While the economic recovery still looms far away in the transportation industry, currency volatility continues to impact the bottom line of transport-related businesses.
I spoke with Rahim Madhavji, president of Knightsbridge Foreign Exchange ( www.knightsbridgefx.com). He believes that the time for accepting rampant currency volatility is over. There are tools businesses can use to minimize this risk. Businesses can plan ahead without having to worry about how the US dollar or Euro will impact their profit margins.
Banks have been providing these risk management tools, but generally only to larger clients. The remaining Canadian businesses are left to figure it out themselves. While banks continue to proactively service large institutions, corporate foreign exchange companies like Madhavji’s focus specifically on small and medium-sized businesses and private clients (foreign property purchasers), offering better than bank FX rates as well as proactive hedging services allowing one to lock-in a rate today for a certain time in the future.
Madhavji explains: “If your business has foreign exchange exposures, currency movements will impact your bottom line. Many businesses are invoiced today in US dollars but are not required to pay for products until they are delivered months later. In that time, the exchange rate could have dramatically taken a turn for the worse, exposing the company to losses. The impact on cash flows affects the ability to repay bank debt as well as pay shareholders. Businesses should consider hedging their predictable currency requirements to protect cash flows. Madhavji said FX companies help businesses take the “foreign out of foreign exchange.”
So how do you improve your bottom line?
The big five banks have a stronghold on the corporate foreign exchange market. Market share is estimated at more than 95%. However, high currency margins of up to 2.5% are hidden within the FX rate. This has created the entry of independent providers which provide more competitive pricing and proactive service.
Businesses should consider validating the FX pricing they receive with another provider to determine if there are opportunities for significant savings.
Are there risk management options?
In addition to better pricing, there are a couple of things a business can do to protect itself from foreign exchange volatility.
Business can book a forward contract. A forward contract allows a company to lock in an exchange rate today for use at a predetermined date in the future. An importer can lock in an exchange rate of 1.0300 USD/CAD today for six months and can therefore fix its US inventory cost and know the price it should sell its products in Canada. If the exchange rate moves unfavourably -the business is not impacted. A forward contract removes the element of risk associated with future foreign currency requirements and allows one to plan ahead.
However, some businesses may want to take on some currency risk. Madhavji suggests a solution called a “bid order.”
This allows a business to instruct their FX provider to execute a transaction only if the foreign exchange rate can be executed at the rate specified by the client. “If the current rate is 1.0300 and the client requests 1.0200, the FX firm can watch the markets in real-time, until the rate meets the appropriate threshold. Even if the exchange rates meet the threshold for a few seconds, the transaction can be executed in that time. Madhavji said that this can often save a CFO significant time from having to watch the markets on a constant basis.
Each company has unique foreign exchange exposures to consider and varying internal resources to manage them. Using a foreign exchange company is an effective method to outsource the treasury function, save time, and improve one’s bottom line.
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