A Solid Approach to Currency Risk: A Primer

Foreign exchange is a risk factor that is often overlooked by small and medium-sized enterprises (“SMEs”) that wish to enter, grow, and succeed in the global marketplace. Although most U.S. SME exporters prefer to sell in U.S. dollars, creditworthy foreign buyers are increasingly demanding to pay in their local currencies. For a U.S. exporter who chooses to sell in foreign currencies, FX risk is the exposure to potential financial losses due to devaluation of the foreign currency against the U.S. dollar.

Grayline-Partners_Currency-Risk

Companies can avoid this exposure by insisting on sales in U.S. dollars. However, that approach may result in losing export opportunities to competitors who are willing to accommodate their foreign buyers by selling in their local currencies. It could also result in the non-payment by a foreign buyer who may find it impossible to meet U.S. dollar-denominated payment obligations due to the devaluation of the local currency against the U.S. dollar. While coverage for non-payment could be covered by export credit insurance, such “what-if” protection is meaningless if export opportunities are lost in the first place because of the “payment in U.S. dollars only” policy.

But when foreign exchange risk is successfully managed, selling (or buying) in foreign currencies can be a profitable alternative for U.S. exporters. And here’s what you need to know:

  • Most foreign buyers generally prefer to trade in their local currencies to avoid exposure to changing currency rates of exchange.
  • U.S. SME exporters who choose to trade in foreign currencies can minimize foreign exchange exposure by using straightforward risk management techniques available in the United States.
  • The volatile nature of the currency markets poses a great risk of sudden and drastic currency movements, which may cause damaging financial losses against otherwise profitable export sales.
  • Solid currency risk management minimizes potential currency losses (not to make a profit from currency movements, which are often sudden and unpredictable).

Since business activities across borders often expose a company to changing currency exchange rates, exposure can be both transparent and non-transparent. That’s why Grayline’s risk analysis process is comprised of the following five step process:

  1. FX Risk Identification

    Understand a business requires uncovering FX risks embedded in tax strategies, supply chain, and product delivery channels. (The impact is often hidden, affecting earnings, cash flows, and balance sheet composition.)
     
  2. FX Exposure Analysis

    Quantify earnings and cash flow at risk due to changes in currency exchange rates weekly, monthly, quarterly, annually. Measure the uncertainty and opportunity cost of over-hedging or under-hedging.
     
  3. Hedge Recommendations/Presentations

    Recommend potential hedging strategies and simplify needless complexity. Compare the various degrees of impact on income, cash flow, and balance sheet.
     
  4. Hedge Execution

    Address the regulatory, governance, credit, accounting, and educational requirements of each recommendation and create a plan to execute.
     
  5. Valuation, Monitoring, and Analysis

    Value the hedge (and the hedged item, if necessary), provide accounting advice and/or journal entries, and set up a framework for monitoring the effectiveness of the program.

Determine the aspects of your company’s approach that makes it solid, and identify the biggest challenges.

To learn more about how Grayline can help your business manage currency risk, contact us.


Print Friendly and PDF