How to manage foreign exchange risks
Hedging against foreign exchange risk is a vital part of retaining profits as an e-commerce brand. This article will run through some foreign exchange risk management strategies to help your money go further.
If you run a borderless business, you want to make the best possible financial decisions without risking your cash flow and profit margins. However, external factors can affect your business’s bottom line – like foreign exchange risk, for example.
With so much volatility in the currency exchange markets in general, your store could be profitable one month, then the following month – because of FX rate changes – you could be running at a loss.
Small online sellers, especially dropshippers, run on small profit margins (under 10% in many cases). Therefore, it is vital to have foreign exchange risk management policies in place to ensure you don’t get stung by ever-changing currency exchange fees.
This article will look at some approaches to managing foreign currency risk when trading overseas as a marketplace seller.
Foreign exchange risk: Marketplace pricing structures
If you run an online store on a marketplace like Amazon or eBay, it’s easy to open up your business to international customers. However, if you haven’t considered exchange fees when setting your product pricing, you may lose profits.
Pricing software (known as repricers) uses AI to calculate and re-price your goods based on how much your direct competitors charge for the same products. You can use these tools to check price points within select countries to make sure that your prices match the buying power of your customers.
You can also set your profit margins within these tools to ensure the repricer doesn’t go below your lowest desired price point. Pricing your products competitively on marketplace platforms helps you boost conversions. If the marketplace algorithm places your products high in search rankings, you can lower your profit margins and make up your losses via an increased number of conversions.
Foreign exchange risk: Accepting payments in multiple currencies
International customers often feel more comfortable paying for products in their home currencies. Traditionally, international sellers would open a multi-currency bank account to store these funds and then pay suppliers in local currencies. Or, they would exchange the money when the FX market presented them with a favourable opportunity.
Unfortunately, multi-currency bank accounts often come with minimum deposit agreements, transfer fees, and monthly costs to keep the account open.
For online sellers, multi-currency accounts from high street banks may not be the most cost-effective option for foreign exchange risk management. You may not have the resources to research FX rates to find the best time to exchange your funds. Plus, you may not be able to make the minimum deposit amount to open the account in the first place.
Online payment gateways like WorldFirst offer SMEs the chance to open a World Account for free. Once registered, you can start collecting foreign payments in less than 24 hours. There is no minimum deposit amount required, and from one dashboard, you can open up to 10 local currency collection accounts.
- Open up to 20 local currency accounts, with local sort codes, account numbers and IBANs
- Collect secure payments from 130+ marketplaces, overseas buyers and payment processing gateways
- Pay suppliers, partners and staff in 40 currencies without hidden fees
- Pay and get paid easily with local bank details on your invoices
- Lock in conversion rates to manage your currency risk
Foreign exchange risk example: Paying suppliers
Paying international suppliers is another crucial area where foreign exchange risk management is vital.
Global manufacturers deal with many clients in international markets and will try to save on exchange rates wherever possible. Receiving payment in your home currency reduces the time and cost of admin. It also allows you to protect your business from foreign exchange rate volatility.
If you have an ongoing relationship with a manufacturer, you can choose to hold supplier payment funds in a multi-currency account (where foreign exchange rates appreciate or depreciate over time). Alternatively, you can fix the exchange rate with a Forward Exchange Contract (FEC). Here is an example of how an FEC could help an SME get a better deal on exchange rates:
- A UK fashion brand orders £10,000 of sustainable textiles from France. The UK importer has an ongoing sales contract with the manufacturer and bulk buys fabric every six months.
- The UK importer used to pay the manufacturer in EUR in previous years because the exchange rate remained relatively stable. However, a month before they placed their most recent order, GBP lost around 10% of its value against the EUR. The UK importer now considers switching to a cheaper supplier to retain their profits.
- In this instance, the manufacturer and importer could agree on a Forward Exchange Contract where the exchange rate is fixed for a certain period. The French manufacturer keeps the UK importer’s business by agreeing to lock in an exchange rate of 0.95 GBP for 1 EUR for six months. The UK importer pays the remaining balance at their agreed exchange rate at the end of the six months (known as the contract maturity date).
FECs are useful if you have an established business relationship, but they also come with drawbacks. For example, as an online seller, with a fixed FEC, you are locked into paying the balance at an agreed rate, so you cannot switch to a cheaper supplier. Additionally, if the exchange moves significantly against you, you may need to pay back funds in a process known as a margin call.
To provide more flexibility within an FEC, it’s possible to incorporate a range of settlement dates (known as windows). Here, you can buy specific amounts of currency within the settlement dates to provide you with a better overall exchange rate. WorldFirst offers flexible Forward Exchange Contract options for its account holders. Find out more here.
Managing foreign exchange risks
Foreign exchange risk management is vital to e-commerce brands. This article offers tips to help with foreign exchange risk.
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