How to avoid foreign exchange pitfalls for small and medium sized business

Since the Brexit vote, foreign trade has become a hot political issue and many small and medium-sized UK companies have felt compelled to launch into international markets – in Europe and worldwide.

Trading abroad offers lucrative opportunities and some commentators suggest that companies who trade internationally are 30 percent more productive, more profitable and offer more job growth than businesses who focus solely on the domestic market. However, the changeable global economy, in particular the volatility in foreign exchange, brings increased risks for SMEs.

The value of sterling compared to the dollar has fallen by almost 19 percent since the Brexit vote in June 2016, and about 15 percent against the Euro. This is a boost to exports, as the low value of the pound makes British exports cheaper to foreign buyers, but it makes imports more expensive and affects UK manufacturers who have to pay more for the materials they purchase from abroad.

Politics, natural disasters and market jitters all affect foreign currency rates, and ongoing Brexit negotiations will not make the rates any less volatile in the future. A good example of the volatility in foreign exchange was the ‘flash crash’ last October when the pound briefly dropped by 6 percent, before quickly rallying again.

Foreign exchange dangers for small and medium sized business

• Profits can be wiped out by a bad foreign exchange deal. If a company picks the wrong moment to complete a currency transaction, it could lose out to a poor exchange rate.
• Hidden costs of transfers can strip away profitability. Banks may set a fee for currency transfers but this can be dwarfed by a poor exchange rate that can cost a company dearly.
• Business forecasting becomes extremely difficult during times of uncertainty in the currency markets because the changing exchange rate means a company cannot be sure how much it will receive from a deal. Values may have increased or decreased significantly between the time of ordering and the payment deadline.
• Many SMEs lack the time and skills to pursue the best possible foreign exchange deals. 

Tips for reducing the risk of currency fluctuations when trading internationally

• Invoice in pounds and transfer the exchange rate risk to the buyer. This may be easier if you are dealing with a smaller company.
• Restrict transactions to the major currencies, like dollars and Euros, which tend to be less volatile than smaller currencies.
• Agree a forward contract to fix the exchange rate at the start of the deal regardless of currency fluctuations by the time of delivery. This is particularly relevant for transactions where there is a significant time lag between when the price is agreed and the items are paid for. You may lose out if exchange rates change in your favour in the interim, but you gain more from having the certainty of knowing exactly what income will come in.
• Stage payments over a period of time in order to even out any fluctuations in the exchange rate.
• Open a foreign currency bank account so payments don’t have to be converted to pounds. Holding a bank account in a foreign country may also enable you to borrow money in that currency.
• Buy currency when rates are high as a hedge against poor exchange rates.

Expert advice will help companies reduce their foreign currency risk 

Most businesses aren’t experts in matters relating to foreign currency exchange, so accessing professional guidance is often the best way forward. Exchange rate fluctuations are a manageable risk to SMEs which, with a little advice and planning, should not stop businesses enjoying success in the international market. Banks, brokers, accountants and independent foreign exchange firms will all offer advice and services on a number of topics, including:

• Drawing up a bespoke strategy for reducing foreign exchange risk.
• Preparing forward contracts to fix the rate at which currency is bought or sold in the future or to fix the exchange rate for a particular transaction.
• Structuring hedging plans in which a company regularly buys foreign currency over a period of time to even out variances.
• Dealers can arrange to ring fence upper and lower exchange rates within which companies are only prepared to buy and sell currency – which helps to avoid any market shocks.