With the end of the financial year upon us, small and medium-sized enterprises are squarely focused on tax. However, there is an equally important consideration that should be on the radar of any internationally trading enterprise – foreign exchange.
Research from East & Partners reveals that 80 per cent of Australia’s importers and exporters suffer currency loss.
This inflicts an unnecessary drain on costs, profits and ultimately business performance, says Michael Judge, head of Australia and New Zealand at global money transfer specialist OFX.
“Not having adequate risk management practices in place can lead to considerable losses. It creates a lot of instability in terms of your earnings or, equally, your cost base.”
Understand your needs and set goals
Off the back of pandemic-induced currency volatility, there has been a surge of interest in foreign exchange (FX) management tools.
According to OFX data, Australian businesses have really shone a light on currency management, with a 57 per cent increase in OFX forward exchange contract usage between March 2020 and February 2021, compared to the prior twelve months.
For businesses wanting to implement an FX strategy, Judge says the first step is to examine the size and make-up of your FX requirements – how much you expect to receive and/or pay in foreign currency over the coming year.
The second step is to establish your FX objectives. This creates a framework that your business can follow day-to-day, thereby eliminating any spur-of-the-moment (and costly) decisions.
Creating a framework often entails setting a budget rate: the lowest rate you are prepared to exchange at while still meeting profit goals.
An Australian importer, for example, might cost their products at an exchange rate of A$0.78 to US$1 and need the certainty of protecting this position to avoid having to increase their prices if the currency markets were to negatively move.
“Throughout the course of the year, you want to make sure you’re achieving that budget rate as a floor; everything above it is topside,” Judge says.
Another simple objective to include in your strategy is a hedge ratio: the worst-case exchange rate that you can model into your budget for a percentage of your projected exposure.
“You might be very cautious and hedge 50 per cent of known exposure throughout the year with a forward exchange contract,” Judge suggests.
“On the downside, you’ve got a defined floor in terms of what exchange rate outcome you’re going to achieve, but it does allow you to be a little more nimble around the other 50 per cent.”
Formulate an FX plan
As the saying goes, forewarned is forearmed. When it comes to FX, Judge believes that having a plan in place, complemented by an understanding of the markets and your appetite for risk, will allow you to make the right moves at the right times.
“Partnering with a specialist can ensure you’re executing against that plan with the right mix of products,” he adds.
FX specialists can also make a significant difference to a business’s bottom line. Such has been the case for Natalie Ducki CPA who, as managing director of accounting, taxation and bookkeeping firm Collective Works, draws on the expertise of currency specialists to support her clients in the entertainment industry.
“Production budgets are often extremely tight and, while they might be in a foreign currency, our clients have the security and comfort of eliminating foreign currency fluctuations by locking in forward contracts,” she explains.
“Forward contracts provide our clients with a confirmed Australian dollar budget and also, on many occasions, real savings against unfavourable changes in foreign currency markets.”
Bringing this kind of certainty to what can otherwise be an unpredictable area of business is, for Judge, the greatest benefit of a currency plan.
“You’re putting the weight of your outcome against your plan, versus putting it to chance on any given day,” he says.
“You’re creating definition in terms of what you can achieve.”
Find out how an OFX expert can help your business.