The risk management landscape for inventory-centric businesses can sometimes seem like it’s fraught with an endless amount of problems and pitfalls. Restrictive product lifecycles, unpredictable demand and underperforming departments, among many others, all contribute to sizable management headaches. Foreign currency risks can affect the costs associated with buying, carrying and selling inventory. To what degree will depend on how much of a business’ inventory is bought or sold overseas.
For smaller businesses in particular, some of these more ‘far away’ problems end up relegated to the low priority bin, due to a lack of manpower, time or expertise. While many businesses can operate like this for a while, inevitably the time comes when these issues must be dealt with.
While it’s not realistic (or sensible) for companies to try and predict currency fluctuations, most successful businesses will have a risk management strategy that includes a workable approach to foreign currency risks. When it comes to inventory management, pragmatic risk analysis and strategizing is essential for long-term business success.
Identify products with thin margins
One way that foreign currency fluctuations can greatly affect a small business is if they are selling products overseas with small profit margins. During times of fluctuation, these margins can become damagingly reduced.
If a business in New Zealand is selling products in the United States, changes to the dollar value can distort the balance between costs and revenues. The business is generating revenue in U.S. dollars but incurring costs in NZ dollars. During times of stability, this can be navigated with a fair amount of ease, but during times of fluctuation, the water starts to get muddy.
An important step for small businesses to take is to monitor both the margins of products being sold overseas and the value of the relevant currencies. In some cases, it may pay to increase the margin on certain products as a safeguard against significant changes. When the margins are small, even a 3-5% fluctuation can effectively destroy the profitability of selling a product to overseas customers.
Avoid large overseas sales with delayed payment
A common trap that can cause problems for smaller businesses is selling an item in bulk with delayed payment options. If your customer has agreed to pay in a months’ time, then any change in currency value will affect the true cost of the transaction. A good idea for small or start-up businesses is to avoid this situation as much as possible. If unavoidable, a forward exchange contract can be used.
Enter into a forward exchange contract with your bank
A common way to mitigate the risk of future currency fluctuations is to use forward exchange contracts. Put simply, this means ‘locking in’ the current currency value on a future transaction. If you have an obligation to make or receive a payment from a foreign client at some point in the future, you can effectively buy the required dollars in advance. This type of ‘hedging’ is one of the best ways that a business can guard against currency uncertainty.
Buy in bulk during favorable markets
Some businesses use targeted approaches to offset currency risk like buying products or parts in bulk. While this isn’t always possible due to spoilage risk or lack of capital, it can be a good way to take advantage of favorable markets.
Transfer foreign currency risks to your overseas suppliers
Transferring risk to your overseas suppliers is an easy way to offset some of the burden on your business. While not all suppliers may agree to do so, it’s worth requesting that all quotes are provided in the currency of the country where your business is based. This can help guard against distorted accounting and surprise fluctuations.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.