Foreign exchange essentials
Whether you’re importing or exporting, an unexpected change in the value of the dollar can put a real dent in your profits. So it’s important to understand foreign exchange risk, then think about how you can control it.
Foreign exchange or forex is a hot topic for business owners trading overseas, and it’s not hard to understand why. Most offshore transactions take place in a foreign currency, typically US dollars or Euros. This means that an unexpected surge or slump in the value of the Aussie can put a hole in your pocket — or a smile on your face, depending which side of the fence you’re on.
Remember, the Australian dollar has a floating exchange rate, which simply means that its value can rise and fall from day to day, at the whim of the market. The dollar that was worth 97 US cents on the day you sent your order may have fallen to 87 cents by the time the goods arrive, four weeks later.
In the first eight months of 2008 the dollar moved in a range of around 12 US cents, which is about the annual average since it was floated in 1983. But that doesn’t mean more rapid movements are out of the question. For example, in February 1985 the dollar fell by around 8% in a matter of days. If you’d been an importer working on a 20% margin and you’d been exposed to that fall, then your profits would have been slashed by a third. Not pleasant.
So how do changes in the value of the dollar affect you when you’re buying or selling offshore?
| Importers | Exporters | |
|---|---|---|
| Rising Australian dollar | Reduces your costs | Reduces your profits |
| Falling Australian dollar | Increases your costs | Increases your profits |
| Example |
You place an order for USD50,000 worth of shoes from India. At the time, the Australian dollar is worth 90 US cents, so you set aside AUD55,556 to pay for the order. But when the shoes arrive three months later, the Australian dollar has fallen to 80 US cents. That order’s now going to cost you AUD62,500 — an extra AUD6,944. |
You receive an order for EUR30,000 worth of furniture from Germany. At the time, 50 Euro cents will buy you one Australian dollar, so you expect the sale to be worth AUD60,000. But when the furniture arrives in Germany, three months later, the Australian dollar has risen to 60 Euro cents. That means your order is now only worth AUD50,000. |
Obviously the size of your currency risk depends on your payment terms and the size of each transaction. But in many cases it’s a risk worth guarding against. So how do you go about it?
Here are some of the options:
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Forward Foreign Exchange
A contract that allows you to lock in an exchange rate for a specific date. The big advantage of forward foreign exchange is that it allows you to plan with certainty, even if a transaction isn’t due to be settled until a future date. -
Currency Options
Gives you the right, but not the obligation, to exchange at a specified rate on a specified date. -
Flexible Forwards
Flexible Forwards combine the security of a Forward Exchange Contract and the flexibility of a Currency Option. With flexible forwards, you can protect your business against adverse exchange rate movements, while still benefiting if the exchange rate moves in your favour.
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Important information
As this advice has been prepared without considering your objectives, financial situation or needs, you should, before acting on the advice, consider its appropriateness to your circumstances. All products mentioned on this web page are issued by the Commonwealth Bank of Australia; view our Financial Services Guide (PDF 59kb)
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