations in exchange rates expose businesses to economic risk. If a company has invested in international projects, it will also need to consider contingency risk too.
High upfront fees for making international payments are another issue. Unfortunately, costs are concealed and immersed in the exchange rates offered, making it challenging for small businesses to understand exactly how much they are being charged.
Here, are three key strategies SMEs can use to balance these risks and save money on their foreign currency exchange:
1. Strike the best deal
Most banks don’t commonly offer a variety of financial payment options or stable payment technology that FX specialists do. In fact, when it comes to traditional bank transfers, there is often a lack of transparency or power over when a transfer occurs meaning most businesses end up accepting whatever the exchange rate is at the time. Therefore, businesses should think about working with money transfer companies with business account managers and FX experts.
There are a few ways SMEs can organise their preferred exchange rates with an FX specialist. One is to negotiate the FX margin on the exchange rate offered based on the size of the transfer and / or based on the size of the future volume of currency exchange and transfers.
During discussions, businesses can ask their foreign exchange partners if they provide the option to buy the currency at a set amount in the future, which is known as a forward exchange contract. Buying at the forward rate allows companies to handle their risk of currency exchange rate fluctuation more precisely.
Remember what is best for each unique company will vary. These all seem like beneficial options, but to guarantee businesses make the right decisions, they must find the best partner to work with.
It is not just about having the relevant expertise either. FX specialists should also be willing to take the time to work out which risk management tools are most suited to their customers’ industry.
2. Go local
Banking like a local, decreases the FX costs that clients may need to absorb when paying a company. Eradicating foreign exchange fees for clients could, in turn, make a business more attractive to new prospects in other foreign markets.
When thinking about money from a localised perspective, be aware that political instability, economic downturn, and other major global changes like the COVID-19 pandemic shake up global currency markets.
Partnering with a money transfer company that offers multicurrency accounts is a good way to prepare for possible circumstances outside of a business’s control. It is often free to collect and hold money from international customers or marketplaces, which means businesses could save on marketplace FX transfer fees and take advantage of more substantial exchange rates at a future date.
Banks don’t always have the most expedient exchange rates, but a foreign currency account located in a foreign market gives the option of keeping money in the currency of the transaction until it is advantageous to convert it.
Another way to alleviate possible risks is through hedging, which offsets money fluctuations in foreign markets. However, hedging rarely results in company profits, so it’s more practical to think of it as a scheme to use for primarily hindering losses.
3. Timing is everything
When it comes to foreign exchange, there are key windows where FX profitability can go up or down, depending on daily, weekly, and monthly trends. Keep this in mind, as it’s useful to research and check which times might be more appropriate for business money transfers and, equally if there are ones which should be avoided.
For example, market volumes and prices are unpredictable first thing in the morning. So, it might be better to forestall doing any foreign exchange transactions during these riskier periods.
Some transnational currency transfer businesses do not provide weekend money exchanges and transfers when the foreign exchange markets are closed. The ones that do, often raise their fees to prevent their risk exposure to closed FX markets.
For example, if a business desires to pay its foreign suppliers on a Saturday their FX company may expand the exchange rate margin offered to ease the potential currency fluctuation risk for booking a trade when the market opens.
SMEs that want to save money on their foreign exchange need to understand their current situation and risks and make them a priority. They should be sensitive to market fluctuations, and research money transfer providers that suit their requirements.