HOW TO PROTECT YOURSELF AGAINST EXCHANGE RATE RISKS
Are you ready to export your products or services? Do your transactions take time? Is there a delay between sales and payments? Does the exchange rate between your currency and the country of your client(s) vary greatly? Is your profit margin thin? Does your customer insist to be billed in the currency of his country? You’d better protect yourself.
I must confess that I’m not as familiar as I would like to be with this topic, mainly because I have never used this instrument before. So I do not know how this works exactly, but I think it’s important that you are aware that it exists. I found out about these protections thanks to one of my export clients, who was buying them to protect himself against the currency risk involved in trade between Mexico and Canada. The transactions between the two countries were in US dollars. So the protection was for the variation in the exchange rate between the Canadian and US dollars, even if the customer was Mexican.
To put this in context, imagine that you sell a product to a customer in a given country and that this customer pays you according to your agreement some 30–60 days later. In addition, exchange rate fluctuations between both your countries are strong. So if the selling price on day 1 is X in the buyer’s currency (which is often the case) the price will remain constant. But if the buyer’s currency goes up in relation to your own, the money you will receive will be less than what you charged in the beginning.
The best way to protect yourself would be to invoice in your own currency. That means that the currency risk will be bared only by the buyer. But not all customers want to go that route, either because you are in a very competitive environment and the buyer has many options to chose from, either because there are no protection instruments in the buyer’s country, or because the transactions are made in an internationally recognized currency (as in the example of my client who used US dollars to make the transaction even if the customer was Mexican), or for any other reason.
Under these circumstances, know that there are instruments that can protect you. According to my quick research, financial institutions offer protections revolving around 3 options:
- Exchange contracts allow you to set a predetermined price on the basis of which your company is required to buy or sell a currency on a date of your choice. This fixed price will allow you to protect your income, profit margins or expenses.
- Currency forward contracts allow you to agree on a pre-determined price on the basis of which a particular currency will be bought or sold at a later date. You can enter into a contract more rapidly if it is to your advantage.
- Currency option contracts allow you to buy or sell currencies at a pre-determined exchange rate for a pre-determined period of time.
Although these are advantageous tools to counter the risks associated with exchange rates, there are complex tax and accounting treatments for each of them. Ask your accountant about the impact on your business when using these instruments.
If you have more information, questions or comments on this subject, please do not hesitate to contact me.