Influenced by globalization, small local businesses have increasingly crept beyond their own borders to compete on the world stage. This growing global trend has offered small-to-midsize companies with huge opportunities to expand their customer base, grow revenue, and learn from international partners. And while the benefits are vast, owners also face new and existing challenges associated with buying and selling products and services with foreign vendors — including the broad and often confusing world of foreign exchange markets.
The mechanics of foreign exchange can be a mystery to those outside of the finance, banking, and payments industry. But, knowing the ins and outs of why rates change will keep you informed, help you plan for the future, and improve your cash flow, saving your business money on global transfers.
Understanding foreign currency transactions and knowing how to mitigate the risk is essential to growing a business globally. The good news is, it doesn’t need to be difficult. In this article, we will explore strategies and guidelines to help small-to-midsize and home businesses pay, get paid and manage their global business payments.
To understand how to mitigate risk, business owners need to have a firm grasp of the basics. To start, there are currently 180 ‘circulating’ currencies among the UN Member States, meaning these 180 currencies are in use, in various capacities, in the global economy. Just like with a product or service, currency is a commodity that is bought and sold. In order to trade or make purchases in another country in their local currency, you must first buy that country’s money with your own country’s money, or alternatively, your supplier could invoice the purchase in your own currency.
What makes currency a unique commodity is twofold: its tendency to fluctuate, and the mark-up associated with purchasing it.
How to minimize foreign currency transaction risks
The frequent mistake we see business owners make when purchasing internationally is forecasting based on search engine results. When you Google an exchange rate, you’ll see a value and a graph showing fluctuations over time. If you could exchange your money at that rate, at that exact moment, there wouldn’t be much to explain. But this rate is called the mid-market rate. Think of it as ground zero for cost. Banks are the biggest traders of currency.
The mid-market rate is what major banks use when they trade currency with other major banks — not with independent businesses. For independent businesses, banks mark up exchange rates by around 3-5%. This means that they charge more than the mid-market rate you initially see on Google if you’re buying a currency, and frequently offer less if you’re selling.
To better understand this concept, it’s helpful to compare the mid-market rate to the cost of any product from a supplier. The more your purchase, the better rate you will be able to get. But you will almost never get the rate the supplier purchased the product for. Small, midsize and home businesses see their largest foreign exchange losses when they do not plan ahead, factor in additional costs, and hedge against them. The unpredictability of the foreign exchange market can be difficult to navigate at first, but it’s not impossible.
There are several methods small businesses can use to minimize the risks associated with foreign exchange transactions including: diversifying supply-chains around stable currencies, hedging risk by locking in an exchange rate, invoicing in your preferred currency (i.e. requesting payment in USD or your local currency), and leveraging digital wallets (to withdraw when the foreign exchange rate is optimal).
These strategies are more easily put into action by transacting through a dedicated payment provider, who is motivated to provide stronger and more transparent rates than a bank. Payment providers who specialize in global business-to-business transactions — like Veem — centralize these financial tools previously reserved for large enterprises to one dashboard. This strategy helps ramp up small businesses to start transacting internationally significantly quicker, and with dedicated support.
Benefits of managing forex risk
Like all unpredictable scenarios, sometimes foreign exchange rates can play in a business’s favor. But the uncertainty of trading internationally without a strategy can be damaging to the growth and competitiveness of a business. The obvious benefit of managing foreign exchange risk is reducing the cost and fees associated with international transactions. However, there are some ancillary time-saving benefits as well when businesses opt to use modern non-bank technology to pay and get paid around the world.
By taking the reins on their international payment processes, businesses of any size can more easily predict cash flow, and forecast more accurately, freeing up time to focus on other parts of their company’s operations.
Choosing non-bank, online payment providers to send and receive money globally can save entrepreneurs a considerable amount of time and frustration by empowering them to access their rate, issue an invoice or payment, and manage their buyers and suppliers without ever needing to walk into a physical branch or speak to a bank manager. Unlike banks, online payment providers use a variety of methods to transfer funds internationally — like treasury, SWIFT, digital wallets and more — ultimately speeding up payment timing so business owners (or a member of their team) can better predict cash flow.
Top tips for protecting your business profits from currency volatility
Invoicing in your local currency and using digital wallets where possible are two of the best options to de-risk currency volatility. These methods offer business owners more flexibility and more opportunity to contain fluctuation risk.
Consider this example: You live in Australia, and you’re supplying products from Australia to sell to a buyer based in the US. You can invoice your buyer in Australian Dollar (AUD) to protect your business from any currency fluctuation. The buyer can then pay locally, by purchasing AUD, and as the supplier, you have not lost any money in the trade.
Now consider another tech-forward solution for the same scenario, the digital wallet. Digital wallets enable business owners to receive, hold, or send payments without a traditional bank account — and many financial technology companies offer them.
As an Australian supplier, you could request your US buyer to pay you in USD. Using an online payment provider, like Veem, you could then deposit a USD payment to your digital wallet on the same online account you used to invoice. The digital wallet provides you the flexibility to hold on to the payment, safe from fluctuation, until it is optimal for you to withdraw the payment to the bank account of your choice. This is an excellent and emerging way to protect against volatility.
Best options for businesses to receive, send and transfer money abroad
Foreign exchange rates differ depending on overall annual volume, size of payments, currency pairs, hedging requirements, speed, and more. The biggest favor small businesses can do for themselves is to ensure that they have access to fair and transparent foreign exchange rates. There are several tech-forward payment options available on the market today that offer competitive and up-front pricing.
It is also important to keep in mind that the price of transacting internationally varies significantly between countries. For example, the rate of sending money from the United States to the United Kingdom compared to the rate of sending money to Vietnam is very different. The United States to United Kingdom rates are more commoditized relative to other markets that have less liquidity. With this in mind, it is in your best interest to talk with your provider about your overall business goals and payment volume instead of one currency pair at a time.
The largest opportunity for small businesses is to identify a payment solution that offers fair pricing on foreign exchange, combined with functionality that gives the business owner more control over the process. Control includes the ability to hold funds until the exchange rates are favorable, lock rates for future payables or receivables, and have the flexibility to have the payment sent and requested in local currency.
