Managing Foreign Exchange Markets to Your Advantage

Say the words “foreign exchange” to many small business owners and you are likely to be on the receiving end of deer-in-headlights looks.

Foreign exchange, or FX, can be complicated, especially for entrepreneurs whose business is buying or selling overseas, according to Mark Warms, Managing Director, FX Product Head USA at BBVA Compass. But it makes sense to develop a currency risk management strategy, no matter the size of your company.

“The minute your company begins dealing overseas—purchasing supplies or selling products—you are in the FX market,” he says. “Even if you transact in U.S. dollar denominations only, it is important to pull back the curtain to figure out how currencies can and will affect your business.”

The concept of dealing in currencies is foreign to many American business people, Warms says. “In the U.S., everyone grows up with knowledge of only a single currency, the dollar,” he says. “You might have an inkling about the Canadian dollar or the Mexico peso, but that’s about it.”

That mentality is completely different, though, in other parts of the world. In Europe, for example, Warms explains that today’s business leaders grew up with more than 25 currencies. “It’s always been part of their daily life,” he says. “They are used to looking at FX rates because it’s second nature to them. For us Americans, it isn’t something that comes naturally.”

This means that it’s all the more important for U.S. based entrepreneurs to educate themselves on the ins and outs of the FX market.

General FX Information

Think for a minute about how you buy or sell goods or services overseas. Are your purchases made using the USD or the local currency? Do you examine the exchange rates to determine the optimal currency to price your goods in order to attain the lowest cost? Do you check the markets on a regular basis to make sure you are still getting the best deal?

“A lot of people will turn on CNBC to look at FX rates, but it can be incredibly confusing,” says Warms. “Some rates are quoted in dollars per foreign currency and others are quoted the other way around. For example, the British pounds (GBP) and Euros (EUR) are typically quoted in USD cost for one GBP or one EUR. So as the rate increases it is signaling a weakening of the dollar against either. The reverse is true for the Mexican peso (MXN) and Canadian dollar (CAD), which are quoted in CAD or MXN per one U.S. dollar. Rate increases in USD against CAD or MXN signify a strengthening of the USD.” It pays to enlist the help of professionals.

It also is important to understand your exposure to currency fluctuations and how to make those fluctuations work for you. Examples can be seen when looking at major corporations. Let’s say a company does business in the U.K. and priced their goods in GBP. Their pricing was set at a time when 1 GBP was equivalent to $1.50 USD. Then after 18 months, the GBP declines in value and is worth only $1.20 per GBP.

This poses a problem for the U.S.-based company because when they decide to repatriate their GBP revenue to USD, they will receive 30 cents less for each GBP sold, an unplanned reduction of 20% versus the original plan. The implication for the company is they will likely need to raise their prices in GBP to receive the same amount of USD. But then other questions arise, like: Will locals stop buying products priced at higher rates? The development of an FX hedging strategy, with the aid of an expert, may be the next order of business for that company.

Many American businesses are more comfortable dealing in USD, Warms says, but they may be missing an opportunity in some cases.

“If you started out purchasing goods from overseas priced in USD, and then the local currency devalues vs. the USD, you may end up overpaying for your goods,” he says.

Managing your Risk

Enlisting the help of professionals like the BBVA Compass FX team is a great start. They help customers understand their risk and provide alternatives to help maximize a company’s profitability. For example, asking overseas vendors for dual-currency invoices so you can choose the most efficient means to pay.

“Ask for a dual-currency invoice every time,” he suggests. “That way, you can make the choice to pay in USD or in the local currency—whichever is more advantageous to your business.”

But what if your vendor won’t give you such an invoice?

“Companies that don’t have a lot of market power may not be able to get it,” he says. “But look for transparent vendors. Ask your vendor when you are setting up the relationship if they are open to dual-currency invoicing. If they aren’t, look for another partner.”

This article was originally published by BBVA Compass.