SMEs looking further afield for growth in 2016 could run into trouble if they don’t consider the impact exchange rates could have on their profits. Here, chief economist at World First Jeremy Cook offers his advice to make your exporting aspirations a successful reality.
For those of us in financial markets the Christmas holidays were not so much a break, but a stay of execution. The fears, uncertainties and concerns that pockmarked currency markets through 2015 have, if anything, intensified in the first few weeks of 2016. Panic has not set in just yet but wherever you look, be it economical or geopolitical, there are issues that pose risks and must be dealt with in the next 12 months.
Small and medium sized businesses looking to expand operations through 2016 will naturally see thoughts turn to the prospects of dipping their toes into a new international market. There is no reward without risk, however, and the decision to operate internationally brings responsibilities that businesses may not have had to deal with in the past.
Whilst UK SMEs are regularly characterised as the lifeblood of the British economy, with many more springing up since the global financial crisis playing a valuable role in helping to boost GDP, failure to prepare for the impending currency volatility may seriously blunt their effectiveness.
Word from the front
Indeed, in a World First survey of over 1,000 senior decision makers at UK-based SMEs making cross-border payments we found that despite 75% fearing that currency volatility from the upcoming EU referendum will impact their business, almost half (47%) are failing to take any notice of foreign exchange markets and over a third (35%) believe that having a currency strategy is not important.
Furthermore, 45% said they have been caught out by a sudden movement in exchange rates in the last 12 months, with 1 in 4 (26%) saying that they had been ‘severely impacted by market volatility’.
So where is the volatility likely to come from? You can literally take your pick.
The starting gun for this volatility was the Federal Reserve’s decision to begin increasing interest rates as part of a policy of normalisation at its meeting in December. The US economy is finally seen as healthy enough for the Federal Reserve to start reducing the amount of crisis level support that it was providing. As the most important central bank in the world, movements in Washington have an immediate effect elsewhere.
The subsequent flows into the dollar in a hunger for expected ever rising yields is creating volatility within other currencies and that is saying nothing of the individual risks that businesses dealing internationally must face.
Sterling will have to combat a referendum on the UK’s membership of the European Union, the Chinese yuan is subject to monetary authorities battling with the impossible dilemma of having a reserve currency and wanting to control the renminbi and the dollars of Canada, Australia and New Zealand are all at the mercy of the oil and commodity markets. Wherever you look, businesses with international operations are facing a challenging 2016.
So what can businesses and SMEs of all sizes do to better manage the risk to their business posed by foreign currency?
At a very minimum as a first step, you need to sort out the pricing of contracts that you wish to hedge. You can then set a budget by looking ahead at the known costs and ensuring that these costs are covered. Budget levels can be protected via forward contracts or currency options at the time of setting the budget.
Secondly, businesses need to consider their objectives when hedging; are you a risk averse company that is simply looking to protect a budget rate or maybe happy to take on risk in order to outperform current market levels?
Finally, businesses must take into account how the hedge will affect the business cash flow. Different foreign exchange trades carry different levels of risk and you need to be clear on what implications rate moves will have. Also consider whether you are paying a deposit or provided a credit line; hedging is flexible, so a strategy can easily be designed to suit your business’s cash flow requirements.
Trading internationally can make businesses world beaters almost overnight. Mini-multinationals who don’t have the balance sheet strength to absorb major exchange rate shocks need to look at ways of protecting themselves from these wild and turbulent markets. Our survey has shown that there is a widespread lack of appreciation on how such rate movements can impact a company’s bottom line; hedging your currency exposure can prevent your business becoming a statistic.