Why Businesses Need Foreign Exchange

Foreign currency can be a precarious topic. When seeing the words “FX”, it can set off alarm bells that someone is trying to convince you to speculate, gamble, or to pay them to teach you how to speculate and gamble.

FX trading is one thing, whilst managing currency as a business is something entirely different. The truth is that currency fluctuations can be deadly to any business, and so can currency without any fluctuations.

Avoiding bad exchange margins

There are two ways currency can hurt a business. Firstly, the buying and selling of currency itself. Now, you may not think of yourself as someone who regularly buys and sells currency, but if you’re dealing with international clients and/or customers, then you most likely will be. 

This is because when you’re selling something to a customer overseas, one of you must exchange currency in order for the transaction to happen. Often, it’s abstracted, like on Amazon. This means the customer only sees their domestic currency, and the seller only sees their own too. 

The reality behind the scenes is that Amazon (among other marketplaces) are reconciling and exchanging these currencies at a very poor rate, which is directly taken out of the seller’s revenue. 

Often, this is around 3% lost to margins. This may be thousands per year lost in revenue, which can make an even larger dent in gross profit margins. Businesses often get stung the other way around too, when purchasing supplies or SaaS in foreign currency. If it’s not the marketplace intermediary ripping you off, it’s the high street banks, as many still charge terrible ~3% margins too.

The best way to mitigate exploitative margins is to take control over the exchange. To take control over it is to receive money into a virtual wallet in a multi-currency account, and exchange on your own terms.

There are over 40 business foreign exchange options to choose from when picking a multi-currency wallet. These will exchange at margins between 0% and 1% usually, with no extra fees (or if they have fees, they usually have no significant margin).

Many of these exchange companies are fintechs with a great understanding on the laws surrounding virtual wallets, and use this in their favour to let users create what is essentially a bank account (though it may not be technically), with bank account details for receiving money into, in often ~30 currencies (though some deal with over 100 currencies).

Avoiding currency fluctuation

The second way currency hurts business is that the market prices fluctuate wildly. Even when volatility is forecasted to be low (which it isn’t), small movements in the price can make your raw materials and products much more expensive.

A British firm putting in a large order with a US supplier, for example, could result in the goods being a lot more expensive than agreed. For example, agreeing to pay $10,000, but you’ll pay 30 days after the invoice as agreed, may mean paying £8,000 instead of today’s £7,227 because there was a price fluctuation. 

War, commodity prices, business confidence, pure speculation and momentum, among thousands of other factors causes prices to fluctuate. The amount of volatility is hard to predict, let alone the direction of the price. Thus, this is the opposite to speculation, this is about insurance.

To insure and protect from these events happening, we can purchase hedging products through the same foreign exchange brokers as mentioned above. Though, only some will be suitable, as others focus on multi-currency wallets only, and neglect hedging.

We can see the spot rate for GBP/USD going from 1.16 on March 20th to over 1.30 at the end of July. Or worse, two weeks before it was 1.16 in March, it was 1.30. This could be a matter of losing out on thousands of pounds if an order was placed during this time, or if goods were sold during this two week period.

The price direction doesn’t matter in many cases, and it’s simply being unable to predict your costs and revenue accurately in the future that is worrisome. It makes cash flow forecasting difficult, along with managing liabilities and risk.

Small business international payments should be set in stone upon being agreed, and hedging products do this in a few ways. Firstly, a Forward Contract is a way to agree on the purchasing of a specific amount of foreign currency, at a definitive price, but for a date in the future. 

So, in the previous example of buying the $10,000 worth of supplies, we could lock in the purchasing of this dollar amount at the price of £7,298 (plus a small fee, which is the cost of this “insurance”), and thus our forecasts and purchases are definite. We can also use this business foreign exchange hedging method with revenue too, where we preemptively purchase foreign currency back into our domestic currency, collect the revenue in foreign wallets, then exchange back when the forward contract is to be executed.

Two potential issues can arise from this, though. Firstly, currency may fluctuate in a way that’s favourable to you, and the hedging contract is now a bad deal. Secondly, revenue may be delayed, and the firm may not yet have that foreign currency that they wish to exchange – which could be a major problem.

To solve these issues, foreign exchange companies sometimes offer Option Contracts. These are similar to Forwards, but instead afford the option of executing the exchange to the business. Thus, we can simply decline the exchange if it isn’t a good set of circumstances when the agreed date comes round. Businesses will lose this small fee, but this is worthwhile in many cases, as the alternative could be losing thousands.

Foreign exchange costs are something many small firms forget to factor in. But the reality is that business fx is no more difficult than individual use cases, such as an expat using TransferWise to exchange their pension money. Small businesses do not need to be experts at FX, and they certainly don’t need to predict price fluctuations.

For small businesses that are unconfident in hedging, and would like extra advice, many of the foreign exchange companies have a dedicated dealer. These dealers will be there to offer free advice, facilitate deals, and nudge firms in the right direction. For example, they may challenge your assumptions, such as exchanging when it’s not actually necessary because if you wait, you may get a better price due to a larger transaction amount.

Though, for those who are confident, and simply wish for speed and convenience, there are apps in which FX transactions can happen in a split second at the click of a button.