When Chancellor Osborne told us the UK economy was on the mend earlier this week, those who tend to tut at him, tutted and those who tend to applaud him, clapped. The rest of us just smiled and got on with trying to grow our little piece of the economy. After all, a protracted debate about whether the economy is or isn’t growing is not going to put bread on the table or meet the salary run. That only happens through the intelligent application of plenty of hard work and a degree of business nous.
However, the side effect of the ‘recovery’, if indeed that is what it is, is that the Pound is strengthening. Now that is worth discussing because if you are involved in any international business, the strength of Sterling is going to affect your prospects. Whether that is a positive or negative effect is partly down to the exchange rate movement itself, but is more heavily influenced by the action you take with regard to your business’s currency needs. Understanding that you are not simply a bystander to currency market events is a very important step towards improving your bottom line profit through some degree of forward or strategic planning allied to effective risk management.
As companies grow into and some stumble into international trade, it often takes some time to get to grips with foreign exchange management. The expression, ‘We win some and lose some’ is regularly used to describe how accounts departments deal with currency fluctuations but that should never be the case. A currency strategy need not be a complex melee of tricky instruments or a time consuming toil watching exchange rates around the clock. Something as simple as forward contracts or the use of market orders is very straightforward and that is generally enough to add certainty to budgets, as well as sales and cash-flow forecasts.
The chart shows the movement in the Sterling – Euro exchange rate through 2013, culminating in the spike we saw on 11 September. The defining feature is the flat ‘resistance’ line across the chart at €1.19. That equates to the Euro being worth 84 pence. For reasons which would take a much longer article to fully explain, this has become the technical turning point for this exchange rate throughout the year. For very obvious reasons, that makes the €1.19 level a very attractive point at which to buy Euros with Sterling. Importers and companies paying funds overseas for salaries, to parent companies, for management fees etc. would be wise to do so at this point. That assumes their requirements are short to medium term.
If the requirement is a short term one, an immediate ‘Spot Trade’ will allow you to agree an exchange rate for settlement in the few days which follow. If the requirement is a medium term or even a long term one, as long as you are happy, your contracts are profitable and/or you are risk averse, you can cover your requirements with a ‘forward contract’ to set that exchange rate but delay the exchange of funds for up to two years.
A forward contract gives the financial director certainty for budget and forecast needs, gives the sales director accurate profit figures and gives the managing director peace of mind that the company’s hard earned gross profit is not at risk from exchange rate volatility.
These are simple ways to cut out all and any risk from exchange rate movements. Nonetheless, if the Pound does manage to break above €1.19 the weight of market orders will push the exchange rate much higher and that could bring us to €1.20 and perhaps even as high as €1.235, the level we saw at the very start of the year.
The strategy to take advantage of that kind of break out but maintain control over the potentially negative impact of the Pound losing strength is to do just as the banks and financial institutions do and place automated orders at strategic points. Please don’t get too het up on the term ‘strategic’ though.
Just as this chart shows the top line in the market, it also highlights the upward trend in this exchange rate. So, if the Pound fails to break €1.19, it is highly likely to fall back to the channel bottom at €1.17. As long as it remains above that level, another attempt at €1.19 is on the cards.
Logically then, if the Pound falls below €1.17, we ought to see a more substantial decline to the €1.14 low we have seen sporadically throughout the year. A protective measure just below €1.17 would protect you from the worst of that fall, but allow you the chance to take advantage if the Pound rallies.
As long as you can cost your goods or services profitably at €1.17, you can guarantee you will receive that exchange rate as a bare minimum, but may be able to improve the bottom line if Sterling improves and the chancellor’s recovery continues apace.
No matter how you set your strategy – and that can require some external input from a currency specialist – the essential thing is that, with a minimal amount of forward planning, you can significantly improve your forecasts, your ability to meet those forecasts and ultimately, your gross profit.
Hands up anyone who doesn’t want that to happen in their business…anyone? No I thought not.