Do you work at a multi-national organisation? Are you involved in the import and export industry, or rely on foreign labour? Then you likely have to keep an eye on changes in the currency exchange rates.
This can be a difficult balancing act because there are so many factors that come into play – a war between Russia and Ukraine has an impact on European currencies which affects consumer goods prices down the line.
Here’s a look at the foreign exchange rates, their impact, and how this affects international business.
What affects the currency exchange rate?
Economists have their work cut out for them! There really are so many factors that impact the currency exchange rate on a daily basis. Here’s a look at some of the biggest influencers.
- Inflation: This is the purchasing power of one currency compared with another – so where it costs a single unit of currency to buy a loaf of bread in one country, that same loaf could cost several hundred units of currency. Those countries with a lower inflation rate generally have stronger currencies.
- Public debt: Many developing countries have to borrow money to finance their economic growth. Unfortunately, where the debt is growing faster than the economy, the currency devalues.
- Political instability: As we’ve witnessed with the Russian war on Ukraine, instability events within the country devalue the local currency.
- Interest rates: Central bankers have to adjust the country’s interest rates as a way to balance the inflation and attract foreign capital. Higher interest rates increase the value of a country’s currency.
- Balance of trade: This is the difference between a country’s exports and imports, with countries that export more than they import perceived to have better economic health and better currency exchange rates.
- Investor confidence: Traders will consider factors like election outcomes, unemployment figures and other economic news for investment options. These views, however, are often short-lived and not necessarily based on fact.
How does the currency exchange rate impact business?
The fluctuating currency exchange rate impacts us all in some way or another. Most businesses will either benefit from or lose out on sudden changes. Here’s a look at some of the ways it impacts international business and the risks involved.
If you work with foreign suppliers then an adjustment to the currency exchange rate could mean you save money if it shifts in your favour, or lose out because you’re paying more for the same goods or services. You will need to consider this well in advance as it can determine whether you order goods upfront or decide to buy as you go.
Changes in currency exchange rates also make it incredibly difficult for international businesses to perform accurate sales forecasting. Where sales might be going really well in an international branch, the amount coming in can shift drastically if the exchange rate suddenly turns against you.
Finance directors have an incredibly tough time when working out the value of assets or liabilities as they have to factor in fluctuating exchange rates. This is impactful for businesses when it comes to tax regulations as well as loans taken out in foreign currencies.
We’re all acutely aware of the rising fuel prices against the backdrop of global political instability, but this doesn’t just impact individual households but also businesses. The fluctuating exchange rate could mean a depreciation of the local currency and a rise in transportation costs and, therefore, sold goods.
Mergers and acquisitions
The value of businesses themselves is also very much tied to the currency exchange rate. This means that a business located in a country with a stronger currency is more likely to consider mergers and acquisitions with companies located in regions with a weaker currency.
Travel and tourism
The current currency exchange rate has a massive influence on the travel and tourism industries. Where the currency depreciates, the area becomes a more attractive tourism offering as visitors will be able to get more for their money. This shows that there are actually indirect benefits of a weaker currency.
How do you manage changes in currency exchange rates?
There are several ways you can attempt to mitigate the risk presented by ever-fluctuating currency exchange. Here are some of the preferred options.
This is where you enter into an agreement with other parties that protect your business from any fluctuations in the exchange rate. This means that items such as imported or exported materials or products remain at a fixed rate. (No matter whether the exchange rate goes up or down.)
Buy in bulk
If your business has the means, it might be worth buying goods in bulk. (When they’re available at a reasonable rate.) When you go with a need-to-buy option, you’re taking the risk of an unfavourable exchange rate down the line.
Transact in your currency
Is your company in a strong competitive position? Then you might be able to negotiate for transactions in a currency of your choice. This allows you to pass the risk of currency exchange on to the supplier.
The advances in financial technology (FinTech) have made international transactions much safer and swifter which means that aren’t delays in payments. For a small upfront fee, you can pay money overseas on the day so you don’t have to worry about currency exchange rate fluctuations.
Big multinational companies even build foreign exchange fluctuations into contract clauses. This means that their revenue can be recouped when the exchange rate deviates from the agreed amount. This, once again, passes the risk onto the supplier.
It’s also important to adopt enterprise resource planning (ERP) software that allows for the management of trade in multiple currencies. The ERP software manages daily activities – accounting, procurement, compliance, project management and supply chain operations – so it’s important that it’s able to operate across currencies, and make the necessary adjustments when the foreign exchange rate fluctuates.
If you need help with these elements in your business, please feel free to contact the Omni team for assistance.