FX Exposure - Do You Really Know Where it Starts?

Doing business in multiple currencies certainly has its upsides. By offering your products priced locally in different markets, you increase both your competitiveness and conversion rates. Of course, working with multiple currencies isn’t without its hazards. Exchange rates are constantly moving. And for any firm buying and selling across borders, FX exposure is inevitable.

While the majority of international businesses are aware of this risk, many of them wrongly evaluate where it starts. Consequently, these firms wind up leaving precious money on the table. This often overlooked yet extremely critical component of the post-sales process raises an important question: why don’t firms actually pinpoint where their FX exposure start? Let’s look at the possibilities.

Indecent (FX) Exposure

Companies doing business with multiple currencies are inherently exposed to FX risk. From the time a sale is made until the cash is collected and converted to the home currency, the exchange rate is constantly moving, impacting the purchase’s real value.

The finance department has various risk mitigation tools at their disposal such as options or NDFs. However, the treasurer’s tool of choice for protecting their company against FX risk is the forward contract.

In theory, treasurers will instruct a forward contract once a sale hits their system as an account receivable in their enterprise resource planner (ERP). They set a contract to buy their home currency versus the selling currency on the date they receive the proceeds. Their risk is covered and their margin is protected. Sounds great, right? Unfortunately, in this example, the exposure is still there.

When treasurers instruct forwards on sales, they do so when they’re notified by their ERP. The problem is that there are often delays between when the sale takes place, when the invoice is sent to the customer, and when the receivable hits the treasury’s desk for forward protection. Since currency markets are in constant motion, it can very well happen that the translated value of the sale changes in between the purchase date and the forward date.

While companies could technically earn an additional profit during this delay, they can equally take a loss. For the CFO or treasurer trying to protect their revenue stream, is it really worth playing roulette with their margins? Wouldn’t it, therefore, make sense to instruct the forward as soon as the sale takes place? Let’s take a theoretical example using historical exchange rates to see how damaging this delay can be.

The Brexit Example

As you’ll no doubt recall, the citizens of the UK voted on June 23, 2016, to leave the European Union. In the vote’s immediate aftermath, the British pound (GBP) went tumbling. Literally overnight, it lost 11% versus the USD and 7% against the EUR. For foreign companies working with GBP, the FX exposure was very real. For those not immediately protecting their sales, the effects were catastrophic.

Let’s imagine that a German B2B selling auto-parts via their website made a large sale for 150,000 GBP on the 22nd of June - a day before the vote. That day, 1 GBP bought 1.3056 EUR, provisionally generating €195,330.30 in revenue.

Because the CFO has decided to do FX management once a week to net their positions, the ERP only notifies treasury of FX receivables every Monday. As the 22nd of June was a Wednesday, the treasury would only be notified to instruct the forward on the 27th - 4 business days later.

As we now know, news of voters choosing to leave the EU sent the pound tumbling. By the close of business on the 24th, the GBP fell more than 7 euro cents to GBPEUR 1.2384.

The pound continued its downward spiral. By the time the treasury got the order on their desk, GBPEUR was at 1.1990

For the German auto-parts Merchant, this meant that the EUR value of their sale plummeted to only €179,856.12, generating €15,570.89 less revenue than initially predicted.

A 7.92% loss in revenue is damaging regardless of the industry. For some companies, it constitutes a fatal blow.

Covering Up (the Risk)

In our above example, we saw just how damaging FX exposure can be when there’s a delay between the time of sale and reporting. While one could argue that Brexit is a ‘one-off’ event, the truth is that currency fluctuations like this aren’t as rare as we’d like to think. In the first quarter of 2015 alone, the CHF went through a shock revaluation and the USD gained 10% on the EUR.

For companies doing large-volume or big-ticket sales in foreign currencies, it is imperative that they both recognize that FX exposure starts at the time of sale, and not when it hits their ERP. In order to do so, key decision makers must implement internal process changes.

Primarily, the CFO must re-evaluate when the ERP reports sales to the treasury desk, ensuring that this information is conveyed in the shortest time possible. Next, the CFO needs to implement standard operating procedures (SOPs) for the treasury to buy forwards same day; protecting the balance sheet from FX exposure sooner rather than later.

Of course, this is easier said than done. In competitive, high-volume low-margin businesses such as travel, e-commerce or even ad-tech, daily sales can number in the hundreds, if not thousands.

While instructing all these forwards are unavoidable, they impose a heavy burden on the treasury’s human capital; tossing CFOs yet more balls for their constant juggling act. With that being said, there are automated solutions available that take care of the heavy lifting in treasury.

Don’t get caught exposed. If you’re doing business in multiple currencies, there’s no sense taking unnecessary losses by not hedging yourself at the time of sale. After all, we never know when the next FX shock wave will hit.

Interested in learning more about protecting your profits from exchange rate volatility? Check out our guide to Identifying FX exposure!