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Sometimes businesses avoid trading in multiple currencies because they are not familiar with the process (a lack of confidence, perhaps?) but it really isn’t complicated. In this blog post I give a brief overview of how to do business in multiple currencies.
To begin, you will need to open a bank account in each currency. A business in the UK, for example, might open a Euro bank account.
When running a business you will need to view financial reports in one currency, so if you trade in multiple currencies, you will need to assign them all a value.
Sticking with the example just mentioned, you may have a Sterling bank account and a Euro bank account but you want to view your accounts in Sterling – you therefore need to assign a ‘cost price’ for Euros.
You can set the cost price for each of your currencies in your accounting software. A selection of the most popular include:
You can update the cost price of currencies as frequently as you like. My company updates the figure monthly. We use the figures provided by the Inland Revenue (we use these because they are the same figures HMRC use to calculate VAT – no nasty surprises!). You can use different figures or update it more frequently if you wish. Your accountancy software will be able to provide an up to date figure should you require it; most accounting programs are able to generate figures hourly.
Whatever value you give your currency, you must always remember that the currency is not exchanged into Sterling at that moment – it’s just a figure – your accounts essentially contain a snapshot. The true value of your currency won’t be realised until you exchange it.
Let’s say you receive 100,000 Euros and want to convert it into Sterling. On the day you receive it the exchange rate might be 1.40. When you exchange it the rate may have dropped to 1.39. This small change doesn’t sound much but it will cost you over £500 – and the fluctuations can be much, much bigger than this – from one week to the next the difference on 100,000 Euros could amount to many thousands of pounds.
The number of decimal points you use is also important, especially when trading larger amounts.
The way my business manages multiple currencies has changed over time. Initially we were invoicing customers in Sterling but buying the raw materials in Euros. This opened us up to big exchange rate variances when we have to pay for raw materials. We essentially had to ‘buy’ Euros to pay for raw materials.
Businesses use Foreign Exchange (FX) companies to buy and sell currencies. When you are buying a currency you want the exchange rate to be high. I found it best to select a few companies and play them off against each other. They normally offer you very good introductory rate but will creep it up over time. Playing companies off against one another means you will always get a good deal.
One popular one is FX International Payments from American Express. A perk of using the Amex platform is that you earn Membership Reward points, which can be redeemed for flights and hotel stays, so all other things being equal this will sway the decision to use Amex over another provider. If you’re interested in this, you may want to read my article called How To Collect Airmiles Through A Business.
Over time my business took the decision to start invoicing some of our customers in Euros. This meant we were buying raw materials in Euros and invoicing customers in Euros. Businesses can be averse to doing this because it creates work. The major advantage is greater stability because it reduces your susceptibility to exchange rate fluctuations.
I said earlier that when you are buying a currency you want the exchange rate to be high. Conversely, when converting currencies back (e.g. converting Euros back into Sterling) you want it to be low. The ideal solution for a business is to wait until the exchange rate is favourable. Unfortunately most SME’s don’t have funds lying around to enable them to do this. This is doubly likely if you are a high-growth business (because growth costs money).
At this stage you may want to consider Forward Contracting. A forward contract is “a contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today”.
Forward Contracting will ‘lock in’ the exchange rate in return for a small percentage-based fee. This will stand even if the exchange rate changes. Essentially it is gambling; if the rate goes one way you win, if it goes the other way you lose. There will always be a risk that you make a trade then the exchange rate moves one way or the other. It’s difficult to predict and there will always be macro-economic factors impacting the exchange rate. But all businesses are in the same boat, so try not to worry too much, trading currencies is just part and parcel of running a modern company on a global stage.
Alternatively, a business could consider other sources of finance to avoid a poor exchange rate. The most obvious example would be an overdraft; if exchange rates are on the up, you may be better off allowing some time to pass, even if it means going temporarily overdrawn. It’s a case of weighing up the options – risk losing a few thousand pounds on a trade – or incur the overdraft charges.
One other consideration is tax. Payments to companies overseas will generally not incur VAT but payments to companies in the UK do – even if two UK companies are doing business in Euros – they will still have to account for VAT.
I am personally finding an increasing number of companies trading in Euros – even UK businesses – which is the upshot of globalisation. If done correctly, doing business in multiple currencies should be self-improving. As a company learns and understands more about the intricacies of trading currencies they will inevitably become better at it. It’s a constant refinement process. As are most things in business.