How can SMEs mitigate exchange rate risk?

Risks associated with foreign exchange

From soaring inflation rates to general elections, the global foreign exchange market is dynamic, sensitive, and unpredictable. But what can we do about it?

The value of one currency against another can change in seconds. As an SME owner, you might feel you have little control over cross-border currencies. But there are things you can do to reduce the effect of fluctuations on your bottom line. 

Reactive business owners are liable to sit back and hope that exchange rates don't suddenly dip in value when the time comes for them to make an international payment. However, as with anything in business, it's better to be proactive. 

FX risk can apply when:

• You import/export goods, and invoices/receipts are in a foreign currency.

• You convert profits from another currency into Sterling.

• You pay or receive foreign currency amounts.

• You have assets/investments in currencies you want to bring to the UK.

Exchange risk mitigation strategies

The key to mitigating and managing exchange rate risk is to create a solid strategy. This is called "foreign exchange hedging". 

Timing is crucial. If you want to make international payments when the market is favourable, you must better implement solutions to protect your business against exchange rate volatility. 

Hedging can help to:

• Protect your business' profit margins

• Have a stable cash flow, enabling you to deal with uncertainty

• Remain competitive with other businesses

Let's take a look at some of the features your hedging strategy could include:

1. Forward contract: 

A forward contract lets you fix an exchange rate for a set amount. You can use the agreement on an agreed date or period, which typically ranges from two weeks to 12 months. 

Forward contracts provide certainty because they allow you to lock in rates, so you know how much your international payments will cost. It means your cash flow will be more predictable and manageable.

However, it's important to remember that currency can fluctuate both ways. So you might end up being locked into a set rate even if the market changes in your favour. Using a forward contract for part of your total foreign exchange is possible. 

2. Limit order

A limit order lets you target an exchange rate above the current market level. There's no guarantee that the market will reach your aim, but if it does, you'll be able to secure your rate and optimise your FX transactions. 

It might be a suitable option if you don't have to meet a tight deadline. 

3. Stop loss order

A stop loss order enables you to establish a minimum exchange rate. If the rate drops to your chosen level, your payment will go ahead automatically. This could help protect you against adverse FX fluctuations. 

Sign up for an international Wise business account

90% of the world's businesses are small-to-medium sized businesses. In the UK alone, SMEs contribute an enormous £2 trillion to the economy yearly and even more to international trade volumes.

At Funding Options, we're committed to matching businesses with the funding they need to trade and grow with confidence. So, if you require additional finance to fund your international expansion plans or for your supply chain, we're here to help. 

Despite SMEs' significant role, businesses' cash flow is still impacted by unfavourable rates and high processing fees. You can also use Funding Options to sign up for an international business account with Wise. 

Unlike most banks, Wise uses the real exchange rate for sending money abroad, and you can set up a Wise business account to pay invoices based on the actual foreign exchange rate. 

It's fast, too, with 40% of payments instantly arriving in the recipient's account. 

Moreover, you can easily convert and move funds from your international account to one of your other accounts and avoid high recipient or conversion fees. Transfers are approximately six times cheaper than traditional banks.