Hedging your bets – how to stop currency fluctuations eating your profits

SMEs are losing around £900m a year from currency fluctuations, according to research by exchange broker World First.

Since September the pound has fallen dramatically against the dollar to its lowest point in five years and is currently at a record low against the euro.

But by adopting a series of measures such as bank forward contracts companies can reduce the impact of currency fluctuations and keep losses to a minimum.

The Association of Chartered Certified Accountants (ACCA) has issued a top 10 guide to helping smaller firms turn prevent otherwise profitable contracts turning into loss-making enterprises.

According to Dr Steve Priddy, ACCA’s director of technical policy and research, the useful tips could ease the strain being felt by SMEs as a result of the global economic downturn.

“Especially hard-hit are businesses which import goods and services and find the buying-power of their sterling is weakened in foreign markets,” he adds.

“This comes as a surprise to many businesses after a decade of a strong and stable British currency. UK-based SMEs constitute a fifth of the UK’s import and export business, worth £141bn.”

ACCA’s top 10 tips

Consider banks’ forward contracts
These fix the currency exchange rate at which you buy and sell currency for delivery at a later date. Remember to make sure you have a reliable date in mind of when you will be paying your suppliers as the date in these contracts is fixed.

Open a foreign currency account
If you keep your foreign payments in the currency in which they were made, you could benefit by opening a foreign currency account. This is only worthwhile if the majority of your business’ payments are in the same currency.

Agree an exchange rate with suppliers
Consider whether your suppliers would allow you to agree future orders at an agreed currency exchange rate. Foreign exchange rates present a risk and hedging against foreign exchange rates is a cost. As with all suppliers that become riskier and/or costlier, business’ could reconsider their suppliers or renegotiate prices.

Agree prices to manage taxes
Ensure any price agreed with a non UK supplier is exclusive of all local taxes, levies, duties and import costs. This will avoid the unilateral deduction of sums to cover local, non UK tax changes.

Consider negotiating prices
Suggest a mechanism for renegotiating the price where foreign exchange losses move outside a specified level of tolerance. This will depend on commercial circumstances and is unlikely to be acceptable with Euro denominated contracts. It is possible to achieve in jurisdictions with so-called “softer” currencies, such as roubles, for example.

Match the currency
Match the currency of income to that of expenditure wherever this is possible and practical to eliminate foreign exchange risks.

Check transaction costs
Do be clear about the transaction costs associated with keeping funds in a local currency. In some jurisdictions these can be considerable. Seek currency protection: More flexible currency protection products also exist, which give you protection against adverse exchange rate fluctuations but still allow you to take advantage if the exchange rates go in your favour. These products are expensive, however.

Stress test your costs
Businesses need to take stock of their costs and liabilities in foreign currencies and proactively ‘stress test’ their exposure against worst-case scenarios. This is simpler than it sounds – for example, businesses need to ask the question -if the pound should fall to parity with the euro, where does that leave us?

Build in contingencies for potential losses
When establishing your price, build in a contingency for possible foreign exchange losses. Evaluating the level of contingency can be based on discussion with the foreign exchange department of your bank. They should be able to tell you what the forward exchange rate is estimated to be over the next 12 months. Of course, this simply reflects the perception of the money market as at stands today and should not be relied on as a certainty.