How FX Services Can Reduce the Impact of Foreign Exchange Risk on a Company’s Cash Flow
In a global economy, the ability to price and invoice in a local currency is important to businesses. By reducing the impact of foreign exchange risks, companies can focus on customer acquisition and international expansion. A bank that offers foreign exchange services is an ideal partner to help companies manage their risk profile. Citi offers a range of FX services, including treasury management.
While the market is volatile and unpredictable, it is vital that companies understand their exposure to FX risk. These changes can occur daily, and can be greatly affected by international events. For example, the search for a vaccine for COVID-19 or unrest in Hong Kong can all impact exchange rates. Furthermore, the Federal Reserve’s rate decisions can affect FX rates. For these reasons, businesses can no longer afford to be complacent when it comes to managing their risk.
Currency fluctuations impact the value of a company’s assets and can have a negative impact on financial performance. For example, if a US company pays for its goods and services in EUR, it runs the risk of depreciation. This can significantly impact the company’s future value. It also affects its competitiveness.
Interbank forex markets are facilitated by banks and non-bank dealers who use electronic brokering platforms to exchange currencies. These electronic brokers facilitate close to $200 billion in spot FX transactions daily. ICAP, for example, operates electronic and voice markets, which handle close to $1 trillion daily in spot FX transactions.
The market is highly competitive and dominated by big commercial banks with global operations. As a result, the competition is fierce and each bank tries to maintain a share of corporate business. Moreover, these firms must comply with FX regulations. Regulatory issues often revolve around documentation, disclosure, and reporting requirements.
For companies and investors, the risk of foreign exchange can be managed through strategies. Currency risk affects cash flow and is a significant issue for importers and exporters as the proceeds of a trade are denominated in another currency. This means that they must convert their profits and sales in the target currency back to their base currency. In some cases, the exchange rate will decline, making them unable to receive the full amount of profits.
Hedging strategies can reduce the company’s exposure to foreign exchange risk. These strategies include foreign exchange derivatives, money markets, and operational techniques, which include currency invoicing and exposure netting. Each strategy has its benefits and disadvantages. For companies, it is best to seek professional advice before implementing these strategies.
When buying products from another country, the exchange rate affects the final price. If the company is transferring funds from one account to another, the risk of currency fluctuations is greater. For example, a Canadian company with operations in China needs to transfer CNY600 of earnings to a Canadian account. The exchange rate drops to 7 CNY before the transaction settles.