Foreign Exchange Strategies for Boosting Your Shop's Profits

For those involved in international trade, the implementation of risk management tools and market monitoring services to safeguard against currency fluctuations should be of great concern.

Spending on machinery and tools tells a lot about the future direction of the entire economy. Production equipment from complicated industrial machinery to small hand tools is used in almost every business from food processing to auto manufacturing. When companies establish, expand or upgrade their production facilities, it's usually good news for both the industry and the economy.

In June 2004, the U.S. machine tool consumption totaled $236.93 million, according to The Association For Manufacturing Technology (AMT) and the American Machine Tool Distributors' Association (AMTDA). The total as reported by companies participating in the USMTC program, was up 19.5 percent from May and up 0.9 percent from the total $234.79 million reported for June 2003. With a first-half total of $1,249.68 million, 2004 is up 31.9 percent compared with 2003.

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Business is picking up again for manufacturers and executives who are involved in international trade, thus one needs to understand the implications of currency fluctuations. By implementing a few simple strategies, such as the utilization of risk management tools and market monitoring services, executives can safeguard against adverse market movements.

 

Strategies to Improve Your Shop's Bottom Line

On an average business day, nearly $2 trillion trade in the foreign exchange market, where currency volatility has become the norm. Due to this inherent instability, the value in the U.S. dollar fluctuates constantly against other currencies. From June 2002 to June 2005, the U.S. dollar weakened by 26 percent against a basket of currencies comprised from America's major trading partners—the Eurozone, Canada, Britain, Japan, Australia and Mexico. Numerous factors contributed to the dollar's decline and market participants are currently debating whether the dollar has bottomed. As a result, short-term fluctuation increased significantly.

Whether your company is importing or exporting tooling and machinery, you can improve your bottom line with a few simple actions, such as formulating a foreign exchange risk management plan, monitoring the market for short-term opportunities, executing orders when favorable market opportunities arise, making and accepting payment in foreign currency and timely use of forward contracts. Not only will these tools empower you to control costs, but they also may build goodwill with suppliers and clients, leading to increased business.

In the past, U.S. companies conducted business abroad in U.S. dollars. The advantage was clear; this approach placed the burden of the foreign exchange risk on the shoulders of the foreign customer. Today, savvy overseas partners and domestic brokers are less willing to accept the added cost of converting funds.

If your machinery supplies such as packaging lines, plastic molding equipment and machines used for punching, stamping or bending metal allows you to lock in a rate of exchange when making a payment in foreign currency, you should take advantage of it. Consequently, you will immediately know the exact U.S. dollar amount of the foreign currency equivalent required, and the risk of sending too much, too little or of being re-billed is eliminated. In addition to saving money, you build a better relationship with suppliers, as they receive immediate payment without paying an expensive conversion fee.

Often, suppliers send an invoice with the U.S. dollar equivalent calculated for the customer. Clients who remit this amount can be sure that the supplier has included an added cushion to guard against dramatic rate fluctuations and high conversion fees in order to ensure a certain profit margin.

By paying in U.S. dollars, a buyer most likely spends more than the equivalent cost of the foreign currency. The solution is to ask your supplier to quote a price in both foreign currency and the U.S. dollar amount. You can compare the two and pay the lower amount.

 

Selling with Foreign Funds

To compete in today's international marketplace, savvy exporters price goods and receive payment in foreign currency. For those exporting manufacturing equipment directly abroad, accepting foreign funds facilitates payment procedures for clients and may boost the manufacturer's competitive edge in the overseas markets. Consider also, that when the U.S. dollar is weak, exporters may be missing an opportunity to earn higher profits in the buyer's currency. The key is to remember that the impact of the foreign exchange risk you assume can be managed effectively.

Many manufacturers look for convenience and low fees/rates when selecting their foreign exchange supplier. They usually buy when a payment is due, aggregating various liabilities into one large transaction.

Whether you are paying for tools and machinery for imports or exports, paying for the raw materials to manufacture tools and machinery, purchasing equipment from overseas or paying a parent company or international subsidiary overseas, it is critical to plan how you will hedge against currency risk exposure. Most tooling/machinery businesses have regular foreign payments that are usually deliverable between 30 and 90 days. Thus tooling and machinery businesses are prime candidates for forward contracts and short forwards.

 

Locking in Profits

Once your manufacturing company has committed to conducting a transaction in a foreign currency, you are exposed to market fluctuations. There are simple ways to manage risk without undue stress.

One of the most basic means of protecting against currency exposure for a pending financial transaction is buying or selling funds forward, using a forward contract. With a forward contract, you lock in a current rate of exchange for a payment for goods you have contracted to buy in the future. As a result of this, you know what the funds will cost when you convert the currency at a future date. Once the exchange rate is established, the U.S. dollar amount is set, regardless of subsequent market movements, which can amount to 5 percent during a single month. A fixed rate allows manufacturers to budget effectively without currency fluctuations eroding profit margins.

The only typical requirement to enter into a forward contract is a deposit between 10 and15 percent of the dollar cost of the funds. However, there also are forwards that require no deposit and can be executed within 45 days.

For example, there is a product available called a short forward, which is a forward ranging from three days to two weeks in length plus a window of one to 30 days. Because companies usually have up to 60 days to pay their invoices, a short forward is a perfect risk management tool to capture the rate of a good trading day and thus enables manufacturers to fix their margin cost at any time. If your cash flow is low, your company can utilize a short forward with no impact on your liquid assets.

 

A Variety of Tools to Minimize Risk

In addition to forward contracts, manufacturers also can leverage standing orders as a risk management tool. Standing orders require a foreign exchange specialist to monitor the market and act upon the client's request to buy foreign currency at a target rate. Manufacturers can capitalize on standing orders either through intraday or overnight ($100,000 minimum) agreements to secure their profit margin ahead of a due payment. Manufacturers sometimes use holding balances for incoming funds to make payments in foreign currency without having to maintain and pay for overseas accounts or lose money in the exchange process.

 

Sophisticated Monitoring

Because currency rates fluctuate from minute to minute, staying informed about the foreign currency market is a fundamental prerequisite for effectively managing foreign exchange. Numerous variables such as economic indicators and social events impact the foreign exchange market and account for currency volatility.

A foreign exchange provider should offer comprehensive monitoring services, which greatly reduce the effort of otherwise painstaking data collection. By staying abreast of pertinent news, managers can time transactions to coincide with favorable market conditions and thereby potentially increase their savings.

 

Select an Expert

The key, as with any client/supplier relationship is to select a foreign exchange expert who will work with you to improve your company's bottom line. Simplicity and convenience are both notable factors to consider when selecting a specialist. The supplier you select may mean the difference between a savings of several hundred dollars in the short term and potentially saving thousands of dollars in the long term. Most importantly, seek the advice of a foreign exchange supplier, who will customize a program to meet your specific demands. Understanding the market will help keep you ahead.

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