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Foreign Currency Hedging – Have you adapted to the roller-coaster ride?


Joseph R. Schlett on June 8, 2011 in Advice for Business Owners

You can effectively mitigate your foreign currency exposure by taking pro-active measures. Why leave your company exposed to potentially lethal financial impacts related to foreign currency fluctuations. If you have been a net exporter (i.e. manufacturing in Canada, however selling more in the U.S.) or net importer (i.e. importing from the U.S., however selling more in Canada) over the last several years, you know exactly what I mean. How do you navigate through the peaks and valleys of say, the US-Canada exchange rate, at 1.02 today, .94 one year ago, .89 two years ago, 1.01 three years ago etc.?

Do take comfort that private Canadian businesses are staying ahead of the potential financial impacts related to foreign currency fluctuations. I continue to be amazed by the creativity, innovation and management ability demonstrated by our private company entrepreneurial clients. Measures taken are generally pragmatic, well-executed and of low/moderate risk. Here are some strategies to consider from actual client situations:

 

 

 

  • Strive for a natural hedge – basically, attempt to re-engineer your business to match the quantum of foreign sales and foreign purchases. This strategy has been the most popular and most successful. For example, we have seen Canadian manufacturing clients selling in the U.S. completely change their sources of purchasing to vendors transacting in U.S. dollars, generally located in the U.S. or Asia. Also, we have seen aggressive expansion into U.S. markets to source more U.S. dollars to fund U.S. material purchases.
  • Shift from manufacturing to distribution – many of our manufacturing clients continue to expand sales into foreign markets, in particular U.S. markets. Logically, increasing manufacturing costs (direct costs and overheads) require funding in Canadian dollars and thus exposure to foreign currency fluctuations. I have seen the successful implementation of a strategy to substantially down-size Canadian manufacturing activities concurrently with the matched foreign currency purchase (i.e. say, in US dollars) of replacement finished goods for customer sale. For example, I have noted at least 2 situations where the current manufacturing of product is only 15% to 20% of previous levels.
  • Change billing practices – although your company may be based in Canada, there is no reason that you cannot modify your billing practices to your customers. For example, if you have excess U.S currency requirements for cost inputs consider shifting your billing currency from Canadian dollars to U.S. dollars. In fact, some of your customers may welcome the modification to support their own foreign currency hedging needs.
  • Financing structure – your bank has the ability to advance loans in foreign currencies to match the nature of your planned use of the funds. For example, I have noted situations where U.S. denominated loans were advanced to Canadian companies to fund U.S. capital equipment purchases in conjunction with the projected in-flow of excess U.S. dollars to fund loan repayments.
  • Foreign currency contracts – the use of foreign currency contracts are used extensively to mitigate the risk of foreign currency fluctuations. Rather than simply accepting the ‘foreign currency spot rate’ at the date of settlement, it is possible to contract for the purchase or sale of foreign currencies in the future on a contractual basis. Basically, you can project your net foreign currency needs over an operating period (i.e. 1 to 12 months) and contract to transact at a fixed rate. These contracts are most often facilitated through the banking system and your banker will be pleased to help out with a customized program for your organization.

In summary, step back and take time to analyze your financial risk exposure from a foreign currency standpoint. Think about designing a logical and customized strategy for your business, being pro-active and action-oriented will yield positive results.