Currency fluctuations dominate the eb and flow of trade both within borders and beyond them. For exporters, staying on top of the precipitous peaks and valleys of currency values is important to ensuring profitability.
On a very general level, a low domestic currency value is good for your exports, since foreign buyers will be more attracted to your products when their dollar goes farther in Canada.
A higher currency value mean pay-days are higher, and spikes in currency value between a sale being agreed upon and payment being delivered can mean a dramatic increase in profit.
Unfortunately, the opposite can also be true. An agreed upon price at the time a contract is signed can turn into a dramatically smaller return if the currency value drops.
Currency fluctuations may be determined by factors beyond control, but you can control how you plan for them.
The one of best way to protect your firm against currency fluctuation is through hedging.
You can create a natural hedge by purchasing needed products in the same market where you sell, as well as doing all of your business in a single currency. It provides what Grant Thornton’s Mitchell Osak calls “a proper baseline”.
However, even when doing business in one currency, you are vulnerable to fluctuations.
To better protect yourself, there are financial instruments available, such as forward contracts and options, that allow you to lock in foreign exchange rates for export or import contracts. These are essentially insurance policies on foreign transactions that you can set up with your bank.
Hedging instruments are not cheap, and can in some cases cost up to 15 per cent of the contract, but they can protect you against losing money in a deal.
For example, if you agree on a price for a shipment of goods for a customer in the local currency, but by the time the customer actually pays you, the value of the Canadian dollar has dropped compared to that currency, then you will lose money on the transaction.
Purchasing a hedge (also known as a foreign exchange facility) will lock in the exchange rate available at the time the contract is signed. This means that if the exchange rate drops between the signing of the contract and payment being received, you are guaranteed to be paid at the original rate.
This can save you a lot of money in the event of a drop in currency, but it can have the adverse effect as well. If the currency value goes up between the contract being signed and payment being received, you are locked in at the lower value and won’t be able to profit from the higher exchange rate.
In most cases, currency fluctuations are unpredictable. For individuals who make money off unpredictability, like speculators, this is fine. But for those trying to run a business and make plans based on predictable cash flows, insuring transactions at predictable rates is a good idea.
As stated previously, purchasing hedges is not cheap, so it should not be an automatic decision for every transaction.
Before you insure a transaction, you need to work out the risk associated with the specific transaction, and how sensitive your firm is to the changes in revenue that could result from currency fluctuation. From there, reach out to your bank or an export-focused financial institution about the best way to proceed.
There are several different forms of hedges, some of which are rigid and others with more flexibility, and these vary in price and collateral. Figuring out the best way to insure your transactions is best done on a case-by-case basis.
Sources: EDC and Investopedia
Exporting as a Defensive Strategy
While export sales themselves are vulnerable to currency fluctuations, bringing in international revenue can help guard against the effects of yo-yoing monetary changes on your domestic sales.
“Let’s say Canadian companies are facing an onslaught of low-cost Indian and Chinese goods. They could respond to that by dropping their prices in Canada and hunkering down. Or they could say ‘we’ll compete as much as we can, but we’ll look to replace our volume or our revenue by expanding into the U.S.’ So that revenue growth in the U.S. offsets the revenue you could lose in Canada,“ said Grant Thornton’s Mitchell Osak.
“An exporting company in a lot of ways will be a lower risk company than a company that’s strictly tied into the local market,” Osak continued.
When you are taking in revenue from foreign countries, your business is less reliant on the Canadian market. You can also take advantage of different foreign exchange rates. If the Canadian market suffers, the effects on your business will be mitigated.
Exporting can also serve as a bulwark against changing tariffs and trade regulations, something that business owners are at the mercy of whether they are trading internationally or not. Having multiple irons in the fire across several markets can provide revenue stability and smooth out costs in the face of the foreign and domestic regulatory changes that deeply affect Canada’s economy.
Ultimately, diversifying your client base and investing in foreign markets can stabilize and protect your business.