Five steps to managing your foreign exchange risk


foreign exchange risk

foreign exchange riskIt’s an unfortunate fact that not many Canadian exporters are really good at managing their foreign exchange (FX) risk. This seems surprising, since every exporting company knows that changes in the FX rate of the Canadian dollar can pose risks to its profit margins and cash flow.

Fluctuating rates also mean more guesswork in your budget forecasts, and they can make it harder to know exactly how much you’ll get paid when you complete a contract.

But that’s not all, according to Jean-François Lamoureux, a Senior Underwriter at EDC.

Remember that your bank wants to see good margins, accurate business forecasts and healthy cash flows before it issues credit.

“If you can’t offer these things because of poor FX risk management, it may curtail your ability to obtain the term financing you need. This can cause your growth and competitiveness to suffer,” he says.

Conversely, good FX risk management can bring your company the following benefits:

  • Better protection for your cash flow and profit margins
  • Improved financial forecasting
  • More realistic budgeting
  • Deeper understanding of how FX fluctuations affect your balance sheet
  • Increased borrowing capacity, leading to faster growth and a stronger competitive edge

Create your own FX risk management program

These are all excellent reasons to take a hands-on approach to FX risk management. And while setting up a solid FX risk management program isn’t trivial, it’s well within the reach of any company willing to make the effort. To create your own program, you’ll need to take the following steps:

1. Analyze your business’ operating cycle to identify where FX risk exists.

This helps you determine the sensitivity of your profit margins to FX fluctuations and the stages of your operating cycle where you need protection.

2. Calculate your exposure to FX risk.

This covers both unconfirmed risk (the risk that exists before a sales agreement is finalized) and confirmed risk (the risk that exists after a firm sale is completed but you haven’t yet been paid). Once you know your level of exposure, you can decide how much risk coverage (“hedging”) you need.

3. Hedge your FX risk.

Hedging simply means that you use specially designed financial instruments to lock in the FX rate so that it remains the same over a specified period of time.

There are numerous ways to hedge, but as an exporter you’re most likely to use an “FX facility,” which you’ll obtain from your bank.

An FX facility resembles an operating line and can support various types of financial instruments (or “hedges”), all of which are designed to secure a specific exchange rate for an export contract so you won’t get any surprises at payment time.

4. Create an FX policy and follow it.

In this step you establish the FX risk criteria, procedures and mechanisms that will support your FX risk management program, and implement this policy across the company.

5. Don’t let hedges squeeze your working capital.

The essential advantage of a hedge is that it protects your profits from unfavourable movements in the FX rate.

The drawback is that your bank will want security for any FX facility it issues to you, which it will usually carve out of your operating line. This will leave you with less working capital, which is never a good thing.

There’s an EDC solution designed for just this situation: the Foreign Exchange Facility Guarantee (FXG). An FXG provides a 100 percent guarantee of the security your bank requires for providing you with an FX facility. Once the guarantee is in place, the bank won’t need to take the security from your operating line, which means you’ll have full access to your working capital.

The view from the front line

Normand Faubert is President of Optionsdevises, a Montreal consulting firm that for 20 years has helped exporters deal with their FX issues. In his view, a business that wants to take control of its bottom line and profit margins will follow carefully designed strategies for managing its FX risk.

“EDC’s FXG is a great tool for this since companies can sometimes be very tight for cash,” he says. “By providing guarantees, EDC can help them obtain the financial tools they need to hedge their FX risk, while avoiding any restrictions on their credit and thus on their working capital.”

Want to learn more about managing your FX risk? Watch a video with me and my EDC colleague Dominique Bergevin, then download EDC’s (whitepaper download) Managing Foreign Exchange Risk with EDC Guarantees and EDC’s guide to Building a Foreign Exchange Policy.

Have you ever had your bottom line diminished because of fluctuating exchange rates? What steps did you take to diminish your future risk?

 Disclaimer: The opinions expressed in this article are those of the contributing author, and do not necessarily reflect those of the Forum for International Trade Training.

About the author

Author: Mélanie Carter

Knowledge Partnerships Lead, Export Development Canada

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