Foreign Currency Fluctuation – The Butterfly Effect

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Foreign currency fluctuation is a volatile beast – capricious, unforgiving, and to an unwary supply-chain business, dangerous to profit margins. It is a variable to global supply chains that operates with the ruthless unpredictability of a double-edged sword; capable of either obliterating profit margins or boosting them with one upward or downward swing on the FOREX currency charts.

While the risk of fluctuating foreign exchange rates on inventory can never be eliminated altogether, there remains a lot that can be done by businesses looking to contain and manage foreign currency risk proactively. But first one must understand the threats it poses to inventory, and operating profit in general:

No business is immune

In the global, integrated, and interdependent economy in which supply chains operate today there is no business – small, medium or large – that will remain unaffected by global currency fluctuation. Simply put, when the butterfly flaps its wings emblazoned with the symbol of a foreign currency in a market far, far away, there is nowhere for domestic businesses to hide.

Managing inventory efficiently within this constantly shifting global landscape is challenging enough without having to contend with the uncontrollable and unpredictable surges and drops in currency value.

Many businesses new to operating a global supply chain fall too easily into the trap of believing that the risk posed by fluctuations in currency exchange rates is one posed only to firms that deal in foreign investment. This line of thinking often leads to some nasty surprises down the line.

A study by SunGuard Data Systems revealed that 59% of the 275 US-based businesses it polled reported losses or gains in excess of 5% as a result of foreign currency fluctuations in the preceding year. For businesses – both large and small – 5% points taken off or added to profit margins can amount to many millions of dollars.

Furthermore, it is important to note that the majority of the companies affected by currency fluctuation are not international FOREX investment firms in the business of hedging currencies – as is the main assumption by new businesses setting up a global supply chain – but rather businesses involved in trading, manufacturing and production and retail.

Think you’re safe because you source and sell domestically? Think again.

What many businesses that do not export or sell internationally often overlook is how much impact foreign currency fluctuations can exert on their business operations here at home. As more and more countries set off down the path of divergent monetary policies the global stability of the central currencies – the USD, EURO, Japanese YEN – have become increasingly unsettled.

These changes can have a significant impact on the operating profitability of all organizations – both global and domestic. So what does this have to do with the business sourcing inventory and selling domestically with no activity in international markets? Everything.

While domestic businesses may not feel the impact of foreign currency fluctuations directly – as it impacts on the cost of inventory – they will definitely feel it when international businesses who sell in the same domestic market are suddenly able to out price them due to sudden changes in the strength of foreign currency.

The importance of currency fluctuation on businesses competing in the same market as other companies, who are able to source their goods and labor from other markets, is one that must be taken into consideration and planned around.

This being the case, the successful business is the one that values the importance of managing the risk foreign currency fluctuation will have on their inventory management operation. While there is no bulletproof risk management strategy to insulate your business from loss completely, there are a number of key strategies that can and should be implemented, to hedge against spikes and dips in currency value and how these can either positively or negatively impact your inventory costs, and therefore your profitability.

1. Establish a currency exchange rate baseline with international suppliers

Good inventory management protocol, with regards to sourcing from international suppliers operating in a foreign currency, is to always establish a baseline currency exchange rate agreed to by both parties.

Negotiating an agreement with your supplier that the exchange rate at the time you receive the quote will be the same exchange rate used to calculate payment just prior to, or upon delivery of the goods, will insulate your business from the risk of having to pay more for the goods than you agreed to, should your local currency weaken against that of your supplier.

This also means that forecasting, budgeting, and more efficient inventory purchase planning can be carried out, since your inventory management team will be able to work with a stable and predictable pricing structure.

2. Request suppliers to quote in your own currency

Retain the home-ground advantage by asking your suppliers to quote in your local currency – such as NZD, USD or AUD. This is the most commonly touted piece of advice to new businesses looking to mitigate the risk to their inventory costs through foreign currency fluctuation.

It is important to keep in mind however, that while requesting quotes and payment to be made in your local currency will help insulate against the risk of currency fluctuation, it is still important to stipulate and agree to an exchange rate baseline in supply agreements up front.

Establishing a clear exchange rate baseline with your suppliers in your supply agreement lays the foundation for the implementation of more effective risk management strategies for your inventory.

3. Factor exchange rate risk into your margins

Adjusting your margins to absorb the risk of foreign currency fluctuation is another way businesses can create an additional buffer against loss. Process managers should liaise closely with the finance department – particularly the risk management team if one is in place – to ensure that your inventory management remains in sync with the risk management strategies put in place.

Investing in a powerful inventory management software solution like Unleashed is critical for financial planners to be able to carry out these calculations correctly. The last thing a business needs is to inflate its margins beyond being competitive, due to an inaccurate appreciation of its inventory situation.

A comprehensive and effective inventory risk management strategy is essential for all businesses – domestic and international – to guard against the effects foreign currency fluctuation can have on their operating profit. By ensuring that exchange rate baselines are drawn into supply agreements, requesting quotes in your own currency, and factoring foreign currency exposure into your margins, businesses will be better placed to manage the threat of foreign currency fluctuation to their inventory costs.

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Melanie - Unleashed Software

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.

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