Aside from the myriad challenges of forecasting demand for products and services, small and medium sized enterprises (SMEs) that import goods can face serious risks when dealing in foreign exchange (FX) markets, with currency movements hitting some importers with large and unpredictable losses.
The Australian dollar is one of the world’s most volatile major currencies. Speculators buy and sell it frequently, led by the prevailing global and local economic conditions. Upward movements are boosted by ‘flight to safety’ effects and ‘carry trading’ where a dealer sells out of a currency that pays a relatively low interest rate and uses the funds to purchase a higher yielding currency pocketing the difference. Downward movements are influenced by such factors as lackluster economic growth, lower interest rates and global uncertainty, such as that existing around the Trans-Pacific Partnership (TPP) at present, and generally how US President Donald Trump will engage with the world on trade.
These FX swings can significantly hurt your bottom line, but there is absolutely no way to predict which way the dollar will go with any precision. So, once you agree on a price with an offshore supplier, being in a position to lock in pricing and hedging your currency risks can be key to protecting your returns.
Currency risks often overlooked
There are two major ways that a business can hedge its currency risks. The most common way is using ‘FX forwards’. A forward contract is an agreement between two parties to exchange a specific amount in one currency for the equivalent amount in another currency at an agreed rate at a future date.
Essentially, you ‘lock in’ the future rate at which you will exchange your money when the time comes to pay for the goods you are importing. This form of hedging protects you entirely against a fall in the value of the Australian dollar.
The downside is that a forward contract does not let you benefit from any rise in the local dollar, which would reduce the price of the imports in the other currency.
A good alternative to FX forwards are ‘FX options’. When you purchase an FX option, you have the right, but not the obligation, to change an amount of money in one currency into another currency at an agreed rate on a specific date.
You are not required to exercise your option, so if the Australian dollar strengthens, you can just let the option expire and take full advantage of the rise.
But overall, Australian small businesses’ engagement with FX risk products such as options and forwards is relatively low, according to research from East & Partners. In November 2016, the research firm found that around 85% of micro businesses with annual turnover between $1 million and $ 5 million had never used options or forwards.
For SMEs with annual turnover of $5 million to $20 million, that figure was around 70%.
But as SMEs become more educated, and FX platforms become more accessible and less costly, those percentages could trend upward.
Quick finance helps to lock in good pricing
There are other financing options that can help you take advantage of favourable pricing and buying conditions.
A Tradeline facility allows businesses access finance quickly to make purchases sooner. The alternatives are often either waiting to build up the funds over time from cash flow (which may result in the opportunity slipping through fingers), or taking out costly, inflexible business loans which come with a burden of administration.
A Tradeline solution will pay a client’s supplier upfront on the client’s behalf, and provide the client with flexible repayment terms of either 30, 60 or 90 days. This means the business can take full advantage of good (but time sensitive) buying opportunities such as temporary supplier discounts or favourable exchange rates. A Tradeline facility can be set up quickly and the imported goods can be bought virtually straight away.
This is not a hedging strategy, but having better control over the timing of purchases and being able to buy them sooner and quicker when the time is right can help you to secure the best possible pricing on goods you import.
This can be a good step towards more profitable trading. On a $500,000 purchase of capital equipment, for example, this could equate to substantial cost savings, which you could reinvest in the business for growth.
HOW TRADELINE WORKS:
• Credit application to Scottish Pacific Tradeline
• Approval of application (usually within 5 business days)
• Agreements signed (importer and exporter)
• Goods shipped to destination
• Importer reviews Bill of Lading and accepts goods
• Scottish Pacific Tradeline pays exporter
• Importer pays Tradeline within 90 days