Currency risk management strategies belong in the boardroom.
If your business faces foreign exchange (FX) exposure, you may feel that dealing with it is a treasury or finance function. But a “leave it to treasury” mindset could actually be costing you in terms of strategic planning and resilience, as well as profitability.
FX risk strategy is top-down. The treasury function can instigate trades and put financial instruments in place, but they must be fully aware of your exposure to currency risk and guided by a coherent and company-wide risk management strategy.
The ripple effects of FX volatility on your business
Any time your business buys, sells, or invests in a different currency, there’s exposure to market fluctuations. An exchange rate move can affect everything from your bottom line to cash flow forecasting and investing decisions.
In other words, without currency risk management strategies in place, foreign exchange movements pose a risk to commercial strategy and business resilience. That makes formulating a strategic FX approach a boardroom priority as much as a technical one.
Here’s what you need to know:
Profits
Most obviously, FX movements affect profits. If you buy from abroad, money market fluctuations can mean you end up paying more for the same goods or services, regardless of the ticket price. If you sell abroad, exchange rate movements can mean you receive less for the goods or services you export.
Pricing
How does your pricing strategy reflect these fluctuations, and how can you protect cash flow from the slow puncture of FX risk? These are strategic decisions that require boardroom intervention, but that’s not possible without a thorough boardroom understanding of your exposure to currency risk.
Forecasting
Lots of things move money markets, from interest rates and inflation to tariffs and geopolitical tension. Anything that impacts economies can affect currency exchange rates. In these circumstances, accurate financial forecasting can seem all but impossible for businesses with significant FX exposure, but effective currency risk management strategies can improve forecasting.
The right FX planning strategy for you may depend on your appetite for risk and other commercial considerations – decisions for the C suite, not just the treasury team.
Investment
FX exposure, foreign exchange risk and currency fluctuations impact revenue and forecasting and, as a result, investment decisions. Uncertainty over exchange rate movements can make companies reluctant to invest, whereas certainty has the opposite effect, providing the foundation for accurate investment decision-making. Businesses need to spend if they want to grow, so again, currency risk management strategies and FX planning belong in the boardroom, alongside other core business growth decisions.
Investor & shareholder confidence
Investors and shareholders want their money in businesses that have robust strategies to mitigate currency risk and manage risks of all kinds, rather than companies that are at the mercy of the whims of the market. A good business manages foreign exchange risk from the top down, giving investors confidence in its leadership and its ability to protect the bottom line.
Hedging your risk
If currency risk management strategies are a boardroom concern, what do business leaders need to know? Most importantly, they need to understand that foreign currency exposure can impact profitability, investment planning and business reputation. The boardroom should develop a nuanced understanding of the factors that move money markets and what currency fluctuations mean for payments, prices and more. and have a tailored hedging strategy in place that aligns to proactively manage risk, taking into consideration commercial objectives, operations and risk appetite.
FX hedging strategy is a financial strategy that protects businesses from potential financial losses due to adverse movements in exchange rates by using FX products and tools or taking offsetting positions to mitigate the impact of currency volatility. If necessary, a currency specialist can help curate a tailored hedging strategy.
Key currency risk management tools every business should understand
Forward contracts
Forward contracts are one of the most common tools you can use to mitigate FX risk. They are customised agreements between two parties, such as your business and a financial institution, that allow you to fix a price, based on the current market rate, for buying or selling currencies on a specified date in the future
Market orders
These allow you to either transact immediately at the best available price or set a target currency exchange rate in advance. There are two types of market orders:
- Limit order: This is where you set up an order in advance to buy or sell currency only when it reaches a pre-set exchange rate (or better).
- Stop-loss order: This is used to limit potential losses, and is triggered when the exchange rate falls to a specified “stop price”. For example, if you buy GBP/USD at 1.1500 and put a stop loss at 1.1485, you would limit your potential losses to 15 pips (percentage in point).
You don’t have to be an expert on these strategies, but you should know the basics. A currency consultant can work with your leadership team to help you shape effective risk management, including deciding on the best hedging tools for your specific needs.
All the above tools can help you mitigate currency risk and create certainty in a volatile situation, allowing for more accurate planning, forecasting and investing.
Currency options*
Options are a specialised financial instrument that allow a business to buy or sell an asset at a specific price within a specific time frame. They’re a bit like forward contracts, except you’re not obliged to go through with the transaction, so they can be more useful for one-off or sporadic payments.
TIP: If some of these tools sound complex, don’t worry. A currency specialist can help you understand the suitability of FX tools for your business and hedging strategy.
*FX options are derivative financial instruments. They can carry a high level of risk and may not be appropriate and/or suitable for everyone. Please take reasonable steps to understand certain key concepts and seek independent advice if necessary. This article is not offered as an endorsement, advice, recommendation or solicitation to buy or sell FX options.
Strengthening cash flow management with FX planning
Applied effectively, the use of financial tools as part of a wider risk management strategy creates much greater certainty around payments, prices and revenue. That, in turn, helps businesses with cash flow management.
In effect, a successful FX strategy makes inflows and outflows more stable and predictable. It mitigates against the spikes and dips in exchange rates that mean you might pay more for goods or services or receive less for foreign sales.
Again, it’s clear that currency volatility and margin protection are strategic concerns that boardrooms need to take the lead on.
Senior leadership must own the FX risk strategy
None of this can be done without the involvement of your senior leadership team. Ultimately, FX risk strategy is top-down. The treasury function can instigate trades and put financial instruments in place, but they must be fully aware of your exposure to currency risk and guided by a coherent and company-wide risk management strategy.
Scenario testing
The treasury function might handle the technicalities of testing different scenarios and strategies, but it’s up to leaders to give them the resources they need, ensure the scenarios meet the needs of the business as a whole, and ensure the results are analysed and disseminated. This is the best way to make a positive impact on your bottom line.
Regular reviews
An FX strategy that is set in stone is one that may be more challenging to adapt to wider changes in circumstances. Regular reviews of your currency strategy are vital. Business leaders don’t need to run these reviews, but they do need to make sure they happen, analyse the results with a strategic eye and tweak risk management policies to meet changing circumstances.
TIP: Even if your business doesn’t have an in-house treasury team, an FX specialist can help simulate different outcomes and build confidence in your hedging strategy. Another benefit of leadership involvement is the message it sends to the wider business. It speaks of an involved and committed C-suite that takes your exposure to currency risk seriously.
Working with a currency risk management specialist
Tackling FX risk doesn’t need to add more work to your already busy schedule. Partnering with currency specialists can take a lot of the hard work and time commitment away from effectively managing currency risk.
Working with a specialist like Lumon also means you get instant access to a deep pool of accumulated knowledge. We’ve been supporting clients with their FX strategies for 25 years, so we know what works and what doesn’t when it comes to an FX risk strategy tailored to your needs.
Your dedicated currency specialist will help you develop tailored currency risk strategies to help manage cash flows and protect profits against fluctuations. They’ll also be your eyes and ears on the markets, providing you with the information you need, when you need it, to execute your FX based on market insights and data. .
Need support with your FX strategy? Let’s talk.
If you’d like to know more, please do get in touch. Your currency risk management strategy is not something to leave to chance. Make FX tools and partner guidance a boardroom priority and help keep your cash flow, planning and profitability on track.
Email us: business@lumonpay.com
Call us on: UK: +44 (0) 203 384 7280
This publication is provided for general information purposes and does not constitute legal, tax or other professional advice from Lumon or its subsidiaries, and it is not intended as a substitute for obtaining advice from the relevant professional services. We make no representations, warranties or guarantees, whether expressed or implied, that the content in the publication is accurate, complete or up to date.
