When doing business with foreign countries who prefe4 to pay I their local currencies consider your option to manage and mitigate foreign exchange risk. From the viewpoint of USA export, foreign exchange risk is the exposure to potential financial losses due to depreciation of the foreign currency against the US dollars. For instance, USA goods are sold to European company for 1 million Euro pounds and at the exchange rate of £1 to $1.25 in a 60-day payment term. If the exchange rate remains the same when the payment is due, the USA exporters receive $1,250,000. However, if Euro’s value weakens to an exchange rate of £1 to $1.20, the exporters receive only $1,200,000. That’s a loss of $50,000. Such losses can have a big impact on your company.
The good news is that there are practical options to help manage foreign exchange risk to avoid potential currency losses. They include:
- The exporter negotiates a forward contract with a bank or a foreign exchange service provider if the importer is credit worth or an established customer. This is the most direct and common method used. The contract ensures the US exporter will receive a predetermined payment in US dollars. To set up a forward contract, an exporter must know the foreign currency amount, when the importer will pay, choose a currency exchange delivery date.
- The exporter accepts foreign currency payments only with cash in advance. The method is simple, ensures full payment and is the most risk-free. It is ideal for small transactions as well as for new relationships with importers. The drawback is that cash in advance is the least method for importers.
- Match foreign currency receipts with expenditures. In this method, the exporter sets up a foreign currency bank account to conduct transactions and eliminate currency conversion fees. It is ideal for US exporters that they may use the same foreign currency with different trading partners. The drawback is the cost and effort required to:
- Maintain a foreign currency bank account
- Received gains and losses resulting from currency conversions in financial statements
Consult with your bank before agreeing to the importer’s foreign currency payment request.
Questions to ask:
- When should an exporter consider selling in a foreign currency?
- How common is it for a small exporter to set prices in a foreign currency?
- What type of transactions is more suitable for foreign exchange?
- What are the fees for using a forward contract?
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