If you own a business with services and products offered overseas, you should always beware of the foreign exchange rates. If you think the exchange rates is a thing that only bankers should worry about, then you are wrong. Many small businesses are subjected to exchange rate risks, and unfortunately, some of these businesses don’t realize it.
For instance, consider the Brexit vote that took place last year in the UK. After the UK’s vote to leave the EU, the pound dropped instantly against the euro. That was not enough as there were severe consequences for many small businesses offering their services and products overseas.
There are several ways in which the currency exchange rate impacts small businesses. The impact is as a result of rate fluctuations in foreign exchange. The impacts can be roughly divided into liquidity, translational, transactional, and credit risks. All these categories can fit in all kinds of businesses and the effect seen. The major category that impacts small businesses is the transaction side. The following are the impacts of exchange rates;
1. Supplier payments
The exchange rate exposure is a crucial thing when paying a supplier. For instance, if you have contracted a Japanese supplier for a shipment of goods in seven months at the cost of $50,000, then every fluctuation or percent change in the Japan-USA currency pair will directly impact you. If at that time of paying the rate sits at 0.91, then the final bill would be $45,000. However, should the value of the US dollar drop by 2.5%, then the rate would rise to 0.93; hence lifting your supplier bill to over $46,500.
Therefore, it means you are paying an additional $1,000 for the same shipment of goods. Nonetheless, if the exchange rates are on your side, then you’d end up paying less to your supplier for the same shipment of goods.
2. Balance sheet hedging
This is what finance directors go through like every single day particularly those dealing with small businesses operating overseas. Holding liabilities and assets in different currencies is a burden, and if not carefully dealt with, it may bring a lot of problems. One of these problems is going again through a balance sheet that you had submitted as some of the assets and liabilities changed due to currency exchange fluctuations. Due to the volatility and unpredictability of the forex market, a loan taken out in Japanese yen will appear totally different on a US dollar-denominated balance sheet. Therefore, balancing it may be a hectic process.
3. Appreciation and depreciation impacts
It is a broad category that affects almost everything in small businesses. Let’s look at the effects caused by the depreciation of the exchange rates.
- Depreciation effects
Let’s say there is a depreciation in the value of the US dollar; then it will make US exports cheap while making imports into the US more expensive. Therefore, if a fall in the price of a commodity sold by a small business happens, then there will be a relatively small increase in elasticity of demand.
- Appreciation effects
The two common appreciation effects of exchange rates on small businesses include exports becoming more expensive leading to reduced demands. Another effect is imports becoming cheaper, mainly imports involving raw materials.
4. Inflation impacts
The exchange rates affect the rate of inflation and which in turn affects small businesses. These are some of the ways;
- Commodity prices: Any change in the exchange rates directly affects commodities, especially the ones being imported. For instance, a stronger dollar will make it expensive for small businesses owners in Britain to import any item.
- Fluctuations in the growth of exports: A high exchange rate will make it hard to sell products and services overseas. Therefore, if the exports slow down, then some small businesses owners may opt to cut their prices and reduce their output.
As a small business owner, you may know little about foreign exchange rates. Well, if you are planning to build up your businesses or maintain your profit margin, it is vital to know how the exchange rates move.