Written by in Business on April 23, 2020
Photo by Mark Finn on Unsplash
As the global community grows increasingly connected, a world of opportunity has opened for Canadian businesses. Though, with new opportunities comes new challenges. For example, international business requires the ability to deal in multiple currencies. This leaves us all at the mercy of the markets, whether you’re importing raw materials from China, paying staff in Sydney, or exporting goods to the US.
If the pound is strong, your costs come down but it’s harder to sell abroad. If the loonie is weak, the opposite is true. The result is an unpredictable and unstable bottom line. Businesses can’t be adjusting their prices as the market shifts as it would not bode well for retaining customers and building brand trust. Though, absorbing losses made while transferring between currencies isn’t an attractive option, either.
More than 300,000 businesses trade with the United States alone. That makes foreign exchange volatility a pressing concern for CFOs at companies across Canada.
We asked financial directors and controllers how they’d been impacted by currency volatility. They revealed which currencies they exchange and why, and what happens when the markets drive up the cost of doing business. They also talked about the measures they take to manage risk.
What emerges is a portrait of a financial community with exposure to overseas markets, grappling to find a timely solution to manage Forex risk. Not only are they worried about how they can absorb losses when currency fluctuations impact their bottom line, but they also hold widely different views about the future of the loonie.
Our survey quizzed 150 financial directors, controllers and managers across Canada about their experiences and attitudes towards currency volatility. Respondents ranged from small businesses with fewer than 10 staff to large enterprises with more than 500 employees. All spend at least $250,000 per year on foreign currency transactions.
First and foremost, it’s important to understand why the country’s businesses are exchanging currency and exposing themselves to potential losses in the face of volatility.
In short, it is essential to their business models to deal internationally. More specifically, More than half of all companies are buying goods from abroad. 59% make regular payments to suppliers in the US and beyond, while 50% make one-off payments here and there either in addition to or instead of those ongoing bills.
Slightly less than half pay staff and suppliers located abroad (49%) and need to bring foreign sales revenue back to Canada (48%). All three activities expose them to currency market volatility.
There’s a clear difference between the needs of small businesses and large enterprises. Three-quarters of companies with 10-99 staff make regular payments abroad to buy goods and services, and63% make one-off purchases. By contrast, only 61%of large businesses with more than 500 employees make regular payments and just 45% make those occasional purchases.
On the other hand, 67% of companies with 100-500 employees are paying staff and suppliers abroad, and 63% repatriating income. Just 38% of the smallest businesses surveyed do the same.
Businesses are either importing, exporting, or paying staff in other countries and therefore other currencies.
According to our findings, three quarters (76%) of Canada’s businesses are concerned about the impact of the current volatility. The same number say that fluctuations in the value of the loonie negatively impacts their bottom line. Of those individuals 73% point to the significant amount of their time they spend managing this particular risk; time that could be better spent on proactive, strategic initiatives. Therefore, currency volatility poses such a risk that even just the time spent to mitigate it is costing Canadian businesses exponentially.
When a weak loonie increases the cost of doing business, 32% of respondents say they will always take the hit themselves. A further 37% of businesses draw a line in the sand – deciding only to pass the costs on if currency fluctuation exceeds a certain threshold.
The alternative is to pass on the cost to customers, either elsewhere in the supply chain or to the end consumer. 29% do just that. But neither is likely to have a happy outcome.
Customers might look elsewhere – for example to a rival that’s prepared to absorb those costs.
When currency volatility increases costs, it’s a lose-lose situation.
Though a majority of the businesses surveyed deal with foreign exchange regularly, there was little consistency among the respondents about their predictions for the future of the loonie.
Compounding the problem of the cost of volatility is unpredictability. As if to exemplify this unpredictability, when asked how the loonie will perform against the euro and dollar, respondents cast their vote widely.
However, a deeper dive reveals a fascinating pack mentality among companies of similar size. Essentially, the bigger the company the more bullish they are on the loonies chances. The smaller the business, the more downbeat their assessment.
More than a third of the very largest companies surveyed (36%) thought the loonie would rise to be worth more than $1.35 in six months. Roughly the same amount (32%) asserted it would be worth more than $1.0 by that time. Not a single company with fewer than 250 employees agreed.
Conversely, two thirds (63%) of the smallest companies (50-99 employees) worried that the loonie would be worth less than $1.25 or $1.30. The number of financial directors at large enterprises (more than 1,000 employees) who thought the same was just 23% and 14% respectively. Either way, there is a lot of confusion when setting a budget rate for 2020.
Why are Canada’s largest businesses feeling positive about the future of the loonie while the smallest feel the opposite?
While volatility makes foreign exchange unpredictable and therefore potentially stressful, that’s not to say it’s always a bad thing for the business. That’s why, when we asked financial directors to describe the impact currency volatility has had on profits over the past 12 months, not everyone was crying into their spreadsheets.
We asked respondents to score the impact of currency market volatility out of ten, where one is extremely negative and ten extremely positive. The mean score was more than seven, which shows sterling’s rollercoaster ride hasn’t been all bad news.
This demonstrates the difference between large and small companies; three-quarters of companies with 10-99 employees marked a score of five or less, whereas half of the largest enterprises gave a score of nine or ten.
This correlates with our earlier finding that large enterprises tend to sell abroad benefiting from a weak loonie while small businesses find their money going less far when buying goods and services.
Perhaps the main reason some companies are upbeat about the impact of volatility is that they are taking active steps to mitigate risks. More than 9 out of 10 of our survey respondents use ‘hedging’ techniques, either sometimes (49%) or always (42%).
Large companies, as you’d expect, are most likely to fall into the second camp. 57% of those with more than 500 employees say they always hedge, against 38% of the smallest companies we surveyed.
63% of those smallest companies say they use hedging techniques ‘sometimes.’ This could be because annual FX flow is too small for it to be a priority (though all companies surveyed spend at least $250,000 pa on currency exchange). It might also be that they lack the structures or resources to make sure they hedge as a matter of course.
Midsize companies are the only group who are relatively lacking in take-up of risk management strategies. Of the companies with between 10-100 employees, 1 in 4 say they don’t hedge at all (against an average of just 8%).
The solution to currency market volatility and its impact on cash flow uncertainty is hedging. Simply put, hedging means transferring currency in such a way as to limit your exposure to volatility in the market.
Rather than exchanging money on the day, it needs to be sent, savvy businesses lock in favourable rates in advance. This helps avoid sudden movements in the currency market that would otherwise have eaten into profits.
It’s even possible to have the best of both worlds. Creating a strategy that includes Currency Options allows companies to buy currency in advance, but also potentially take advantage of a favourable shift in currency value.
Most businesses say they use forward contracts, the simplest hedging technique.
Currency options, a more sophisticated hedging strategy requiring specialist knowledge are unsurprisingly less well-used. No company with 50-99 employees said they used this practice.
The majority of companies surveyed review their strategy on a weekly (35%) or monthly (39%) basis. Fewer than 10% said it was reviewed less often than quarterly. The fact that financial directors are prepared to spend so much time on it is a measure of how seriously they take the risk of currency volatility.
Another reason for this constant review is that most companies are hedging more than they were. Almost half (48%) said they are doing it a little more than in the past, with a further quarter (27%) saying it was happening a lot more. Only 1 in 20 said they were hedging less than they were.
Customers don’t like surprises, especially if it means higher prices. If you can predict your costs over a twelve-month period it means you can afford to price your products competitively without eroding your profit margin.
Implementing a hedging strategy can save money and boost your bottom line. By choosing a specialist FX provider, you can also do away with bank fees and charges.
Hedging lets you lock in a set rate, giving you peace of mind and knowable currency costs.
Reassure shareholders or investors with a smooth projection of costs and profit over a product’s life cycle. Iron out spikes in your financial accounts caused by volatile currency charges.
An effective FX risk management strategy means you protect your profits whilst you focus on the day-to-day running of your business.
To find out how Shift’s custom solutions can serve and elevate your business, get in touch today.