International trade in business: choosing the right currency
By ATB Financial 4 September 2020 3 min read
For Alberta businesses venturing outside Canadian borders to import, export or tap into international opportunities, having a strategy to protect against exchange rate fluctuations can be crucial. Coming up with a plan before engaging with international partners, such as suppliers, can mitigate risk and help you capitalize on these prospects.
First, you’ll want to recognize the various forms of foreign exchange (FX) risk, which exist, for example, when a business receives payments in one currency but pays for its expenses in another.
Risk falls on both sides of import and export
From the perspective of an importer, the risk is that the foreign currency will appreciate (increase) in value, meaning they will have to pay more for imported goods. On the other hand, for exporters the risk is that the foreign currency received loses value against the loonie. If the foreign currency depreciates (decreases) in value after the exporter conducts a sale with an international customer, the exporter will wind up with fewer Canadian dollars (CAD) than expected after conversion.
Businesses can be also exposed to FX risk if they provide price lists in a foreign currency (for example, USD), months before they'll ever issue invoices to clients. Another point of vulnerability could be when a project needs future payments upon completion of certain milestones. In short, a company faces risk as soon as it enters into an official agreement with a supplier or client that involves a currency outside of CAD.
Negotiate invoicing to your advantage
Not all risks are immediately obvious. If an importer is being billed in CAD, that importer needs to investigate what rate the supplier is providing them.
If you purchase goods from a foreign supplier, and ask for a CAD invoice, it could total $685,000 CAD. A supplier will often use an off-market rate, to account for the risk of currency movement on their end.
$500,000 USD of goods totalling $685,000 CAD, gives an implied rate of 1.37 (685 ÷ 500)
Janek Guminski, senior director, head of foreign exchange at ATB, suggests that upon receiving the CAD invoice, you should ask for an invoice in the supplier's common currency (for example, many South Asian suppliers may bill in USD).
When you do the comparison with your FX Expert, a market rate of 1.33 at the time of investigation means the cost to you could be:
$500,000 USD x 1.33 = $665,000 CAD
If an Alberta business were given the choice of being invoiced for products they are purchasing in the US, should they opt for that invoice to be in CAD or US dollars?
“There isn’t a simple black-and-white answer,” Guminski says. “You have to do some calculations to determine what’s better for your business. That advantage can only be determined when the implied rate used by the supplier is compared to what the business owner could lock in at today.”
Minimizing FX risk requires strategic partnership and planning
Some traditional or frequent strategies for managing foreign exchange risk include:
- Forward contracts, where the dollar amounts and exchange rate are set when the sale is made, but payment is done in the future.
- Currency options, which give the company the right to exchange a set amount of foreign currency at a specific rate for a date in the future.
- FX swaps, which allow you to purchase a currency and sell it at a later date, can help with liquidity of managing multiple currencies at once.
Alberta businesses should contemplate what hidden costs will be embedded when billed in your home currency versus the seller's home currency.
“The cost can only be determined if a comparison can be made between the CAD charge and the seller’s home currency charge. As a general rule though, you can count on a supplier ‘charging’ for the convenience of billing in CAD. How much they charge can only be determined by a common currency or 'apples to apples’ comparison,” Guminski notes.
Lastly, Guminski recommends partnering with the right strategic team in order to effectively navigate the many fluctuations that take place within foreign currency markets.
“Your financial partners can help you quantify the risks and help you understand how choosing the right currency can have an impact on your operations, and more importantly, your bottom line.”
To speak with our Financial Markets Group about which foreign exchange strategies might work for your unique international trade arrangements, contact our team directly at 1-855-282-3939 or email@example.com