5 Ways to Minimize the Risks of Foreign Currency Transactions
Having plenty of hands in international markets helps companies like Nu Skin Enterprises Inc. become powerhouses across the globe. However, it also creates significant challenges as companies have to keep up with foreign exchange fluctuations. In the first quarter of 2019, Nu Skin’s revenue growth was impaired by about 6% due to foreign exchange (forex) headwinds.
For Nu Skin, the effects of adverse foreign currency were significant: Management expected forex fluctuations to affect the top line in 2019 by 2% to 3%, with an additional negative foreign currency impact of 4% to 5%.
How Forex Mismanagement Costs Money
Navigating forex is just one form of currency mismanagement facing global businesses today. Currency conversions, the process of converting one type of currency into another country’s usable currency, can itself pose problems. Depending on current exchange rates, companies might receive more or less value after converting.
Bank relations within each country are also a significant problem. If you have international subsidiaries or partners, you might have to pay for those entities in their respective local currencies. In some cases, managing multiple relationships for entities that are strictly cost centers and not revenue-generating can make your global financial operation unnecessarily complex.
A well-planned forex strategy can help simplify your operations. Unfortunately, a surprisingly large percentage of businesses don’t have defined management strategies in place — especially small businesses with limited resources. While some companies may use an independent treasury department or manage international accounts payable (AP) in-house, they typically don’t have processes in place that effectively address the volatile nature of forex.
Consequences of Foreign Currency Mismanagement
Complicated currency conversion, uneasy bank relations, and lack of a defined forex strategy are all issues that can cost companies dearly, and not just in cash flow. Nu Skin’s impaired growth is a stark example that currency mismanagement can cost your company more than just revenue.
Another example is Unilever, the global food and household goods provider. In 2016, currency exchange fluctuations put a strain on its operations when it was forced to stop delivering products to Tesco in the U.K. and Ireland due to a 10% price increase.
According to Unilever, the increase was necessary because of the British pound’s devaluation after the June 2016 vote for Brexit. Short-term fluctuations are frequent, but they usually range between 10% and 15%. At 16%, the devaluation exceeded the average. Eventually, they settled the dispute, and the relationship was saved. But if either company had been a smaller business, it could have eliminated their profits entirely.
In more common situations, companies on tight timelines can buy spot-rate conversations to meet shortfalls resulting from standard fluctuations. This requires keeping an on-demand mentality at times, which makes it more difficult to layer on a strategic approach. The cost of converting funds will be at that spot rate, which might not be the best in the market, and those fees can add up for an individual business.
Whether strategic or on-demand, exchanging currencies means navigating several highly complex layers of bank relations.
That includes communication lags around different time zones, weekends, and holidays, as well as language barriers and miscommunications. Some banks also place service fees for both payers and payees on top of the typical conversion fees, which may go unnoticed.
For small and midsize businesses, those fees are more likely to have significant impacts. For example, American Express was recently forced to refund $1.6 million to customers in the wake of a probe into its forex department for international payments. The probe revealed that the department would attract customers with low currency conversion rates, only to secretly raise those rates once they signed up.
Without a clearly defined currency management strategy, any business is open to errors and oversights. It isn’t a big enough job for one person, so someone has to carve time from his or her core job to manage it. Given the sensitive nature of transferring funds, senior financial leaders such as CFOs, controllers, or VPs of finance are usually left in charge, and it’s not a task that maximizes their time or skill sets.
Building a Strategy That Minimizes Forex Risks
If your company exports or imports anything, or owns assets abroad, it needs a strategy to mitigate forex transaction risks. Even if “business abroad” merely means cross-border wires, they can be subject to numerous explicit and implicit fees, as well as handling by several intermediaries. A clear strategy will allow you to plan, especially if you keep these tips in mind when structuring it:
1. Keep a disciplined approach
When the market is neutral, it’s easy to develop a policy that’s easier to navigate. However, in the next few weeks or months, conditions will change, and a calm market strategy won’t be enough to account for fluctuations. Your strategy should protect your business from unforeseen, unavoidable international events, such as natural disasters or tumultuous governments.
Dealing with multiple currencies means managing numerous currency risks, which makes it even more critical to ensure that discipline is the driving factor of your strategy. When your decisions aren’t solely reactive, you can quickly and adeptly respond to rate changes.
2. Focus on regulatory requirements
Meeting regulatory requirements and proving that you’ve met them is essential for any business. Every international transaction is governed by many laws, regulations, and reporting requirements from different countries. When building your strategy, it’s important to research and understand all legalities for every country that will be involved.
Small and midsize businesses may not have the in-house capabilities to do this effectively, so consider hiring a specialist or implementing the right tools. Several payment-processing platforms can automatically handle these and other functions for you, and most come with global currency management capabilities.
3. Have a cash-flow system built for forex
Whether it’s regulatory or not, efficient cash flow should be the theme of your payment-processing system. Any invoicing and payment system you use should automatically include the correct fees and regional identifiers, lock in forex rates, and track fund transfers for each individual transaction.
4. Adopt an automated payments solution
An automated mass payments solution can also help you manage large volumes of currencies, complicated payment processes, and tight schedules across the globe. Once implemented, and guided by your strategy, the solution can automate back-office tasks, help you efficiently mitigate transaction risks, and streamline your global AP process.
5. Centralize your forex treasury management
By automating and streamlining payment processes for companies that operate globally, fintech has made it easier to centralize operations. For example, you can leverage storage and in-memory software to create a single nerve center for your global payables process, with management and analysis all in one place.
Any data you receive at any point across the globe will be collected in-memory, making it immediately accessible. This creates a foundation that allows your company to view all of its assets and subsidiaries in real time, and to gain valuable insight into what factors might impact your foreign currency management strategy in both the short and long term.
Your company doesn’t have to be as large as Nu Skin or operate as widely as Unilever to feel the effects of foreign currency mismanagement. The regulations and costs of foreign transactions and the factors that make it volatile can be successfully managed only if you have a clear and disciplined strategy for tackling them. No matter the size of your business, investing in the right processes and solutions is an essential first step.