Every small business owner should be concerned about currencies and exchange rates. Rather being than something that only bankers and foreign exchange speculators need to worry about, currency fluctuations can make small businesses subject to risk, whether they realize it or not.
Currency risk (also sometimes described as exchange rate risk or foreign exchange risk) simply refers to the risk of changes in the relative values of different currencies that can impact your business’s revenue, costs, cash flow, and profits.
While currency risk for companies that deal exclusively with local customers and domestic suppliers will generally be minimal, even they can still be affected by the ripple effects of changes in the value of major trading currencies that may result in higher costs eventually being passed onto them.
Obviously for companies that import or export, currency risk is far more of a direct concern. For importers, if the goods you purchase from another country are denominated in a foreign currency that rises in value, it could immediately drive up costs, while your revenue stays the same. Conversely, for exporters that make some earnings in a foreign currency that weakens, your revenues could suddenly be now be worth a lot less.
Increasingly these days, however, companies are both importers and exporters, which results in a far more complicated situation of having some costs in different foreign currencies and quite often some revenue in different currencies as well.
Whatever the case may be, for businesses operating with tight margins, a major bout of currency volatility can make the difference between a profit and a loss. It is important therefore to quantify your potential currency risk and adapt your business practices accordingly so you can better prepare for abrupt changes in currency values.
One method of assessing currency risk involves making a list of everything you do that involves foreign currency such as an inventory of imported raw materials or equipment used in your manufacturing process or revenue earned overseas. This will enable you then run through some possible scenarios to calculate the effect on your business should, for example, your home currency drop or increase in value against other currencies to which you have some exposure.
Having gauged how much currency changes could affect your revenue and sales, the final step is to determine how this figures into your company’s overall profitability. By plugging this information into your annual financial statements, you will then be in a better position to identify which risks are small enough to be tolerable and those which may need to reduced.
To learn more about currency risk, we suggest checking out this informative guide that also outlines a number of strategies for small businesses looking to manage their funds and be more competitive.