What currency exchange rates are actually costing you and how to reduce the risks
Article co-written & researched by Tyler Anthony
When businesses decide to export products to foreign markets there is a lot to consider. Of these considerations, currency exchange risk is the most overlooked. Fluctuating currency rates affect everything from your production costs to consumer affordability and your profitability. A common misconception is that exchange rates are out of a business’s control, leading owners to do little (or nothing) to mitigate their risks. Here we’ll walk you through what it is actually costing you to ignore currency exchange and how to manage these risks in the future.
It is difficult for Canadian businesses to keep track of constantly fluctuating exchange rates. For this reason, businesses decide not to ignore these rates, which is often a costly choice.
For example, say you sell your product in Europe for € 50,000 and give your customer 30 days to pay. On the day you sent the invoice, one euro was equivalent to $1.55 Canadian, meaning you would receive $77,659 if they paid it that day. Fast forward to 30 days later: the exchange rate has gone down so now one euro is equal to $1.45 Canadian, meaning you receive $72,500 Canadian; a difference of $5,159!
Costs of Currency Exchange Risk
As you can see, the exchange rate fluctuation can significantly decrease your profitability. Any time you deal internationally, you’re at risk of being disadvantaged by exchange rate fluctuations. Exchange rates can drastically change from one hour to the next and these fluctuations can hurt (or benefit) your bottom line each time they go up or down.
Here’s another example to show you the potential risks of foreign exchange fluctuations:
|Euro Exchange Rate Compared to the Canadian Dollar
|Amount received in Canadian Dollars for a €50,000 product sale
|Gain or Loss compared to a 1.5 exchange rate
As you can see, there is potential for your business to also profit from the fluctuation of foreign exchange. While it’s certainly easier to roll the dice and hope that you land on the right side of the exchange, a set strategy can mitigate your risk by creating more certainty as to your applicable exchange rate. Not knowing how much you’ll receive on each transaction can severely affect your cash flow and impact your long-term operations, especially for small to mid-sized companies. This uncertainty is unfavourable to every business because it can make you less competitive and slow your growth rate due to potentially lower or inadequate cash flow.
Managing Foreign Currency Exchange Risk
To mitigate foreign currency exchange risks, we recommend building foreign exchange clauses into every contract. These clauses simply allow you to recoup a certain amount in the event exchange rates deviate more than an agreed-upon rate. These clauses do not require strong language and allow you to clearly state the how exchange rates will be measured. For instance, you can agree on a set exchange rate of 1.5 so that any difference greater than 0.1 in either direction will result in one of the parties recouping money from the other. Alternatively, this clause can set the purchase price based on your local currency, payable only in your currency. This way, you’ll have cash flow certainty.
To discuss ways we can help you reduce your vulnerability to exchange rate risks, contact us today. We’ll connect you with a member of the Du Plooy Law team who will help you determine the best solution for your business needs.
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