Cash flow is a big enough challenge for small businesses to master on a level playing field. But when expansion starts happening, and nuances like international sales and global payments are thrown into the mix, managing cash flow can become more of a challenge due to fluctuating foreign exchange costs. Foreign exchange also becomes relevant for businesses that source materials from overseas or that import or export products.
Whether transacting with Europe, Asia or South America, it won't be long before business owners start to notice variations in their margins, sometimes working in their favor and other times against them. This is due to volatility in foreign exchange (forex) rates, which can change on a dime in response to forces such as geopolitics, like the US election, or economic conditions like changes in interest rates.
One common denominator in international commerce is that forex opens the door to uncertainty, which can impact a business's bottom line and affect profits.
Fortunately, there's a way to help protect profits against unforeseen volatility in the foreign exchange markets, a strategy known as hedging. And it's relevant for any business type, whether you're importing, exporting goods or both.
In a nutshell, forex hedging is a forward tool that can be assigned to a risk management strategy. It allows business owners like you to dip their toes into international waters while staying on defense in the face of currency rate fluctuations. If you're concerned your overseas profits could be erased due to unforeseen foreign exchange risks, keep reading to learn how forex hedging can benefit you, so you don't have to limit your business based on the jurisdiction.
If you're new to international business, you may be wondering, 'What are exchange rates?' You're not alone, as many business owners who are expanding into cross-border transactions are wondering the very same thing. Simply put, exchange rates are the rates by which one currency, say the U.S. dollar, can be exchanged for another, like the euro.
Below is an illustration of the U.S. dollar-to-euro exchange rate between 2020 and 2024:
Major companies like Coca-Cola, which makes billions of dollars in sales overseas annually, regularly rely on forex hedging strategies. But it's not a formula that's limited to major corporations or dependent on Fortune 500-sized sales. Just about any business that's looking to grow can harness the efficiency of forex hedging.
Without a forex hedge, you become vulnerable to owing more when a payment is due or putting your bottom line at risk after a sale due to price swings in the currency markets.
What Is Forex Hedging?
Forex hedging is an accounting strategy designed to help a business protect itself against fluctuations in exchange rates, which are constantly changing. One popular type of hedging strategy involves forward contracts, a product available at OFX.
A Forward Contract is a buy now, pay later option for businesses trying to take advantage of a beneficial rate today on a future payment.
They're made with an international fx payments service like OFX to secure an exchange rate today for a transaction that will occur at a latter date. In response, you'll sleep better at night knowing your rate is fixed and won't be affected by volatility in the forex markets.
How OFX Simplifies Forex Hedging
At OFX, when you book a forward contract, you can lock in a rate for up to 12 months. As a result, even if the date or your transaction moves somewhat, you won't lose your rate if it falls within your contract period. A deposit may be required but OFX also offers an option for a zero-margin forward contract account including a 0% deposit option for business owners who qualify.
Additionally, founders should take confidence from the fact that as an ASX-listed company, OFX is regulated in multiple jurisdictions globally. The company adheres to international security standards and monitors transactions for suspicious activity using sophisticated technology.
Something to keep in mind is that there's no cookie-cutter model for forex hedging. It's a strategy that depends on each individual business. Forward contracts are tailored to the business owner's needs.
So if you prefer to fix all or a percentage of your FX costs for the year ahead, you can do so with forward contracts. If things change, you even have the option to make a fixed-rate transfers sooner than the contracted date. The end date of the contract should coincide with the date on which you expect the exchange of your goods and services with a client and payment to occur.
Attached to the contract is a locked-in forex rate, so you know precisely what the conversion from one currency to another will look like, removing the element of surprise. As a result, forex hedging may guard your profits from any erratic movements in forex rates that can occur in the span between when you make a sale and when payment is received.
One thing you'll need to reconcile is you won't be the recipient of any forex advantage that could otherwise result from forex volatility. But you're foregoing that potential benefit in exchange for the confidence of having a set exchange rate that you can budget around. As a result, you won't lose profits if the exchange rate swings in the wrong direction.
Before you can get started a Forward Contract, you'll need to create an OFX account. Open one today at OFX. OFX has been supporting businesses for over 25 years, providing fast, secure transfers.
Pros of Forex Hedging
- Simplicity - a simple way to manage future currency risk. It's easy peace of mind.
- Future protection - Protect your business against the risk of currency fluctuations that could affect your bottom line.
- Fee transparency - Lock in a rate today for certainty on future payments
- Tailored to you - Fix all, or even a portion of your known FX costs for the year ahead.
- in an exchange rate
Cons of Forex Hedging
- Deposit is required in some cases
- No added benefit if forex rates swing in your favor
Partnering With OFX for Your Forex Hedging Strategy Needs
Chalking up forex-related losses to the cost of doing business across borders is a mistake that businesses often make but can easily avoid. Whether you are importing, exporting or both, implementing a forex strategy can benefit your small business similar to how major corporations profit from it.
The sooner you begin your forex hedging journey, the sooner you'll be able to forecast your cash flow for the coming months. OFX, which was founded in 1998, boasts over 1 million clients and supports transfers in more than 50 currencies. Connect with an OFX currency specialist today to start saving time and money on all your forex needs.
