“It’s just the cost of doing business!”
“It takes money to make money.”
Those are often the overused phrases thrown around by people at companies of all shapes and sizes when they run into unexpected expansion costs. While there may be some truth to those phrases in various scenarios, they don’t necessarily apply to the foreign exchange markets.
For businesses completing transactions across borders, ignoring the currency markets can be incredibly costly for the bottom line.
Many business owners or executives are unaware if their company has any foreign currency risk. Even if a company isn’t selling products or services in other countries, it is still at risk for currency exposure if it has a supplier outside of the United States it has to pay.
There are a few questions that can help determine a business’ exposure levels:
- How much revenue is generated in non-U.S. countries?
- How much is spent on imports and paying invoices or payroll in other countries?
- What foreign currencies does the company deal with?
The answers to these question can determine the amount of revenue at risk during a currency exchange, the amount of cost at risk for invoice padding, and what currencies to monitor.
Now, some of you may be saying to yourself, “I don’t need to monitor currencies, my supplier Fred in the U.K. lets me pay him in USD, and he’s never said anything about currency conversions.”
Unfortunately, Fred might be also building in a currency-risk markup. Here’s a little background on why Fred would do this:
How exchange markets impact global business
For international businesses, revenues and profits are at risk every time the dollar weakens or strengthens. If a company is selling products overseas, a stronger dollar could hurt the bottom line when transferring the currency earned in other countries back to USD. The foreign currency earned is worth less when the dollar is strong. When the dollar is weak, the foreign currency earned overseas converts into more USD back home.
For U.S. companies buying goods or services from other countries, a stronger dollar means the currency will go further abroad while a weaker dollar won’t buy as much overseas.
Knowing when to make these transfers is the key. In January 2018, we experienced a weaker dollar, so it would have been a good time to transfer earnings made in Europe, for example, back to the United States. At least it would be a better time than six months earlier.
Let’s take a look at a six-month change in USD when transferring from some other major currencies.
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The value of the dollar and exchange rates fluctuate constantly. If a company made €10,000 in July 2017 and transferred it back to the United States immediately, it would have been worth about $11,650. That same amount of euros is worth about $12,410 six months later.
Finding the hidden costs of cross-border business
Back to Fred. As a supplier who works with foreign companies, he’s ran into currency shifts before and he knows the costs of converting his customers’ U.S. dollars.
If a company sends a payment in USD to a supplier overseas, the supplier will have to convert the money into local currency. His bank will charge him a fee to convert the money, so there is a chance he has already built a 2 to 3% conversion markup into the price to cover fees and any potential shift in the exchange rate. An easy way to determine if there is a hidden cost is to obtain an invoice in the local currency. If the USD invoice, when converted to the local currency, is higher than the amount of the local currency invoice, then there is a cost built in.
For example, if Fred in the U.K. delivers an invoice in pounds that is £700,000, that would convert to $987,000. But the invoice the company normally receives in USD is for $1.01 million. In this case, Fred has included a 2.33% conversion cost, or $23,000.
There are a few tricks to help mitigate currency exposure and decrease conversion costs for businesses.
Don’t just use a bank to make the foreign transfer
Sending money online through the right nonbank provider can be the easiest way for businesses to save on fees and help control exchange-rate risk.
A recent survey by NerdWallet found that national U.S. banks charged an average of $44 for international wire transfers, and this doesn’t account for the exchange rate markup many banks charge users to send foreign currency payments.
Simply sending U.S. dollars when transferring money abroad can usually cause small businesses to incur another fee by the bank when it converts USD into a foreign currency before transferring. If the U.S. bank doesn’t do this, the foreign bank will convert the money and likely charge a markup.
Using credit cards to make payments instead of a bank wire transfer isn’t any better. Most credit cards charge a 1 to 3 percent foreign transaction fee. That’s up to $30 on every $1,000 transferred internationally.
By using a reliable nonbank provider, companies can reduce fees and deliver their payments to suppliers in local currencies. Fred no longer needs to charge a conversion fee in his invoice, since you will be using a service to change USD to GBP and send the payment to him.
Get rate alerts and lock in rates
One way international payment companies empower businesses to manage their exchange-rate risk is through forward contracts. If a company knows they need to make more transfers in the future and likes the current exchange rate, forward contracts secure an exchange rate, for a fixed amount of currency, for a set period of time. This is particularly helpful for companies working with international suppliers.
Say, for example, that a company in Colorado sells fidget spinners through Amazon, but they get their supply from Canada. They have a one-year contract with a Canadian company to buy 5,000 fidget spinners every quarter, with each fidget spinner costing $2 CAD or $1.62 USD based on the hypothetical exchange rate of 1 USD to 1.237 CAD. The Colorado company sells them for $4 USD and wants to make sure they retain the same profit margin of $2.38 per spinner.
The company places an order for Q1 of 5,000 fidget spinners at $2 CAD each, totaling $10,000 CAD or $8,084 USD based on the hypothetical exchange rate. If the exchange rate fluctuates dramatically and the Canadian dollar becomes more valuable in Q4, the Colorado company is looking at a worse exchange rate to buy the 5,000 fidget spinners for $10,000 CAD. Now, the hypothetical exchange rate is $1 USD to $1.190 CAD. It will cost the company $8,403.36 USD to buy the 5,000 fidget spinners. That’s $319.36 more or almost a 4% increase in quarterly cost. If they keep the price of $4 per fidget spinner to stay competitive, the company will see a profit loss of $0.06 for every fidget spinner sold.
Having a forward contract in place would allow the Colorado company to continue to only pay $8,084 USD per quarter for the fidget spinners, and not have to raise prices to keep the same profit margin. The Colorado company could then renegotiate with the Canadian company when the one-year supplier contract expires.
In addition to forward contracts, some payments providers offer firm orders and rate alerts so businesses don’t have to worry about watching the exchange market every day. Firm orders work best for a company that knows they have a certain payment they need to make in the next few months and have seen the exchange rate fluctuating by a couple cents. But those few cents could make a big difference on the bottom line. Rate alerts allow the company to set the rate they want and book the transfer when the market reaches that rate.
As more and more companies take advantage of the opportunity to expand internationally, exchange rates and banking fees don’t have to be just another cost of doing business globally. Finding a reputable international payments provider that works to get great exchange rates can be an easier way to make money go further during foreign business transactions. Learn more about Corporate FX Payments and ways to manage FX risk at OANDA Corporate FX Payments.
Steve Thompson writes on currency news, international payments and business strategies for WorldFirst.