Is currency risk necessarily necessary to be managed?

Opening up to the international market is the dream of many business leaders. However, venturing into unknown territory always exposes entrepreneurs to countless dangers. For example, exchange rate fluctuations can seriously affect company margins. These hazards linked to the global money market are commonly known as currency risk. But do we absolutely have to protect ourselves against it? This is the question that many economic operators should ask themselves, particularly those working in import-export.

exchange rate risk: what is it?

Foreign exchange risk relates to all transactions requiring a company to convert a certain amount into a foreign currency. Since currency prices are constantly fluctuating, the company will not pay the same amount today or in two weeks to make any purchase.

Let’s take the example of a business manager who decides to import industrial equipment from Great Britain worth £10,000. If today, £1 is exchanged for €1.17. The company will have to raise €11,700 to acquire this equipment. Let’s assume that payment is only made in 3 months and that the Pound Sterling increases in value so that one monetary unit is worth €1.23. By waiting 3 months, the equipment will ultimately cost €12,300, an increase of €600. Conversely, if the Pound Sterling loses value, the buyer will save money.

These variations can have a major impact on a company’s results, especially if it regularly buys or sells products whose value is also constantly changing. We mainly want to address the case of raw materials which are currently experiencing a surge in prices. Here, the risk is twofold. On the one hand, we should anticipate the evolution of the price of raw materials and on the other hand we will endeavor to control the price of currencies. Managing exchange rate risk will therefore be crucial for exporters.

Why manage currency risk?

Poorly managed, exchange rate risk does not only increase the price of products purchased on the international market. It will also affect the margins earned from your sales. Which will ultimately move you away from your goals. Losses suffered due to fluctuations in currency prices will distort forecasts. If nothing is done, the manager will have to manage the company on sight. Such an approach will expose the establishment to recurring cash flow problems.

Currency risk can also be seen as an opportunity to be seized. By choosing the right time to build up a currency reserve, the operator will be able to make a profit from its foreign exchange operations. However, it is difficult to embark on this path without exposing yourself to increased risks.

Foreign exchange risk: How to manage it?

Managing foreign exchange risk simply involves becoming aware of the impact of the volatility of currency prices on your turnover and trying to anticipate it. Many strategies can be considered to limit as much as possible the loss of margins suffered by the brand. To do this, the company can simply build up a foreign currency reserve in a dedicated bank account. This is the most popular solution and also the most natural. This is why we talk about natural coverage.

Companies can also rely on specific financial instruments offered by banks. We will mainly cite fixed term contracts or forward contracts. The latter make it possible to hedge risks by freezing the exchange rate. However, these formulas are not all accessible to businesses. Furthermore, the terms provided by banking establishments vary slightly depending on their clients.

Some tips for managing foreign exchange risk

Any foreign exchange risk management tool relies on continuous monitoring of operations executed abroad. In the digital age, business leaders have every interest in equipping themselves with business intelligence tools. The latter will analyze both the company’s flows and the evolution of currency prices. This careful and continuous analysis will allow them to identify the signals. Thus, they will indicate the right time to buy or sell foreign currencies, automatically.

Regardless, the strategy adopted by the company will mainly depend on its level of risk aversion. A brand could choose to fully cover its margins or opt for partial coverage in the hope of making some kind of profit. To make stake adjustments, managers must carry out multiple diagnostics throughout the year. We will then try to estimate the losses suffered due to the drop in prices.

For those who have difficulty implementing a raw material risk management tool, many specialist advisors do not hesitate to share their know-how. Thanks to their expertise, business leaders will be able to protect themselves against losses suffered due to price fluctuations on the global market.