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Year End: thought about setting your annual rate?


The distinct majority of our corporate clients convert currency as and when an invoice arrives on their desks.

Whilst we do understand why this is the case, with some very simple changes to the way you approach dealing in other currencies you can make a meaningful difference to not only your bottom line, but your cash flow and your supply chain payments management.

Few businesses set out to engage with currencies when they are conceiving of their position in their market.

Many know they will be dealing with overseas suppliers even before they begin trading, but, very few address how best to protect themselves from movements in rates of exchange.

We draw this conclusion from more than a decade's work with a variety of businesses.

If you are, as a business, approaching making payments 'as and when' you are compelled to, you will face a different rate of exchange every time you transact.

Rates of exchange will change far quicker than you can amend your selling price, this means that your margin will change with the rate of exchange.

It is unlikely you're foreign currency costs will ever move in line with rates of exchange.

It has to be conceded that if there is a distinct and prolonged drop in the value of your operating currency, your supplier may tweak their own prices to offset what could be a drop in sales for them, but, this will only bleed in to their pricing over time and, because rates are so volatile at the moment, it is just as likely they will keep their prices the same and it is you that has to take the hit on your margin.

So, what can you do?

As we approach year end and, because you probably can't remember the time at which you started converting currency, now is as good a time as any to reassess your currency activities and the rates you use for your underlying product or service pricing.

When you wrap up your financial year your sales cycle could, conceivably and understandably, be set back to zero.

Maybe the cycle begins again with new sales.

Let's put your sales pipeline to one side for a moment and focus on how to approach currency strategy for new business you are courting.

Ask yourself - How do I allow for movements in exchange rates when it comes to pitching for work or setting my prices?

Do I look at the exchange rates when I am negotiating with my customer and, most importantly, does the rate of exchange I see affect the way I price for that client?

Usually the answer is no.

If you were looking at a rate of exchange, on whatever platform or by whatever means, when pricing for your client then you could, in theory, take steps to remove any risk you face of the rate of exchange moving adversely against you, but, simply looking at the rate and tweaking what you quote your customer does not leave you in any less vulnerable a position than not looking at the rate at all.

 

If you have not taken steps to lock out your risk of a fall in the rate of exchange then the 'looking at the rate' when pricing is simply an exercise in record keeping, nothing more.

It is useful to every business to work out what rate of exchange you can afford to transact at in order to forecast your profit margin on sales that have a foreign currency aspect to them - that aspect being the buying in of product from abroad.

 

Here's an example of what we mean:

I am a furniture retailer.

A chair costs me $25 to buy from my supplier/manufacturer in China.

I sell this chair to my customer at a cost of £100.

Where the rate of exchange is when I pay my supplier determines my profit margin, not the markup I place on the chair - this is because the GBP unit cost of the chair is determined by how many USD I paid for it (or should be).

If the rate of exchange is at 1.50 then a $25 chairs costs me £16.66. Therefore I am making £83.34 gross profit.

If the rate of exchange is at 1.25 then the $25 costs me £20, so my gross profit is £80.

It is not a huge difference, but, I cannot accurately forecast my gross profit unless I have fixed that rate of exchange.

Each time I buy chairs from my supplier my margin is higher or lower.

This is not a good way of approaching forecasts.

 

If I want to ensure that I always have a consistent margin and, supposing that my supplier isn't going to change their USD price for me, then I have to change my GBP selling price with each order I place to my supplier.

This means inconsistencies for my customers as my prices have to change every so often to ensure I make the same profit.

If I am competing again another business for my customers and this other business has addressed their currency activity, then, on a like for like basis, I cannot confidently hope to secure the sale, because my price is constantly changing and their's is not.

Furthermore, if I have no strategy in place for reviewing and assessing my rates of exchange I will not actually know my gross profit until after I have concluded the sales cycle at my year end.

How can I borrow or arrange financing if I cannot accurately report my profit margin?

 

So, let's return to our initial premise:

Year end is as good a time as any for a business without a plan or a strategy to set one in place.

View year end as 'day dot'.

It is the first day of the rest of your business's currency life (yep...we said it...urghhh).

From the year end you put in place a strategy and process for addressing issues with the ways you manage your currencies.

 

There are a couple of things that you have to agree and set before proceeding.

These are red lines that you agree your operation must work within.

Look at this like you would a change in your supplier.

If they hike their prices and you're not happy, you look for another supplier that allows you to protect your margin, don't you?

Currencies for importers (whether you think you are an importer or not) should be viewed in the same way.

In consultation with a specialist third party like Prime Cap, you establish what you want to sell your product for in Sterling.

At the year end we look at what the rate of exchange is doing.

From that we extrapolate what the current live GBP unit cost to you is of the USD priced product you buy.

Like we say, you can take any point in time for establishing this GBP unit price.

You can take the low for the rate of exchange...and maybe that was 6 weeks ago.

You can take the average rate you achieved for last year's trading. You can take a rate that is in fact far lower than where the current market is.

The bottom line is that we want to establish the rate we should use to make sure your margin is consistent in the face of an unchanging USD unit price.

 

Once we have established the 'budget rate' of exchange we can apply a strategy for ensuring your have access to this rate of exchange for as long as possible.

Strategy like this depends on things like your cash flow.

What money do you have in the bank?

How long is your production lead time?

Do you take a deposit from your customer? Does you supplier ask for a deposit?

Is the rate of exchange right now better or worse than the budget rate you have set?

When we say each solution is bespoke, we mean it.

Questions like the above are just some of those we might ask and they are truly dependent on the specifics of your relationships with your suppliers and your sales activity with your customer base.

This is why we don't think it evasive to ask you to call us before we set out our stall.

We could not possibly hope to cover all of this material in a one-stop-shop 'how to' post, because your activities are as different, diverse and particular as your business is.

Yes, we might recommend things that we know work for other businesses in the same space, but, we cannot tell you that until we have collected other information and have built up a picture of the broader influences on your trading pattern.

 

One thing we do always tend to recommend is that you incorporate a 'buffer' in to the rate you use for calculations going forward.