How to Manage Currency Risk in a Small Business
Both local and global influences can affect small businesses when it comes to managing currency, but many companies don’t recognize the risk before it’s too late. Acknowledging and adapting to currency risk means a more consistent business that’s less likely to succumb to changes in the economy.
Whether your small business keeps it local or digital with both buying and selling, or it crosses international borders at more than one turn, currency risk management should be a highlight of your business plan. Currency for small business stands to make or break the future of many companies.
What is Currency Risk?
Currency risk, or exchange rate risk, is the concern that a depreciation in the value of a currency can have a negative impact on business. Currency depreciation can devalue assets, investments, interest, and multiple payment streams.
Even for small businesses that only deal locally, a sharp depreciation in currency can have far-reaching impacts. Beyond the financial implications, currency risk also muddies otherwise clear business plans and projections. By adapting business practices to suit each company’s unique risk, business owners only stand to benefit.
Brexit Break Drops Euro
The handiest example of a currency risk disaster is that of Brexit. When the United Kingdom voted to leave the European Union, the value of the pound dropped. Unfortunately, that affected businesses’ income when it came to trading currency.
Even small businesses without much stock in the breakup saw massive impacts, especially those which reached across borders. Further, the effect didn’t cease within weeks or months after the Brexit split. The euro took an extended period to recover, and the shaky ground it sits on could waver once more.
Political Impacts on Currency
Brexit affected businesses in the European Union primarily, but its reach went farther than continental divides.
Globally, drastic changes in the value of currency affect businesses’ ability to maintain revenue from other countries.
But it doesn’t take a worldwide disruption to impact small businesses’ bottom lines. The value of the pound fluctuated leading up to Brexit, and the US has seen similar wavering in the value of the dollar after presidential judgment on that state of the economy.
After President Trump touted the strength of the US dollar, the currency took a nosedive in the months following those comments. If small businesses hadn’t already realized the power of political commentary when it comes to currency values, they would do well to consider it now.
Identifying Currency Risk for Small Business
If your business routinely deals with international clients or customers, you’re likely familiar with currency risk for small business already. After all, even transferring funds from remote outlets to company accounts in the states can cause you to lose money depending on current exchange rates.
But identifying your company’s specific currency risk goes beyond looking at money in versus money out. If your business is in the US, or another country, and only deals in that country’s currency, you likely have few concerns about fluctuations in the market.
On the other hand, if you import, export goods or draw on talent from overseas, it’s important to acknowledge those risks as part of your risk amendment strategy. Apart from the bottom line financial aspects of the business, your tax situation may also depend on figures stemming from currency discrepancies.
Import and Export
For companies that import or export products via one or more other countries, currency risk can become complicated.
If your company’s home base is in the UK, but you hire labor from Canada and the United States while importing product components from China, you’re facing multiple currency exchanges in payroll and purchasing.
Smoothing out those differences takes more than a calculator and a spreadsheet. For companies operating within strict budgets, fluctuations in the value of the currency can skew profits enough to endanger the overall profitability of the business. Fortunately, recognition is the primary step in mitigating risk.
Even if your business operates mainly within the borders of one country, if you outsource labor, you’ll wind up dealing with currency rate complications. For example, if your company hires a writer who works remotely outside your home country, you’ll not only need to negotiate a rate of pay for that worker, but also consider how the exchange rate affects their income and your investment.
There are also tax considerations for any business that deals internationally, and differences in currency compound those concerns. Enterprises are potentially losing thousands or more as currency trading margins shave significant amounts off the top of company profits.
Generating projections that highlight the potential for profit and production losses helps business owners to prepare against currency value changes that can make or break profits. This starts with listing each process or investment thatcorrelates with foreign currency. (Tweet this)
Whether that foreign currency ties in with labor, products, or taxes, considering the geographical location of each component of your business will help distinguish between home currency and foreign currency dependence.
Scrutinize your business plan and identify all revenue sources, materials or equipment investments, labor expenses, and investment accounts to quantify each area. With accurate figures, whether they’re general estimations or past years’ numbers, you can begin to categorize and evaluate specific risks.
How to Reduce Currency Risk
It’s difficult to conceive how to manage currency for small business when you rely on consistent income from multiple sources of currency. But taking a step back and looking at the bigger picture can help companies make difficult decisions regarding risk mitigation and the streamlining of business operations.
Streamline Currency Risk
When considering your business’ unique currency risk, resolving any discrepancies in currency can help streamline that risk. For example, if you’re dealing with variations in revenue based on having sales in one country and manufacturing in another, your monetary gains and losses won’t match up without complicated conversions.
Moving one or the other component of the business makes both operate in the same currency and eliminates variations that have nothing to do with sales. This has the additional benefit of clarifying your revenue for profit and loss projections.
Streamlining Case Study
Without having to compensate for currency differences, you may find that your business sees slightly higher profits as a result. One US company which purchases air conditioning units from China adopted the streamlining strategy with positive overall results, proving that the concept can work.
The company’s chief financial officer ultimately insisted on using US currency for all transactions, following a three-year period in which the company turned to a bank to manage its currency purchases. While conducting business in euros, the company had to deal with fluctuating rates plus additional bank fees and time-consuming meetings and consultations.
The CFO told the New York Times that using currency exchange processes was a lot of work. Therefore, he was willing to pay slightly higher fees to Chinese companies, for example, that were reluctant to accept US dollars because of the unpredictable nature of the exchange rate.
In the end, paying overseas vendors a higher US-dollar amount helped the company to plan out its fiscal year and make predictions for the next, without the complication of factoring in and estimating currency exchange rates.
For smaller companies, this higher-cost model may not make sense. But if outsourcing supplies from overseas has a lower initial cost, there may be room in the budget for an exchange rate buffer of a few dollars.
Pass Costs to Consumers
Depending on where most of your customer base resides, it may be beneficial to pass the costs of currency exchange along to them. If a slight increase in prices will make up for a swing in currency values, you just might get away with passing that expense along to consumers.
However, there is an inherent risk related to rising prices in any scenario, as consumers often balk at price increases where they see no additional value to the product or service despite the change in cost.
Even if you’re open with consumers about the need to raise prices, most people don’t take kindly to companies that put profits over their client base. This is the least desirable mitigation strategy since it risks alienating your consumers, but it’s a worthwhile consideration if you’ve exhausted other options of reducing currency risk.
Passing the Buck Case Study
A US-based travel company was no stranger to currency risk management when it suddenly faced price increases in the thousands of dollars. Because of differing values in the Indian rupee, travel trips jumped in price, and the owner had no choice but to charge customers the difference.
For a company as small as this travel agency, having to eat the costs of a drastically inflated trip cut into profits. It wouldn’t take much to wipe the business out, especially if consumers realized that they were paying a premium based on market instability.
Ultimately, that experience led to the company adjusting its contract practices, opting for extended contract periods plus clauses that locked-in prices for specific periods. At the same time, the company turned to global currency traders to help ease negotiations and lockdown pricing. These adjustments meant no more disgruntled consumers facing a considerable uptick in pricing for their dream trips.
The company learned the hard way that currency exchange rate fluctuations can have severe impacts on day-to-day business and that it’s often hard to break even when they neglect to make accommodations for those variations.
Even small businesses can lock-in preferable rates on currency if they purchase in advance, so that is one consideration for companies who can make an up-front investment toward securing their financial futures. Working with currency traders is one way to make this happen, but for some small businesses, it’s just not part of the short-term business plan.
However, appropriate market research before purchasing is crucial, because a downturn in currency values could cause companies to lose money rather than save it. If companies decide to go it on their own with currency trading, there are more risks involved than if they consult professional help.
Trading Case Study
For one organic beverage company in the United States whose focus was importing product from Sicily, purchasing currency ahead of time seemed the simplest way to deal with currency differences. Locking in a good deal meant that she might even \save money on products.
However, the owner of the company soon found that once she agreed to currency orders, she was inconveniencing herself as she couldn’t back out of the deal if suppliers fell through or the supplies were not needed.
For that small business owner, working with a company that could follow exchange rates and monitor currency costs for her was worth the investment. This way, business owners have their own team that’s focused on securing the best exchange rates, while business owners and their teams take care of day-to-day business.
Whether companies are seeing growth on a global scale, or they’re just struggling to manage currency fluctuations in the digital market, learning how to manage currency for small business should remain a priority.
In today’s global marketplace, there’s no reason why even the smallest companies can’t compete when it comes to mastering and reducing currency risk. At the same time, learning to deal in multiple currencies, or at least how to avoid dealing in them, can help businesses take their profits to the next level.
While economic instability, the political climate, and other outside influences affect small companies from their tax status to profit margins to brand loyalty, small businesses that acknowledge and address those factors will withstand change more solidly.
Managing currency for small business isn’t relevant to every company, as those that exist only in local markets close to home won’t see any need for trading or streamlining their currency. However, awareness is the first step in embracing the global nature of today’s market, so even small businesses without the means to go international may one day need to know more about currency than they ever thought necessary.
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