Currency Fluctuations and Cures

A mix of smart practices and patience is called for in
the currency game. A lot is out of your control.

IN INTERNATIONAL BUSINESS, one of the most critical elements that you need to manage is the home currency you use and its fluctuations relative to other currencies in which you transact business. If your business is founded in the United Kingdom, your home currency will be British Pounds (GBP), but as soon as you do any business with Euro countries, you’ll be involved in currency exchange issues.

When I travel to other countries, I’m not that concerned about the exchange rates for food and lodging, etc. (except to feel I’m either getting gypped or getting terrific bargains, compared to my US dollar base!) Yes, maybe I should check historical trends or look into IMF activities that could be affecting rates, but I don’t, because on a personal level I just don’t convert or spend enough to justify the amount of time necessary to maximize any efforts at getting a favorable exchange rate. And if you use credit cards, the rates (and sometimes, “foreign currency fees”) are set by the credit card company, so it’s out of your hands anyway.

However, it’s not a stupid idea to manage your travel budget with rates in mind, if you’re so inclined and you travel a lot. I know plenty of people who plan ahead for international travel, and they tend to make money by doing so. One of my very good friends who travels to the UK often has done a wonderful job of tracking the relationship between the US dollar (USD) and the GBP. So he regularly buys GBP when the conversion is most favorable, and conversely, he waits to convert his GBP back to USD until the rate becomes favorable again. Planning ahead allows him to maximize the value of both currencies throughout the year for his own benefit.

There have even been a few times when he actually made quite a lot of money. Some years ago he bought GBPs when the buy price for one British Pound was around US$1.50. He later sold his unspent GBPs when the buy price was US$2.01! The guy cleverly made an almost 25 per cent return on his money.

Now just imagine what would have happened if a business had done the necessary research, analysis and forecasting to predict that these types of fluctuations could happen. Wait! They do. Believe it or not, some international businesses have entire investment teams that focus on currency markets, future values and relationships based on all sorts of inputs. However, let’s leave the details for another book.

The rate game

The point is that successfully forecasting currencies can make or break an international deal. That’s especially true in situations such as contract manufacturing, which is something that Scott and I used to do a lot in Southeast Asia, years ago. To make this example short and sweet, imagine this scenario.

• On Day One of a project you get initial production quotes from a factory. You work out an acceptable price with your vendor and name the currency and payment terms. Then, you send your own tooling and other specialty materials to the manufacturer. By now we are 60 days into the project.

• Next, the actual production of your goods starts. It takes four to six weeks, maybe even longer. So now we are roughly four months into the project. The goods are finally ready to ship.

• At this point you have to arrange the shipping and logistics through to the end user, warehouse or customer. The shipping from Southeast Asia to North America can take five to seven weeks on the water.

• Then, your goods have to clear customs, which can go smoothly, in a matter of a few days, or you can be randomly selected for a search, which can hold up a container for weeks.

• Once you clear customs you will most likely have to hire a dedicated transport firm to move the container of goods from the port to a warehouse to further break down the shipment into pallets, etc. This usually takes about three or four days.

As you can see, this process can take easily take four to six months. And a lot can change in the relationship between your home currency and the vendor’s currency over the course of half a year!

Most projects like this are quoted Free on Board (FOB) at the factory, meaning the payment terms clock starts ticking on the day they leave the factory (i.e., you must pay 30 days later, if you get 30-day payment terms). That’s why you should try to arrange terms that extend beyond your final receipt of goods. At least then your money isn’t tied up while ships sail, customs officers peer and prod, and truckers haul.

Currency options

As we’ve just seen, it is important to make sure your transactions are backed by contract language that not only sets pricing, but also locks in the currency conversion rate. If your vendor can’t agree to that, you can buy currency options to protect yourself against fluctuation. Basically, they are a contract (often with your bank) that gives you the right to buy or sell a certain amount of a specific currency, at a certain rate, within a defined period of time. But you don’t have to exercise your option if the currency fluctuates in your favor. If that happens, simply don’t use your option and benefit from the positive change in value. If the currency in question shifts the other way, then at least you are protected. Note that there are lots of variations on the currency option theme, so it’s a good idea to make sure you are using the best form for your purposes and ask lots of questions before you sign up.

Currency options cost money, of course, so sometimes, you may be better off working out some creative payment terms with your vendor (making him your banker). Compare the costs and risks and do your best. In international business, these currency fluctuations are part of the game.

M.O.