Lesley Batchelor OBE is an expert on international trade and a passionate champion of UK exporters. She is also the Director General of the Institute of Export, the professional membership body representing and supporting the interests of everyone involved in importing, exporting and international trade.
Before deciding to export, businesses should consider the basic costs incurred in not just supplying their products, but in preparing them, packing them and collecting payment – which will often be in a foreign currency.
Why are exchange rates important?
With the continued instability of the global economy, the importance of would-be and existing exporters understanding world currency and the intricacies of trading in foreign currencies has never been more critical.
The pound’s recent rise to an eight year high against the Euro was warmly welcomed by holidaymakers keen to make their spending money stretch that bit further, but less so by exporters who faced losing customers because the strength of the pound made their products more expensive. Unfavourable currency rates can negatively affect the demand for your product.
Pricing and currency rates today
As most exporters know, one of the hardest things to get right is the price. There are many factors which need to be taken into account, some of which are predictable – such as customs duties and transportation costs, but others, including currency rates, which are not.
The latest currency rise was short-lived, with the value of the pound once again falling against most of the world’s major currencies. However, this recent movement has provided exporters with a timely reminder of how fickle the currency markets can be.
A major issue is that the buyer and the seller are operating in separate countries using different currencies. Payment is made in either of the currencies, or in a mutually agreed alternative currency. In times of stability, this works well, but since the crash in 2008, there has been a high level of uncertainty, which has in turn adversely affected the exchange rates.
This makes it difficult for exporters to work in absolute figures because the conversion rate between the two currencies can change significantly between the deal being agreed and the payment being received.
Few firms have the financial provision in place to protect themselves against such exchange rate fluctuations, which is why we at the Institute of Export caution our members against entering new markets without ensuring that they have researched the financial resources available.
Who can help?
Organisations such as the Institute of Export (IOE), UK Export Finance (UKEF) and Department for International Trade have specialist advisers who can explain the complexities of currencies. Their advice varies depending on which countries the exporters are trading with.
For example, if a business is buying and using services as well as exporting primarily to the US, then it may be suggested that they open a US bank account and trade solely in US dollars. This has the added benefit of being preferred by US customers.
However, it can prove difficult because US banks are reluctant to extend banking facilities for non-domiciliary customers.
What alternatives are there?
An alternative which works for many exporters is to open a foreign currency bank account with a UK based bank. This can be advantageous where the company purchases raw materials, components or goods and materials in the same currency that they sell in, as this allows them to use currency earned from sales to pay suppliers, removing the currency risk.
If this is not the case, the issue and cost implications of converting the foreign currency to sterling will still remain, as will the risk of currency fluctuation. If the transaction is large enough your bank will work with you to produce an agreed price at which they will buy back the foreign currency you collect from your exports. This is called a forward contract.
This is the most efficient way to transact and allows your company to plan its finances easily. In most cases, you can also set what is called an option to sell the currency which you can take up if you are uncertain of the buyer’s intentions.
Most smaller companies use a foreign exchange boutique bureau who will set an agreed rate when you quote at the start of the sales process. They will also help with hedging strategies across the year – which will enable you to work in another currency with confidence.
This technique allows you to quote at a price you know will achieve a profit, takes the stress out of trading in another currency, and ensures the customer understands what they are being charged. This doesn’t always mean you can trade on the lowest price and exporters learn quickly that selling on price alone is a short term strategy.
Finally, for smaller values, the best way to ensure you maintain your price is to adopt a credit card facility. Although your customer is charged the rate of exchange on the day, it is fair and a lot less trouble than attempting the transaction without any back up at all.
The golden rule
The golden rule is ‘make it easy for your customer to do business with you’ and trading in their domestic currency is certainly easier for them.
However, these benefits for the clients come at a cost and it is crucial that any transaction fees and exchange risks are factored in to the final cost when providing quotes to customers.
Failure to do so could cost you dear – and that is something you can definitely bank on!
You can read more on Open to Export about exchange rates including articles on the pros and cons of local currency pricing, taking and making payments in foreign currency, and our video on managing currency risk.