When supply chains stretch across borders, currency risk becomes a key consideration
Currency risk can be a roller coaster ride for even the largest global manufacturers.
Exhibit "A" could well be Tesla, which has seen its financial fortunes zig and zag due to currency swings in recent years.
In 2016, for example, a stronger Japanese yen caused Tesla to suffer higher battery component costs for its auto manufacturing line. Why? Because its battery cells, made in Japan by Panasonic, had prices denominated in the Japanese currency, triggering a rise in cost that Tesla cited as a risk in its Form 10-K financial documents.
Fast forward to 2017, when a depreciating U.S. dollar boosted the auto maker's financial fortunes. Auto exporters like Tesla, which has large manufacturing plants in Nevada and California, benefit from a weaker dollar, as any significant slide in the dollar boosts quarterly revenues as auto makers ship vehicles overseas and collect revenues in other foreign currencies.
As Tesla can attest, recent history shows that global manufacturing firms are particularly vulnerable to currency risk, and if 2018 was any indication, that's going to continue to be the case rolling into 2019.
A bottom line impact
According to risk analysis software providers, North American and European companies reported $15.4 billion in quantified negative currency impacts in the second quarter of 2018.
Here's how analysts break down the negative currency impact:
North American firms reported $1.0 billion in negative currency impacts, a huge jump of 2,657% from the first quarter of 2018. Additionally, the report cited a 150% uptick in the number of North American companies reporting negative currency impacts.
European firms fared worse, reporting $14.4 billion in negative currency impacts for the quarter. The number of euro-zone companies reporting negative currency impacts rose by 16%.
In recent history, major global manufacturers have reported heavy currency risk-related losses, underscoring the need for a solid currency risk management strategy.
In 2017, General Motors reported that fourth-quarter net income declined by $500 million due to foreign currency losses.
Also in 2017, Estee Lauder, the beauty products manufacturer, reported currency risk losses would “depress reported sales for the full fiscal year by nearly two percentage points."
VF Corporation, a global apparel manufacturer, reported that the company's profit margin would be 0.8% lower due to negative currency shifts.
Minimize the damage from negative currency shifts
With key geopolitical issues like the ongoing Brexit saga, global trade wars, and battered economies like Turkey and Venezuela on the front burner as 2019 beckons, manufacturers need an action plan to deal with foreign currency risk.
To neutralize foreign currency risk, manufacturers doing business overseas can take the following steps:
Examine your supply chain. Just because a manufacturer only deals in contracts paid in U.S dollars, that doesn't mean it is immune to foreign exchange risk. For example, a firm's supply chain may have a manufacturer buying vehicle fleets from Japan, steel from India, or oil and gas from Russia. Even if the contract includes language that payment will be made in U.S. dollars, the actual pricing calculation component will stem from the underlying value of currencies in Japan, India or Russia. A close evaluation of supply chain contracts with business partners in foreign lands can minimize currency risk.
Trade in local currencies. The price of buying and selling products with overseas partners can be curbed if manufacturers create contracts where the transaction is paid in local currency. By and large, manufacturers will find that the best deals from foreign partners comes when payment is made in local currencies. That's primarily due to the fact that overseas business partners add additional charges when they have to convert a currency to U.S. dollars.
Work with an overseas “currency concierge." An investment in foreign exchange currency experts in foreign countries can also reduce currency risk. Such specialists offer currency concierge services that range from developing an overall foreign exchange risk plan for doing business in a particular country to deal-specific services that lock in a currency rate on a forward contract to better hedge a manufacturer's currency risk in that country.
Get currency alerts. Get ahead of potentially negative foreign currency-related losses by investing in currency alerts provided by currency tracking firms, and use that data to improve FX hedging strategies. Manufacturers can get a heads up on currency shifts and crosses in real time, by email, text, or through data feeds that show up on a corporate financial manager's computer. That enables a firm to better manage its hedging practices when a certain currency is at preferable levels.
Have a forward-looking currency risk mindset
Manufacturers of all sizes, and in all industries, are increasingly doing business overseas. In doing so, the need for an efficient and productive currency risk strategy rises to the top of the to-do list for corporate financial officers.
The good news is that creating an effective FX risk strategy doesn't need to be complicated. Just know your own unique currency risk management needs and build a forward-looking plan that anticipates problems—and opportunities—and acts on them effectively and in a timely fashion.
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