With an in-depth analysis into the overall effect of the pound’s fluctuation on small businesses, here Saskia Johnston, Foreign Exchange Expert at Sable International provides exclusive insight for Finance Monthly’s economy savvy on several ways SMEs can protect themselves for the coming years.
As we wait to see what kind of effect the UK’s looming exit from the European Union will have on the national economy, there is very little in the way of absolute certainties. The weakening pound is one of the only tangible consequences of the vote so far (political unrest notwithstanding), to the point that HSBC’s chief currencies analyst described it as the ‘official Opposition’ to the Brexit-enabling UK government.
But beyond the politics and macroeconomics of it, a weak pound has an immediate effect on the bottom line of many UK-based SMEs. Any company importing products from Europe has seen costs rise by at least 22% – enough to deliver a serious blow to margins, and for businesses with sensitive enough cashflows, enough to be outright lethal.
If you’re running one of these SMEs, it’s vital to protect your organisation against exposure to the weakening pound. Here’s how.
As the UK and the EU continue to circle around each other, each peering suspiciously at the other, currency markets will continue to be volatile. Uncertainty is the new norm, so make use of whatever certainty is available.
Forward contracts represent a kind of security, if not certainty, for any company with a foreign currency amount due at an agreed date. They involve you agreeing a fixed exchange rate at a certain point in the future, and can cover an individual payment or multiple payments across different periods of time.
By setting these dates in advance, you effectively agree to buy or sell the pound at the predetermined price point for up to a year in advance of the sale or purchase. This removes currency risk for you and your supplier or customer – after all, for all that the pound has weakened in recent months, it also tends to shoot back up at times that might be inconvenient for the other party. It may limit your upside gain, but it takes the element of chance and the risk inherent in a changing political context out of the equation – allowing you to lock in your profit and continue working on your projects without losing money.
Limit orders and stop-loss orders.
If your currency exposure is shorter, it may be worth setting up limit orders on certain transactions. This has one chief benefit: it allows you to set a price target above where the market is currently trading, ensuring that your orders are automatically filled when this price is hit. This offers a clear upside and allows you to cover your bases in the event that the pound outperforms expectations.
Stop-loss orders offer the opposite, doing exactly what the name implies: preventing unnecessary loss. They insure you against the possibility of currency underperformance, allowing you to set a “worst case” price against the current market level.
Your order will be filled if the market drops to (or past) your protective price.
One Cancels the Other (OCO)
Of course, limit and stop orders are naturally complementary, and it’s possible to use both as part of a combined One Cancels the Other (OCO). This kind of arrangement allows you to run a limit and stop-loss order together, ensuring that the second your upper or lower price limits are hit, your orders will be filled – with the unfulfilled price target being immediately cancelled. You can also split your gross amount up into a number of smaller transfers if your currency need isn’t especially pressing.
This goes some way towards mitigating your risk and improving your trading position. When you know what your upper and lower rate limits are, much of the uncertainty of currency fluctuation is entirely removed – allowing you to ring-fence your revenues and focus on the things that matter most to your company, rather than the economic and political factors you can’t directly affect.
Of course, every business has different requirements, and the solution that’s most appropriate for yours won’t always be immediately clear. To truly hedge against the uncertain, it’s important to seek the right foreign exchange advice. Currencies may be unpredictable, but you can set your business up to make the most of them.