One of the challenges you’ll face when operating a business in today’s global economy is transaction exposure. It has the potential to erode profits and can place significant risk on your business. However, there are many steps you can take to safeguard your business against those risks.
In this article, we’ll discuss what transaction exposure means for you in international transactions, and what you can do to mitigate the risks and help protect your profits.
What is Transaction Exposure?
Transaction exposure comes from the uncertainty from not knowing which way currency rates will go from the time an international business deal begins (when you sign a contract to buy a product in a foreign currency) and when the deal ends (when you finalize payment). Most transactions aren’t instantaneous, which opens you up to the chance that currency rates can fluctuate—by a little, or a lot.
You face transaction exposure every time your business buys something using a currency other than your home currency, and the risk is especially inherent in large purchases that take more time from beginning to end. The longer the deal is open, the greater the risk involved, and a deal that takes 5 days from signing the contract to making final payment carries a lower risk than one that takes thirty days to complete.
Transaction exposure can result in losses when rates change before your transaction is finished. It generally only affects the business who’s using a foreign currency, usually the buyer. The seller is usually receiving payment in their home currency, so rate fluctuations won’t affect the value of their payment.
Here’s an example:
Your business in the U.S. which operates in U.S. dollars (USD) wants to buy 100 cases of tomatoes from a company in Mexico. You enter into a contract on May 1 and agree to pay for the shipment in Mexican pesos (MXN) when you receive the tomatoes on June 1.
You face transaction exposure during the month because of the possibility that the value of MXN will increase against the value of USD during that time. If the value of MXN goes up, you’re still spending the same amount in pesos, but you’re paying more in dollars than what you originally planned.
How Can You Lessen Transaction Exposure?
While you can’t control the fluctuations in the currency market, you don’t need to leave yourself exposed to every whim of the market. Currency exchange rates change rapidly, and most times, you buy something in a different currency, you’re going to have some transaction exposure until the transaction is finalized. However, there are ways to limit your exposure to transaction risk.
You can offset the risk in your international transactions by using hedging strategies. Hedging is a tool that helps you limit risk in your international transactions. Hedging is simply making an investment that can reduce the risk of rates moving against you. Monex USA can help you with the tools you need to hedge against the risk of transaction exposure. Some of the hedging tools we use with our client base of over 70,000 active commercial clients include:
Lock in rates with forward contracts. A forward contract lets you buy or sell currency at today’s rate, and pay for it at a later time that you specify. By putting down a small initial deposit, you can lock in a rate, free up your cash flow, and not worry about volatility in the currency market. Pay the remainder at the end of the contract, up to two years in the future.
Use multicurrency accounts to send and receive payments. Multicurrency accounts allow you to hold foreign currencies with no fees and no need to convert them to your own currency. If you buy and sell often in a particular currency, such as doing business with companies in Mexico, you can accept payments in MXN, hold it in your multicurrency account, and make payments from that account in MXN. You’ll save money on fees and currency conversion, while making it easier to budget because you have the currency you need to do business.
Choose your exchange rate with market orders. Market orders allow you to set the rate you want to buy currency and will execute the order when the market hits that rate. You won’t have to watch the market, your market order will execute automatically, even if it’s in the middle of the night or on a weekend. This allows you to set it and forget it, while you purchase currencies at favorable rates. Market orders can be a part of your business strategy to help protect your profits if rates are going down, or increase profits by buying more currency as rates rise.
Rely on the Experts to Help You Navigate the Currency Market
As if running a business wasn’t enough to handle, you also need to be aware of transaction exposure and take steps to lessen your risk. The experts at Monex USA can help you manage currency risks in your international transactions, protecting your profits and minimizing the potential for losses.
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