In 2022’s globalised world, pretty much any business that operates is exposed to the ebbs and flows of international foreign currency exchange markets. While the precise nature and exact extent of this exposure varies from one business to another, the reality is that foreign exchange issues can severely impact the profitability of any business. In the testng trading conditions that most global economies are now facing, all businesses would perhaps be wise to take stock of what their own foreign exchange risks are, and work out just what they can do to mitigate them.
With this in mind, we have written this post in which we will take a closer look at business foreign exchange (business fx), how it works and how a business can minimise its corporate foreign exchange risk.
Business Foreign Exchange Risk
Business or corporate foreign exchange risks are quite simply the commercial risks that an enterprise faces owing to fluctuations in currency exchange rates. Business FX rates come in a few different forms so let’s take a look at them.
Transaction Risk – This is the FX risk faced when a company procures goods or services from a foreign supplier. The sale price will be stated in the seller’s currency and therefore if the seller’s currency gains in value against the buyer’s between agreeing the sale and completing payment, then the buyer would end up paying more. If a business is looking into hiring internationally, it needs to factor in the long term risks of being contractually obliged to keep on paying employees in a foreign currency.
Translation Risk – A multi-national business operating a subsidiary company in a foreign nation is exposed to translation risk when the subsidiaries financial statements need to be translated back into the parent companies currency.
Economic Risk – Alternatively called forecast risk, this is when the market value of a business fluctuates because of conditions in the wider, global market.
The Costs of International Payments Involving Foreign Currency Exchanges
As well as facing foreign exchange risks, businesses that trade internationally also need to contend with the fees and costs associated with changing currencies and sending money internationally. In particular, the costs of making a foreign exchange payment using a bank can prove very high indeed.
This is because whenever a business instructs its bank to process an international payment (for example, to pay a foreign currency invoice or make any kind of international b2b payment), the bank levies a transaction fee which could range from just a few dollars, up to $50 depending on the particular bank.
This is not all though. Whenever a bank processes an international payment they are also responsible for handling the currency exchange and instead of applying the current market rate, they apply a “markup” (usually around 3%) that allows them to make some profit at their customers expense. What this means for a business is that not only are they being saddled with banking fees, but they are also having to pay more for foreign currency.
How To Make The Most of Your Foreign Exchange B2B Payments
Very few businesses have too much appetite to lose an additional 3% each and every time they are paying suppliers internationally. Instead, most businesses look to utilise business or corporate services for foreign exchange management in order to lower costs and maximise value.
One common example of a corporate foreign exchange service is a money transfer specialist who can help a business to send money overseas and pay foreign invoices. Money transfer specialists are simply financial services companies who specialise in facilitating international payments. They offer lower fees and more favourable exchange rates than the banks with markups that typically range from 0.5% – 1% rather than the 3% that the banks tend to apply. Some money transfer specialists also offer other corporate foreign exchange services too.
Another common example of a business foreign exchange service is a broker that specialises in currency exchange for businesses. A corporate currency broker is a financial services provider who can help a business get the best possible exchange rate on foreign currencies. Brokers buy and sell currencies in large volume and so can use this leverage to obtain the best possible exchange rates. If a business wanted to use the services of a broker, they would simply tell the broker what amount of which currency they wanted to buy, and negotiate a mutually acceptable exchange rate.
Corporate Foreign Exchange Hedging
Corporate foreign exchange hedging is when a business takes steps to try to mitigate or ‘hedge’ against fluctuations in currency exchange rates. There are a number of different hedging tools that a business can utilise. Let’s take a look at some of the more common ones.
FX Forward Contracts
Forward contracts (otherwise called ‘FX Forwards’) are when parties make a contract agreement to buy (or sell) an agreed amount of a particular currency within a stated time frame at an agreed fixed rate. For example, if our business is going to need €50k in the next month we can enter into a forward contract for the exchange today without having to actually cough up the dollars and execute the exchange at this exact time. The advantages of this are to “lock in” a favourable exchange rate and also to provide certainty for budgetary reasons.
FX options are similar to contracts except that they are not binding. Therefore, a business can secure the “option” to buy (this is called a ‘put’) a stated currency, at an agreed price by a fixed date, but they can allow the option to expire.
Multi Currency Accounts
Quite simply, these are bank accounts that allow a business to hold balances in multiple different currencies. The major advantage of a multi currency account is that it allows the account holder to retain a foreeign currency balance which they can use to pay for goods and services as and when they need to. Alternatively the account holder can convert the foreign currency balances into their main currency whenever they choose to, allowing them to make the most of favourable exchange rates.
Final Thoughts on Business FX
In summary, business foreign exchange matters can prove complicated. Whether a business is buying or selling internationally there is always some inherent foreign exchange risk. Still, by utilising the corporate foreign exchange tools that we covered here, any business can at least mitigate its business FX risk exposure.