Written by in Business on January 9, 2023
Let’s dive into how forex risk can impact your business.
The impact of transaction risk is simple to grasp and may be one of the more evident risk areas if your business is just beginning to expand into the global economy. An example is a US company signing a contract to buy 100 cases of wine from Germany. If the exchange rate upon agreement was 1 USD to 1 Euro and the US exchange rate dips to 1 USD to 1.10 Euro before the payment is settled, the company that was expecting to pay €10,000 will still be paying €10,000, only now, it will cost $11,000 instead of the $10,000 that they were expecting to pay when the contract was signed.
This risk also comes into play when you have an ongoing purchasing relationship across borders. Suppose you are buying or selling something to an international partner with monthly payments, for example. In that case, an unfavourable fluctuation can have you at a loss in any given month. More significant fluctuations might make the partnership unsustainable for one or both parties.
Transaction risk comes into play with any transaction that has a delay between the agreement and the settlement.
Transaction risk can impact your business's cash flow, budget, partnerships, and overall viability if you depend on a foreign relationship in a notoriously volatile currency. The impacts of this type of risk range from intelligible to profound, and it’s certainly something to be aware of when building your business model and growth strategy.
As for economic risk, this can impact your business in a big and all-encompassing way. Economic risk factors include currency fluctuations, government policy or regulations, the general political climate, and macroeconomic conditions that may sway public opinion/discourse.
A business is exposed to economic risk in the countries they have relationships with and in their home country. For example, if something happens in a country where you have a wholesale relationship, this could radically impact your business. If something happens in your country, say a shift in political leadership that adds red tape to your industry, this can also have a radical impact.
It’s important to look at the areas of potential economic exposure on all fronts, but in this case, we’re focusing on economic risk pertaining to foreign exchange. If international operations are a vital piece of your business, a financial crisis or hyperinflation in any relevant country could expose you to monumental loss.
An example we can look at is the 2007 financial crisis in Greece. The aftermath of the crisis caused the government to make significant efforts to pay back its debts. These moves included increased taxes. As a result, citizens were outraged, and international trade plummeted. If you were a Greek business at this time, you would have suffered immense hardship in the international market. Further, foreign companies who relied on Greek exports, for example, would have suffered, too.
There is a lot of forecasting involved in understanding one’s potential for economic risk. There are a ton of events that we could never foresee, but it’s an important exercise nonetheless.
Similar to transaction risk, translation risk is based on currency fluctuations. But, rather than the value of a dollar in a given transaction, it refers to the value of an asset at tax time. If your business owns foreign assets, you are running the risk of movements in the market that will change your balance sheet from period to period. This can impact your business's overall value and investor interest.
In all cases of forex risk, your business is facing a potential loss of money, stability, and company viability. Of course, everyone’s exposure levels are different, and so are the potential impacts.
Mitigating foreign exchange risk is critical for any business that stretches beyond borders. If you want to learn how to identify your risk exposure and some forex risk mitigation strategies, click below to download our free white paper: “Your Guide to Managing Forex Risk as Your Business Grows Global.”
To find out how Shift’s custom solutions can serve and elevate your business, get in touch today.