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True cost of foreign exchange

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Third in our series on 'The True Cost of Exporting' is the cost of foreign exchange and suggestions on ways in which you can minimise these costs, while earning a little along the way. There are a number of actions you can take to minimise the cost of foreign currency transactions for your business: negotiate competitive margins and fees for your foreign exchange deals, use foreign currency accounts, and use products which to lock in a rate or protect a worst case rate to convert your future foreign currency receivables. Margins and fees Possibly the easiest cost to minimise when dealing in foreign currencies, is the margin your provider takes on your foreign exchange deals. Your provider will take margin on both your ‘spot’ deals, that is, deals for settlement within two business days, and your ‘hedging’ deals, that is, deals where you lock in a rate or set a worst case rate for your future foreign currency receivables. Margin just means the difference between your rate and the market rate where banks are trading with each other in large parcels, for example A$5 million lots. Market rates for spot deals are what you see on the TV and a number of free websites that regularly update rates, but this is not the rate you will get. To negotiate the smallest possible foreign exchange margins for your business, you will need to shop around a little, at least consider your main banker and one other provider, which may be either a bank or non-bank. Be open, and make sure they know as much as possible about the size and nature of the transactions you need to do, and about what type of service you prefer; do you like regular phone calls or emails? Do you prefer on-line or over the phone dealing? This type of information will help the provider to quote a margin based on their expected income on your business and how much time you will take to look after. As a rough idea, a business that has foreign currency transactions per year of around A$2 million per year, could expect a margin on spot deals of no more than 20 to 30 points on US dollar deals. This means that if, for example, you have negotiated a margin of 20 points, then your rate to sell US dollars when the market rate is 0.6500, would be 0.6520. Apart from margins, you also need to ask the provider what, if any, fees will apply for each foreign currency transaction. These fees will vary between providers and you need to check they don’t offset the benefit of any reduced margins you have been able to negotiate. It is not normally difficult to set up foreign currency dealing arrangements with a provider other than your main banker. The initial set up time of paperwork, learning a new platform and dealing with new people, could well be worth it if the margins on your foreign exchange deals are less. Once you agree margins with a provider, and you are dealing with that provider, you still need to follow a process that ensures they are delivering the margins as promised. Take some time to document your foreign exchange dealing procedures; this should include a process of recording the approximate margins if possible, especially for spot deals. There are free websites around that update market spot rates every minute, for example xe.com. So make sure you know roughly where the market rate is when you are asking for your rate, and don’t be afraid to question your provider before agreeing to a deal if the margin doesn’t look right.

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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