Exchange rate risk management essential for SME survival
Forward exchange contracts are useful tools to protect businesses from unexpected currency value changes, says Merchant West Incompass
During the five past years, the landscape of international trade for small and medium enterprises (SMEs) has increased in complexity, especially with the advent of Covid and the rise in global geopolitical tensions.
The SA economy has had huge demands on corporate cash reserves, with extremely low economic activity during the pandemic.
At the same time, the uncertainty and instability have led to exceptionally high volatility in exchange rates of all emerging market currencies, which has made conservative cash flow and foreign exchange risk planning a matter of survival for the successful importing or exporting business.
In the world of buying and selling things across borders, SA companies that import or export often hit a roadblock – the ups and downs of currency values.
When SA companies buy and sell goods or services internationally, they deal with money from different countries. These values change every second, which can end up costing the business a loss in profit.
Forward exchange contracts
With forward exchange contracts (FECs), businesses secure the rate to exchange two currencies at a date in the future. It's like setting a price tag for goods in rand in advance, protecting businesses from unexpected currency value changes.
Local businesses can ensure they don't get hit by sudden currency changes by using the FEC to lock in a set price for paying in a foreign currency. It's almost like having a fixed rate for the money they need to spend on a product or service in the future.
This is a method used to safeguard businesses’ finances against unexpected changes in currency values that could make their imports more expensive. It's also a practical tool that lets businesses plan and operate with more certainty, making the world of international trade a bit more straightforward and allowing the business manager space and time to focus on the business operation.
Future budgeting and planning processes become easier because the business knows exactly how much it will be spending or receiving in local currency, regardless of future currency shifts, and management can therefore make financial decisions more confidently.
By using FECs and proper treasury risk management, the importer and exporter can enhance its cash flow
FECs are useful tools offered through authorised dealers (banks). These contracts are essential to mitigate losses from foreign exchange and bring stability and certainty.
By using FECs and proper treasury risk management, the importer and exporter can enhance its cash flow.
Due to the importance of foreign exchange and treasury management on a business’s risk management and long-term planning, many big corporates employ a fully resourced treasury management department to manage risks and optimise cash flows. However, SMEs do not always have the financial resources to manage this important financial function.
Furthermore, when businesses use financial contracts such as FECs, authorised dealers demand security in the form of margin — traditionally this amounts to 10% of the nominal amount of the future value of the exchange contract.
This margin puts a burden on a business's working capital and in many instances is the main cause of the enterprise not utilising FECs – all to the detriment of their business.
Merchant West Incompass, which is part of the Merchant West Group — one of the largest privately owned independent financiers of businesses in SA — enables businesses to take advantage of this essential part of international trade through its foreign exchange and treasury management services.
With years of experience and expertise, Merchant West Incompass can bring stability and certainty to any business's finances.
For enterprises that do not have the working capital to commit the 10% margin required to enter into a FEC, Merchant West Incompass can provide the required margin to approved enterprises, giving these businesses the advantages of FECs and freeing up substantial working capital that can be redirected towards critical operational needs.
If you recognise these challenges and opportunities in your business, contact Merchant West Incompass by calling +27 (0) 21-424-2936, email at email@example.com, or click here to visit the website.
This article was sponsored by Merchant West Incompass.