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© Crown CopyrightInformation used with permission and is covered by Crown Copyright
IntroductionIf your business exports or imports goods or
services, you need to consider how you will protect yourself against changes in the exchange rate. Even a tiny variation in the rate could cost your business thousands of pounds.
You'll also need to decide how to make and receive payments in foreign currencies.
IntroductionThis guide is aimed at businesses that
regularly deal with customers who are based outside of the UK. It explains how to price goods or services, how to combat the risk of exchange rate changes and the practicalities of dealing in foreign currencies.
Foreign currency issues when importing or exportingBusinesses which import or export goods need
to bear in mind a number of key issues when making transactions in foreign currencies:Foreign currency transactions are sensitive to
fluctuations in the exchange rate. A price you agree with a customer or supplier on one day could rise or fall if the exchange rate changes. This is especially true in the current economic climate where currency is fluctuating on a daily basis making it more difficult to keep track of exchange rates. But there are steps you can take to protect yourself against these.
Foreign currency issues when importing or exportingBusinesses which import or export goods
need to bear in mind a number of key issues when making transactions in foreign currencies:If you're exporting, you must decide whether
it's best to price your goods or services in the local currency of the country with which you're trading. The decision will depend on individual circumstances and on factors such as how you want to present yourself in that market and how your competitors set their prices.
Foreign currency issues when importing or exportingBusinesses which import or export goods need
to bear in mind a number of key issues when making transactions in foreign currencies:If you're importing components priced in a
foreign currency that form part of goods you're selling in sterling, you'll need to decide how to price those goods to reflect the exchange rate.
If you are trading with companies in the Eurozone (ie the European Union member states that use the euro) there are many practices and standards to make life easier.
Identify Foreign Exchange RisksWhen your business deals in a foreign currency you are
exposed to certain risks.
For example, you might find that after agreeing a price for exported or imported goods the exchange rate changes before delivery. Clearly, this can work both for and against you.
Some currencies are more volatile than others because of their unstable economies or inflation. However, the current economic climate is also impacting more stable currencies such as the euro and the US dollar. Your bank should be able to advise you about this.
Identify Foreign Exchange RisksAs exchange rates can go both up and down, it can
be tempting to gamble that this will work out in your favour. However, this is extremely risky and could land you with a significant financial loss.
It's safer to reduce the risk by using one of the forms of hedging available through a bank. Hedging simply means insuring against the price of currency moving against you in the future. There are many different types of currency hedging and your bank should be able to help you with the best solutions for your business.
Identify Foreign Exchange RisksYou could trade overseas in sterling -
effectively transferring the foreign exchange risk to the business you're dealing with. Whether this is appropriate will depend on the product in question and the relative bargaining strength of you and your trading partner.
Identify Foreign Exchange RisksBear in mind that exchange rates could have an
effect on your business' competitiveness even if you don't trade overseas. When a country's currency loses value against the pound, imports from that country into the UK become cheaper, so you may have to respond to aggressive pricing from competitors who source from that country.
Similarly, if a country's currency gains value against sterling, UK exports to that country become cheaper.
Forward Foreign Exchange ContractsOne way to hedge against exchange rate
movements is to arrange a forward foreign exchange contract. This is an agreement initiated by you to buy or sell a specific amount of foreign currency at a certain rate, on or before a certain date.
Forward foreign exchange contracts are a secure and simple way of hedging when you're confident your deal will go ahead and the currency will be required.
Forward Foreign Exchange ContractsImagine you will need to purchase components worth
€100,000 from a German supplier in 12 months' time. One euro might currently be worth 90 pence, meaning the supplies would theoretically cost £90,000.
However, if the euro increases in value against the pound to 95 pence over the year, the components would then cost you £95,000.
If the euro is expected to increase in value, you might agree a forward foreign exchange contract to buy €100,000 for £92,000 on a specified date. Of course, you'll lose out if the euro falls in value.
Forward Foreign Exchange ContractsThis solution suits almost all businesses that
are at risk of losses stemming from adverse foreign exchange rates especially those who:Trade in a volatile market or to tight marginsRequire large amounts of currency and so have
a greater risk of losses resulting from unfavourable foreign exchange rates in relation to turnover
Forward Foreign Exchange Contracts – AdvantagesYou're protected against any adverse
movements in the exchange rate.
You can set budgets knowing exactly how much the transaction costs.
Forward Foreign Exchange Contracts – DisadvantagesYou have to go ahead with the contract once
you have arranged it, regardless of whether your circumstances change.
Because the rate is fixed, you can't benefit from any favourable movement in the exchange rate.
Forward Foreign Exchange ContractsForward foreign exchange contracts can be
arranged through all the major UK clearing banks or independent foreign exchange dealers and can be tailored to meet your specific requirements. Your bank or financial organisation should be able to advise you.
The cost of a forward contract is usually built into the exchange rate.
Banking overseas & UK foreign currency accountsYou may want to consider opening a foreign
bank account to help manage your business' currency and exchange risks. Alternatively, most UK clearing banks offer euro accounts, as well as accounts in other foreign currencies.
Opening an account with a bank overseas could be beneficial if you will be making or receiving lots of payments in a foreign currency - especially lots of small payments.
Banking overseas & UK foreign currency accounts AdvantagesBecause your money will be held in the local
currency, you can wait for the exchange rate to become more favourable before converting it - as long as you don't need the funds immediately.
A bank in the country with which you're trading will be fully conversant with the rules and regulations regarding transactions in that country, and your customers might prefer to deal with a bank in their own country and in their own language.
UK-based foreign currency accountsForeign currency accounts can be a good option
for importers and exporters as they allow you to 'net' receivables and payables in the same currency. This allows you to hedge against exchange rate changes by keeping money in the account until the rate is beneficial to you. This solution suits businesses with:A large number of dealings in a particular currencyA strong cash flow - which means they're unlikely to
require immediate access to fundsA need to hold currency for future payments
UK-based foreign currency accountsUsing a foreign currency account based in the UK
allows you easy access to your money while also allowing you to discuss transactions in English with your own bank.
However, there can also be some disadvantages to this, including:If you need to convert funds in your foreign currency account
into sterling for UK use - eg to ease cashflow - you will face a loss if the pound is strong against that currency.
You may also have to wait a long time for the exchange rate to move in your favour - and it may never do so.
Banks tend to charge ongoing fees for these types of accounts.
Buying Currency OptionsThere are different ways of hedging your
exchange rate exposure and your bank will be best placed to keep you updated with any new alternatives available.
Buying currency options is a more flexible form of hedging than setting up a forward foreign exchange contract - but it's also more expensive.
Buying Currency OptionsCurrency options give you the right, but not the
obligation, to buy or sell a certain amount of currency at a specific exchange rate on or before a specified date. But unlike a forward foreign exchange contract, you're not obliged to buy or sell the currency at the end of the period.
To enjoy this flexibility you'll have to pay premium. Fees which will depend on the amount of currency involved, the exchange rate and the length of the option. Typically, in the region of 1 or 2 per cent of the face value of the contract and with a minimum fee of £500.
Buying Currency OptionsThe ability to buy currency options is offered by
most of the UK clearing banks.
This option suits businesses that:Want to protect themselves from unfavourable rate
changes while retaining the flexibility to benefit from advantageous ones
Are entering into a deal but there's a fair chance of it not going ahead - eg a tender situation
Have a foreign exchange exposure in excess of £500,000 per trade, although this may vary between banks
Buying Currency OptionsAdvantages
You're protected from any adverse movements in the exchange rate.
Your business can benefit if the exchange rate moves in your favour.
DisadvantagesThe expense of setting the option up.Only available to companies with large foreign
exchange exposures.
Foreign currency transactions and your bookkeepingCarrying out business transactions in a foreign
currency will have an effect on your normal accountancy procedures since you'll need to convert foreign currency payments and deposits into sterling.
Accounting procedures are complex and you should take professional advice on your own circumstances. Generally speaking when you account for foreign currency transactions you should calculate the amount in sterling, using the exchange rate that applied on the day of the transaction.
Foreign currency transactions and your bookkeepingAny foreign currency held, as well as any amounts of
currency that you owe or are owed, should be converted into sterling using the rate in force on the date of the balance sheet.
If you make any gains or losses as a result of foreign currency transactions, you should include these in your profit and loss account.
Bear in mind that holding assets in a foreign currency will have an impact on your balance sheet since - owing to exchange rate movements - their value might differ radically from one year to the next.
FormalitiesAll the information provided is for informational purposes
only and you should seek specialist personalised advice as required. As such, we accept no liability for the actions taken by the readers of this slideshow.
All information was provided by Business Link and is covered by Crown Copyright.
All information is available as shown below: BusinessLink (2012) Foreign currency and exchange risks. Available at:
http://www.businesslink.gov.uk/bdotg/action/layer?r.i=1074298682&r.l1=1079717544&r.l2=1087335890&r.l3=1087336309&r.l4=1074298334&r.s=sc&r.t=RESOURCES&topicId=1074298334 [Accessed: 29th August 2012]
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