Hidden sources of FX risk: could your business be exposed?

Running a business can come with great rewards, but it’s not without risk – something businesses in the UK have become all too familiar with in recent years. Living through unprecedented times has made business owners more aware of the potential impact that macroeconomic events, staffing issues, and supply chain problems can cause. While the risks faced by businesses will differ depending on their focus, one thing they’re likely to have in common is FX risk.

In this article, Thanim Islam, Head of FX Analysis at Equals Money, outlines the risk factors threatening UK SMEs and shares his top tips on how to minimise their FX exposure.

All businesses that make transactions, payments, or purchases in foreign currencies are exposed to FX risk. Whether it’s through selling on an international site like Amazon or importing from abroad, FX exposure is an unavoidable part of international trade. While larger, more profitable businesses are better positioned to weather the volatility of the FX market, for those operating with low margins, even slight currency movements can wreak havoc on their bottom lines.

For SMEs, where cashflow is the lifeblood of their businesses, FX exposure is particularly hazardous. As of last year, 99% of UK businesses were classified as SMEs, making this a risk affecting most of the business population.[1]

What are the key FX risks threatening UK SMEs currently?

The threat of ‘sticky’ inflation remains, meaning profit margins for small businesses may well continue to be tight vulnerable to the impact of FX volatility. This isn’t something to be underestimated and FX exposure putting pressure on already restricted margins has the potential to even wipe out businesses all together.

So, what kind of currency movements should SMEs be looking out for?

Since March, sterling in general has performed very well, which has seen GBPEUR rise by 3.18%, GBPUSD by 7%, GBPCAD 4.17%, and GBPAUD by 8%. These are detrimental moves for SMEs who need to convert foreign currencies back to pounds.

Businesses that can forecast their costs and revenues accurately can mitigate this kind of risk to their profit margins through risk management strategies.

Top tips for minimising your FX exposure

Always plan ahead

If you are able to forecast your expected future currency needs then this is a great starting point in minimising the negative implications of currency moves.

Once you know how much of a currency you may need, you can enter into a forward contract. Forward contracts, a form of currency hedging, are an agreement in foreign exchange dealing that allows you to guarantee, or “lock in”, an exchange rate for the sale or purchase of a specified currency for up to 24 months in the future. Whatever rate you book when the contract is agreed, you’re guaranteed that rate for the agreed time of settlement, thus mitigating the impact of market fluctuations. This can provide the stability and foresight that’s key for SMEs looking to plan and grow while taking market uncertainty into account.

Don’t forget inbound payments

It’s not just businesses that make purchases from abroad who could be losing out. If you’re accepting payments from a foreign customer, you also need to make sure you’re getting the best deal when the currency is converted in their accounts. When receiving large payments from a different currency through traditional banks, businesses run the risk of losing significant amounts of money during the conversion due to poor exchange rates. It’s important to consider your FX exposure holistically including your incoming payments to make sure you’re protecting your business from unnecessary losses.

Decide your risk appetite

While some small businesses may wish to play it safe and mitigate as much exposure to market fluctuations as possible, others may wish to gamble on FX rates in the hopes of facilitating growth. Deciding whether or not to take this risk will depend on your business’s margins, and the amount of revenue that’s tied up in international trade. It can be challenging for a small business to make this call, but by working with a payments partner who offers expertise in FX, businesses can gain insight that better informs their decision -making process.

While FX risk is an unavoidable part of business transactions, it’s important for SMEs to recognise the degree of risk they face and consider implementing appropriate risk management strategies. This may include seeking advice from FX and financial advisors, exploring hedging options, diversifying markets, and staying informed and ahead of global economic trends and exchange rate movements. Just a 15 minute conversation with an FX advisor could be enough to put in place an FX strategy that can alleviate FX pressures on your small business.

 

[1] Gov.UK,  Business population estimates for the UK and regions 2022: statistical release, October 2022.

 

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