We all know that today’s marketplace is global. What you may not know is how important it is to minimize your risk when it comes to foreign currency. Your company may be exposed to foreign currency risk even if you don’t do business in a foreign currency. However, there are ways to minimize those risks including foreign currency hedging. Hedging involves taking an equal and opposite position to protect against price fluctuations.
It is easy to see where you have foreign currency risk when you have foreign currency receivables or payables. If you sell some inventory worth $100,000 to a buyer in Europe for an agreed upon price of EUR 667,000 (based on an exchange rate of 1.5), if the payment does not take place immediately, then any market movement on the exchange rate until payment takes place will have a direct impact on your business. If you choose not to hedge that position, than you are truly gambling.
Perhaps you are thinking to yourself that you don’t have to worry about that since you deal in only US dollars. Even though you sell your products around the world, you only accept payment in US dollars and therefore are not subject to foreign currency risk. This could not be farther from the truth.
Suppose you sell your inventory again worth $100,000 again to a buyer in Europe and this time insist on US dollars. Again, assume that the terms or the contract call for payment in 60 days. If the dollar strengthens by 10 percent during that time period, you have effectively raised the price of your product to your client because the dollars are now more expensive. They may find a new seller who accepts Euro’s since it would cost them 10 percent less.
Even worse, suppose you are selling your product not in a European nation but in a country whose market is very volatile. If your normal terms are 30, 60, or even 90 days, what would happen if one day, the foreign currency was devalued overnight by 50 percent? Even though you only accept payment in US Dollars, you have tremendous foreign currency risk since now your client really owes you twice the amount it thought it did when it entered into the contract. In fact, this may cause them to not pay your bill altogether, which could be a huge loss.
Thus, whether you sell to foreign companies and accept foreign currency or only accept US Dollars, you need to consider a proper foreign currency hedging strategy to limit your risk and improve your profitability.
For more information on foreign currency hedging, contact our Tax Planning & Preparation Group at 440-449-6800.