What the FX? Tips for small businesses trading internationally
We’ve never lived in a more globalised world. Many entrepreneurs are making the most of the opportunities to find new markets in other countries or use suppliers and manufacturers all around the world. Your business might already do these things, or you might be thinking of branching out. If that’s the case then international payments will be a part of your business processes.
Expansion and trying out new suppliers can require some extra cash in the short-term to kick things off. If you need a little boost to help fund that stage then a flex loan could offer you fast and flexible funds to cover the costs. Invoice finance can also help you manage your cash flow if you experience inconsistencies in foreign exchange rates once you’re all set up.
While there are many advantages to taking overseas opportunities, there are risks and often hidden extra costs that can occur. One of the areas that can be most confusing and has an impact on your profit margins is foreign exchange. Although international currency fluctuations can seem daunting, this guide will help you trade confidently, anywhere you set your sights on.
We’ll take a look at the following questions:
- What is foreign exchange?
- What factors influence exchange rates?
- How can foreign exchange rates affect my business?
- What can small businesses do to minimise the risks of fluctuating exchange rates?
What is foreign exchange?
Put simply, foreign exchange refers to the process of exchanging one currency for another. Sometimes it’s shortened to Forex or FX. Currencies are exchanged in ‘currency pairs’. There’s always one ‘base’ currency (the one that you trade in) and the ‘quote’ currency (the one you want to exchange it for). The exchange rate tells you how much of the quote currency you’ll get for one unit of the base currency.
That’s fairly straightforward but exchange rates aren’t fixed, so there's a fair amount of risk involved in regularly exchanging currencies. The way that you plan your payment strategies will have an impact on the value you get for the goods or services you pay for in another currency.
What factors influence exchange rates?
All kinds of things can affect currency exchange rates. Political, economic and social factors all contribute to market confidence. If a government introduces a new policy that might be unfavourable for one group in a country, markets might weaken the value of that currency against others.
The typical drivers that influence markets are interest rate decisions, inflation rates, consumer spending levels and unemployment figures. But events over the past 5 or 6 years, like Brexit and US elections have been particularly impactful in their own way. At the moment, the uncertainty caused by the pandemic and different monetary policies is having an ongoing impact on exchange rates worldwide. Likewise, the way that governments around the world have responded to the pandemic and their projected economic recovery influences the market.
How can foreign exchange affect my business?
Exchange rates are volatile and as they move up and down against each other, your business is exposed to financial risks. Businesses that operate internationally must keep an eye on exchange rate fluctuations regularly, as these change from day-to-day.
If your business uses a supplier based in another country and imports goods using their currency, you’ll notice a few changes to the value. If the pound weakens against their currency, you’ll end up paying more for your goods. If the reverse happens then you’ll be paying less.
If the pound is strong this can also have an impact if you sell your goods in another country. For people in that country, their relatively weak currency can make the products seem more expensive. If that happens then you might see a dip in sales.
Foreign exchange volatility is unpredictable. It can happen frequently and you won’t be able to guess the extent it will change. If there are big swings in currency value then you’ll see an immediate effect in your profit margin as it’s harder to predict how much your goods will cost in your own currency on any given day.
What can small businesses do to minimise the risks of fluctuating exchange rates?
Exchange rate variations might be frustrating but there are a few things you can do to make things easier for your business and your customers.
Track the exchange rate – with the impact that fluctuating exchange rates can have on your business, you’ll want to keep up to date with the changes. You can use a rate alert service that many companies offer. You can choose which currency pairs to watch and you’ll get an email or text when the rate changes. Always have an eye on the ups and downs of the currencies most relevant to you and the events that could influence a change.
Lock in an exchange rate with a bank or provider – this is known as a forward contract, or hedging. Essentially what you’re doing is creating a kind of “buy now, pay later” contract with a bank or FX provider like our partner Ebury, which specialises in financial solutions for international trade. You’ll both agree the current exchange rate for a specified payment date. This could be a couple of months or years in the future. They’ll pay out the funds in full or in part at any point during the contract. Bear in mind that fixing the rate in advance is a way of safeguarding your profit margin, not beating the currency market.
Agree contracts only in your home currency – by doing this you can have more confidence with prices staying the same. However, you’re essentially asking your supplier to take on all the risk because they’ll be paid in your currency and have to exchange it themselves. Often this works better for larger orders or bigger companies.
Set up multi-currency accounts – you can pay and get paid in a local currency to avoid foreign exchange fees and any potential losses that a poor exchange rate would create. You could hold pounds, euros and any other currency in one account. Ebury offers collection accounts that help you collect and hold different currencies with one login and can be set up in under an hour. These can be especially useful when expanding into new regions and help you avoid going through the months of paperwork and legwork with a local bank. You can also use these for online marketplaces like Amazon, which means you can sell globally without having to pay high fees.
There’s help out there
Even though nobody can predict how the value of a currency will compare to another, you don’t have to let the risks put you off doing business globally. There are banks and FX providers that can help you manage the changes and help you keep control of what you pay and what you’re paid. And if you’re looking for funds to fuel your export ambitions or global expansion plans, we’ve got a range of fast and flexible finance solutions to choose from.