True cost of foreign exchange
Foreign currency accounts
If possible, you really need to set up accounts with your Australian bank in the foreign currencies you are earning. There are a few good reasons to do this. Firstly it means your customers can EFT (electronic funds transfer) when they make payments, rather than sending cheques.
Foreign currency cheques issued by an offshore bank are usually very slow to convert to Australian dollar funds, up to four weeks, and will usually be converted at a worse rate than EFT funds.
Secondly, using a foreign currency account gives you more control over the conversion of these funds into Australian dollars. You have the flexibility to hold off on the conversion if you don’t need the cash straight away and you have the view that the market rate will move more in your favour in the future.
It also means that you have the ability to check that the conversion rate only includes the agreed margin you have negotiated. Otherwise, if your customer sends over foreign currencies to your Australian dollar bank account, your bank may just immediately convert your funds into Australian dollars and credit your Australian dollar bank account without giving you a chance to be in control of this important transaction.
Thirdly, if you have some payables in the same foreign currency as the account used for your receivables, you can use the account to make these payments. Most banks should provide this service electronically via online platforms. This will minimise the number of foreign currency transactions you need to do, which should always be your goal. Every single foreign exchange deal usually provides some income for your provider, income that ultimately comes out of your bank account.
There are some other tips to remember when using foreign currency to help minimise costs. Make sure you are earning a fair rate of interest on any balances in the foreign currency accounts. If not, and the balance is reasonable, say more than A$100,000 equivalent, ask your bank for a rate on a foreign currency term deposit.
Most banks should offer a more market related rate of interest on terms as short as seven days with interest paid at maturity. Foreign currency term deposits could help you to maximise the return on your foreign currency balances while you are waiting for a better rate to convert, or to use the funds for a payment to an overseas supplier.
Additionally make sure your bank credits your foreign currency account on the day your customer sends the funds. Banks have been known to hold onto funds for one or more days in their own accounts, which often goes unnoticed because of the confusion associated with time zone differences. Keep an eye on this, otherwise you may be missing out on interest that is rightfully yours and, in addition, your cash flow management may be hurt because you don’t know that your customer has actually paid you.
Consider hedging
If you have good idea of the timing and size of future foreign currency receivables, especially on a specific contract, ask your provider for some alternatives to lock in an actual or worst case rate to convert. Locking in an actual rate, or at least a worst-case rate, to convert your future foreign currency receivables, is known as ‘hedging’. Hedging can give you more certainty in forecasting your future cash flows and help you to meet budgets.
Hedging can also help take out some of the emotion associated with foreign exchange dealing and therefore help you to concentrate on your main business of selling products or services. As a rough guide, your provider will probably only want to help you arrange some hedging if your annual foreign currency turnover is at least the equivalent of A$500,000 per year, with a minimum parcel size of at least A$100,000.
Remember, foreign exchange products are very flexible and it usually doesn’t matter too much if you can only estimate future amounts and timing. However, if in doubt about your amounts, always do deals for less rather than more; if you end up being over-hedged, Murphy’s Law says it will not be in your favour.
Regarding timing of future receivables, most providers should usually make arrangements that allow you to bring forward or extend settlement dates to allow for normal commercial circumstances.
It is probably even more important to take steps to check your provider is only taking a reasonable margin on hedging deals, than it is on your spot deals. This is because the market rates for hedging deals are not readily available: your provider will know this and may therefore try to take unreasonable margin without your knowledge.
One way to check the margins from your provider on hedging deals is to get a price from another provider you have used in the past, or has been trying to win your business, but make sure that both providers are pricing off the same spot rate so you can compare apples with apples. Otherwise, use an independent treasury consultant who has access to Thomson Reuters or Bloomberg pricing models and market rates. This type of consultant should be able to replicate the pricing on most types of hedging deals, without margins.
At the end of the day, it does become a subjective decision as a provider who has spent a lot of time understanding your needs and working on the best solution to meet your needs, will expect to be rewarded with a reasonable margin. You just need to be comfortable that you have minimised costs for your business, but still have a good relationship with your provider who is spending time on helping you.
—Merryl Swan is founder and managing director of KISS Market Info, which provides daily information and consulting by subscription
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