Forex, the digital investment ecosystem with the largest number of participants and transaction traffic in the world, includes not only individual investors but also businesses offering global services and products.
Investment projects, along with potential returns, also carry risks, and investors should be prepared for these risks.
Forex markets also experience occasional fluctuations, a dynamic that increases the importance of foreign exchange risk management for its participants.
For businesses, conducting all financial transactions in fiat currencies with enhanced liquidity and low volatility, such as the USD or EURO, carries a significant degree of risk.
Therefore, it may be necessary to diversify all cash reserves between different currencies rather than a single currency.
For businesses operating in global markets, maintaining cash reserves requires preparation for potential internal vs external fx risk management.
There are many proven strategies, research, and approaches to this preparation process.
What Is Foreign Exchange Risk in Global Business?
Foreign exchange risk is critical for businesses operating globally. Businesses operating at this scale may have different currencies for payments received from customers and payments made to suppliers.
A potential forex crisis could disrupt the financial planning of such businesses. For example, a business operating in import and export sectors might manage payments through contracts, sometimes six months in advance, sometimes a year in advance, using checks.
In such a forex crisis, the terms of the contracts could cause the company to suffer financial losses.
It's recommended that businesses operating globally always have a plan B for currency risk management and prioritize risk management strategies.
How FX Risk Affects International Companies?
FX risk is considered a significant problem for international companies, sometimes enough to lead to bankruptcy.
Businesses active in global trade cannot manage their financial transactions solely in a single currency, so they can be significantly affected by potential currency fluctuations, both positively and negatively.
For a business purchasing raw materials in USD, an increase in the EUR/USD exchange rate can directly reduce profit margins.
Previous investment projects for these businesses also experience lower returns.
For international businesses, it's recommended that a team be assigned to forex risk management for businesses and collaborate with a reliable online FX platform.
Investors and businesses that fail to engage with the FX exposure management process and fail to prepare in advance may struggle to manage cash flow in a potential crisis.
Until recently, large companies in many countries were forced to make significant downsizings during currency crises because they failed to develop appropriate risk management approaches.
Common Types of Foreign Exchange Risk
The most common types of foreign exchange risks for businesses across various sectors today fall into three main categories: transaction, translation, and economic risks, and these risks can have different negative consequences for businesses across different sectors.
Transaction risk involves the potential for losses incurred in transfers made in different currencies, while translation risk focuses on the losses incurred when converting between different exchange rates. However, compared to these two, economic risk poses a greater risk.
Unfortunately, this type of FX risk can lead to the loss of future assets, market power, and even reputation.
Therefore, it is critical for businesses to collaborate with reputable online FX trading platforms like BlueSuisse to effectively combat potential risks.
Real-World Examples of FX Risk
The negative scenarios FX risk poses for global companies can be observed not only in theory but also in practice.
- Let's assume a French company purchases raw materials from the US in USD. A potential price increase in the EUR/USD pair would force the company to purchase raw materials at higher costs.
- Another scenario is the USD/JPY pair. A company that frequently makes commercial payments with its suppliers in Japan could experience a decline in sales revenue due to fluctuations in the USD/JPY pair.
To avoid such negative consequences, it's crucial for businesses to manage their FX trading processes with reputable platforms like BlueSuisse, which offer integrated FX exposure management tools. Learn more by opening a demo account with BlueSuisse.
Why Managing FX Risk Is Crucial for Businesses?
The effects of FX risk in international business can sometimes be significant enough to cause a business to go bankrupt. Businesses from various sectors are directly affected by FX crises, even if they don't manage FX trading projects.
If a company develops a mitigation plan against potential FX crises, it can maintain its financial stability even under different market conditions. It avoids fixing its financial profit targets and maintains its cash flow as planned.
Unfortunately, during the global pandemic of 2020, many companies declared bankruptcy due to their vulnerability to FX risks.
If you, a global business, want to develop a systematic hedging plan against FX risks, you can access corporate services now by visiting BlueSuisse.
Internal vs. External FX Risk Management
Internal measures may not always be sufficient to sustain foreign exchange exposure control. An examination of the FX risk management methods of large enterprises active in global trade reveals a multifaceted approach, such as Internal vs. External FX risk management.
Internal methods typically involve hedging, implementing currency alignment targets, and developing exchange rate options, while external methods evaluate financial instruments such as forward contracts and options. Combining these two approaches will yield effective results.
FX Hedging Strategies for Companies
Companies can also try the hedging strategies employed by individual traders as part of their exchange rate protection policies.
The most common foreign exchange risk strategies that can be considered hedging can be listed as follows:
- Forward contracts
- Currency swaps
- Options
- Natural hedging
Just as they combat FX risk for investors, these methods provide effective results for businesses, minimizing losses from potential future exchange rate risks.
Best Practices for Corporate FX Risk Policies
The measures and policies companies must take against FX fluctuations and crises must have a corporate approach and differ from individual FX exposure management in many aspects.
Businesses active in global trade that successfully maintain this approach generally measure currency risk periodically using metrics and publish reports.
Even with reliable currencies like the dollar or euro, potential market fluctuations can occur. This ensures that the company's financial management is constantly vigilant against potential scenarios
Furthermore, using risk management tools and collaborating with reputable platforms like BlueSuisse, which offer these tools, reduces the likelihood of failure through professional consulting. To learn more, open your live forex account in just a few steps.