Exchange rate risk management for SME companies
Exchange rate risk is a reality that SMEs who export and import need to protect themselves against.
In instances of large purchases or sales, an incorrect assessment of the exchange rate risk may result in a loss of margin that's significant enough to compromise the profitability of the transaction, even to the point where it causes losses for the company.
The following will explain the main currency hedging techniques which help minimize the exchange rate risk for companies as well as the currency exchange services that b-sharpe offers to Swiss SMEs for their import and export activities.
The consequences of no currency hedging
An SME importer/exporter who buys or sells goods or services in a foreign currency can decide not to hedge against exchange rate risks. In this case, the exchange transaction is conducted upfront with the exchange fee on the day of the transaction when the company actually arranges for the currencies to be exchanged. However, a company may have invoiced its customer weeks or months before.
The consequences of this type of exchange transaction for a company are as follows:
- The exchange rate is favourable to the company. It makes money on the exchange transaction.
- The exchange rate is unfavourable to the company. It loses money on the exchange transaction.
As you may have noticed, this is rather akin to gambling, which, in the interest of sound management and risk mitigation, is not necessarily desirable. To avoid this risky situation, financial institutions offer various hedging techniques.
b-sharpe, an expert in currency exchange for businesses and individuals, offers not only the best exchange rates in the industry, but can also advise you on various strategies for optimising your exchange transactions and reducing your exchange rate risk.
Various currency hedging techniques for minimising exchange rate risk
Invoicing in local currencies
A Swiss SME can, for example, decide to invoice the sale of goods in Swiss francs to a foreign company. In this situation, the Swiss company eliminates their own exchange rate risk, but might pass it on to their customer. From a risk perspective, it's an ideal situation for the exporting company, but from a sales point of view, this means that the client will take this exchange rate risk into consideration when evaluating the sales proposal. Additionally, if the exporting company is, for example, competing with other companies in the bidding process, this type of proposal may reduce the offer's attractiveness.
Billing in foreign currencies
A Swiss SME exporter can invoice in a foreign currency. The main advantage in this case is commercial, as it allows the client company to have complete control over their budget, and it can compare the sales proposal with other potential suppliers during a call for proposals. For the Swiss company, the problem arises in terms of the exchange rate risk. For a Swiss importer, the problem stems from the fact that the supplier issues their invoices in a foreign currency, which also passes on the exchange rate risk to this Swiss company.
- The Indexation Clause on a Currency or Currency Basket: the customer and supplier decide in this case to index the amount of the transaction in a currency that's neither the customer's nor the supplier's. In certain situations, the two parties can also agree on an indexation to a currency basket. Here, the customer's and the supplier's goal is to share the exchange rate risk and not end up having one take more than the other.
- The Multiple Exchange Clause: with this clause, the customer and/or supplier can decide to settle the transaction in one of the currencies listed in the contract. For example, with this type of contract, a buyer may decide to pay the invoice in Swiss francs, euros or dollars, provided that the contract contains such a clause as well as these three currencies. This clause is also called the "Multiple Currency Clause".
- The Shared Risk Clause: a contract which includes a shared risk clause allows you to manage the period from invoicing to payment of the invoice by having part of the fluctuations contractually taken care of by the buyer and the other part by the supplier. As a general rule, the distribution is 50/50: the risk is therefore shared.
- The "Tunnel" Indexation Clause : this type of clause uses a specific exchange rate as a reference. This rate is then associated with a % variation which then gives the maximum and minimum limits from which the currency can fluctuate without affecting the price of the transaction. When the limits are exceeded, the transaction price is impacted accordingly. For example, a contract can stipulate that the prices are fixed on a EUR/CHF exchange rate of 1.10, with a percentage of 2%. As long as the exchange rate is between 1.10 - 2% (or 1.078) and 1.10 + 2% (or 1.122), then the transaction price does not change.
The Currency Option Clause: this type of clause has a contractual exchange rate (minimum or maximum) which makes it possible for the buyer or seller (depending on the contract) to conduct the transaction in another currency. For example, this type of contract could stipulate that with a EUR/CHF exchange rate of 1.30 or higher, the buyer can pay the invoice in dollars. Please note that in this case, it's an option and not an obligation.
For example, a Swiss company who buys 200,000 EUR worth of goods and sells 250,000 EUR worth of goods to another company will be:
- subject to a currency risk on the sum of 250,000 - 200,000 = 50,000 EUR if it uses the netting technique
- subject to a currency risk of 250,000 + 200,000 = 450,000 EUR if it does not use the offsetting technique