With the US-China trade war getting mutually worse for both parties and with Brexit’s unpredictable outcome fast approaching, there are a lot of potential threats from tariffs and taxes to business around the globe. The biggest sufferers of this will be small businesses who sell internationally. Without the benefit of economies of scale and bargaining power over materials, small businesses, unlike large multinationals, operate on very fine gross and net profit margins.
The thing with these political events is, whilst they’re a threat, there’s no real way to avoid them. The events are out of our hands. You could perhaps relocate your company elsewhere, but for many of us that is impractical, and many have clients both domestically and abroad, meaning a move would just put you on the other side of the same coin. So, where should our focus be? One key focus should be to completely reduce the friction on your international payments.
When selling overseas, you’re going to be dealing with foreign currencies. Customers do not want the hassle or cost involved in converting to your domestic currency, so the burden is on you. Many small businesses and overseas marketplace sellers are currently paying anywhere from 2% to 5% when converting these sales into domestic currency. Many are not even aware of this, which is even more frightening. This could honestly be the difference between accumulating debt and being able to take home a living wage – or earning an extra $15,000 in operating profit. Here are 3 tips to effectively manage your business FX:
Tip 1: Consider sidestepping your bank to get better rates from specialized providers
First thing’s first: banks should be avoided at all costs. Well, there won’t be any costs for avoiding them, quite the opposite. Commercial banks are massive businesses with many different departments. Most of their customers are ordinary people who want somewhere to be paid into, and to get that money out so they can pay their rent. They love earning a few extra bucks on those who go into their overdraft or need a loan, and so foreign exchange is far down on their list of priorities.
Why would you rely on one company to provide 5+ services for your business? It’s much more effective to go to specialized firms that will offer the most competitive service on the market in their chosen field. The extra effort and time spent is much smaller than the price you pay for complacency, and popular corporate FX companies will offer a much, much more competitive rate (under 1% currency spread upon exchange).
Tip 2: Use forward contracts or limit over FX options to hedge. FX options have a big downside
Okay, so when you go to these new providers, they will likely offer hedging opportunities. This is to mitigate the currency risk of future fluctuations. These will eliminate the panic of “shall I transfer my money now before X political event or wait until next month?”
Forward contracts are an agreement to purchase a certain amount of currency at a future date for a price you agree now. This essentially eliminates all risk of future fluctuations. At worst, you could have returned more if you had waited, but unless you’re a financial service business, you shouldn’t be trying to predict anything.
Many businesses have significant cash flow and want to know if they should be saving up to exchange for a better rate, or doing it as they go. The answer is to diversify. In fact, that’s pretty much the answer to any investment or exchange question. Diversifying means to mitigate risk by spreading it around.
Conventionally in FX, this may mean buying various different currencies so that if one crashes, at least only a portion of your assets get hit. Well, you could do this, but if this is too time consuming or causing other issues, then essentially you can just spread your purchases of a single currency over different time frames. Instead of everything either now or then, just drip it in each day or each way. This will completely average out your gains/losses and is the only rational way to minimize currency risk. You could buy some forward contracts, you could spot transfer some next week, and so on… There’s almost a poetic paradox to it: being random could lead to the least risk. You don’t have to have a method or seek a pattern, just split your purchases in terms of time and spot/hedge, and you’ll never jeopardize all of your working capital.
Tip 3: Avoid solutions like PayPal as much as you can with 4.5% currency exchange (same for Amazon’s currency service)
Whatever the plan is, just make sure it isn’t relying on large, centralized services. Like explained with banks, PayPal and Amazon’s currency service is no better. These huge providers are essentially in the game of maximizing what they can from their big user base, instead of trying to expand their user base with cutting-edge ultra-competitive rates. I mean, why would they? Everyone has a PayPal and Amazon account, so they get away with it.
It’s a big mistake to rely on a company, instead of seeking out alternatives. Amazon overseas sellers essentially get paid in foreign currencies and Amazon try and take control of this by offering a collection account and exchange service. To no surprise, it is in that 3% to 5% markup range. There are many alternatives out there, though, who specifically want to provide Amazon overseas sellers with collection accounts for tens of currencies (some over 100), so that when they get paid, they are in control of the transfer and exchange of currency – where you will get a 0% to 1% markup/fee, most likely.
There really is no excuse to be paying any sort of currency spread in this day and age, and certainly not one that is over 1%. Many companies have shown it can be done (sustainably), and this is now the benchmark, and companies can benefit from thousands extra in annual income with a simple switch of providers.