How hedging can help you do better business

Man watering plant

Many months of economic turmoil for the global economy has led to instability within the market, which particularly affects cross-border business. 

While larger businesses are often set up to deal with this volatilitymore effectively, a process called hedging provides an opportunity for SMEs to do the same and maximise profits and revenue, minimise costs, as well as keep themselves competitive in their market place. It also plays a vital role in managing a company’s cashflow.

Hedging is taking action to minimise the financial impact for international payments and/or receipts from changes in foreign exchange rates.

So, for example, you run a clothing business in Australia and you buy materials from a supplier in China, the supplier invoices you in US Dollars but you pay in Australian Dollars. The payment terms for the invoice are 90 days. If the exchange rate changes between the two currencies in that 90 day period, the price you pay could actually work out to be more expensive than you had planned for.

This means your business has a foreign currency exposure to the Australian Dollar/US Dollar exchange rate over that three month period. In simple terms, whatever changes happen between the currencies will impact the price you pay for the materials.

If you’re importing the product to sell on to another business in Australia, you could actually make a loss if you’ve not priced the product correctly for the local sale.

Why is this important?

Foreign currencies experience fluctuations against the Australian dollar throughout the year and this has potential to impact SMEs importing or exporting from overseas quite significantly.

Hedging can address this issue by playing a vital role in managing cash flow and ultimately contributing to the management of financial and operational aspects of any cross-border business.

For us, the key objective when working with companies is to fully understand their currency and payment exposure, as well as their opportunities and risks, in order to properly monitor market conditions and work with them accordingly.

Recently, we worked with a client to increase their amount of hedging via Forward Exchange Contracts (FEC) when the Australian Dollar was at the US$1.06 level. In this scenario, the client had a “budgeted” or “costing” exchange rate of US$1.00 so by taking out additional hedging the client locked in 6 US cents profit on their imported product purchase.

This provided the client with much needed competitive flexibility and allowed them to improve domestic pricing for some of their product sales. It also gave them a buffer in terms of overall product profitability.

A key point here is that by understanding our client’s foreign currency payment exposures and budgeted exchange rates, we are able to monitor market conditions and ensure our clients are informed accordingly.

Take the appropriate steps to implement hedging within your business

The first step SMEs should take to implement hedging within their business is to grasp an understanding of the foreign currency their business is exposed to. How often do they transact in foreign currencies and how much do they transact.

Secondly, it is essential to understand that a hedging policy is not about making profit but about managing risk.

Next, speak to the experts. As an SME, your time is taken up by managing so many different aspects of your business that you may not have the time to fully investigate or implement a hedging policy so it’s important to seek specialist advice. Finally, agree on a hedging policy and implement it.

Hedging provides an opportunity to strategically manage the issue of volatile currency markets, while also providing benefits to your business to maximise efficiencies, manage risk and protect your bottom line.

Sometimes, it’s a good idea to look at what the big corporate companies are doing and ask yourself: is that something that could work for my business?