Managing Foreign Currencies Made Easy
THE NEED TO MANAGE FOREIGN CURRENCIES
The proliferation of technology applications today creates the opportunity to do business with our customers and suppliers and associates in any part of the world.
Firms in Singapore can now sell goods and provide services to customers outside Singapore and can also buy materials and suppliers from overseas suppliers.
Overseas customers pay USD, JPY, EUR, etc to firms in Singapore, and overseas suppliers demand payments in USD, JPY, EUR, etc from Singapore firms.
Such payments and receipts in foreign currencies bring about risks. If the Singapore firms pay more or receive less in SGD values eventually, the firms suffer losses in foreign currency transactions.
It is therefore important for all firms to understand and manage foreign currencies effectively.
BUYING AND SELLING FOREIGN CURRENCIES
Before we decide to buy or sell foreign currencies, it is important to know how to read foreign currencies? Should we read the currency rate as SGD2.00 to one GBP, or 0.50GBP to one SGD?
Well, the first question we should ask is, where are we now?
Let’s say we are in Singapore. So, SGD is the local currency, and GBP is the foreign currency.
So, we are buying or selling the foreign currency, i.e. GBP.
Therefore, we should use SGD2.00 to one GBP. (SGD 2.00 / GBP). Why?
To understand this, imagine you go to the supermarket and want to buy a bottle of soft drink.
Does the price tag say “0.5 bottles per SGD” or “SGD2.00 per bottle”?
The price tag writes “SGD2.00 per bottle”. This is the same principle applying to pricing the foreign currencies.
OVERSEAS CREDIT TRANSACTIONS BRING ABOUT FOREIGN CURRENCY RISK EXPOSURE
Two situations bring about foreign currency transaction exposures.
The first situation is that the firm is dealing with overseas customers. Let’s say a company in Singapore exports goods to customers in Japan and allows the customers to settle payments in 90 days. The settlement currency is JPY. Such credit arrangement brings about foreign currency transaction risks. This is because the foreign exchange rate 90 days later may not be the same as that of today. The worry is that the firm will receive less in SGD term if the JPY depreciates over this 90-day period.
The second situation is that the firm is dealing with overseas suppliers. Let’s say a company in Singapore imports goods from suppliers in the U.S. and the suppliers offers the Singapore firm to settle payments in 90 days. The settlement currency is USD. Such credit arrangement brings about foreign currency transaction risk. This is because the foreign exchange rate 90 days later may not be the same as that of today. The worry is that the firm will have to pay more in the SGD term if the USD appreciates over this 90-day period.
All firms, regardless of size, face foreign currency risk exposure. Even purely domestic firms dealing with only local customers and suppliers face such risks. For example, ABC, a Singapore firm buys materials from DEF, local suppliers in Singapore. The transaction settlement is SGD. On the surface, there is no foreign currency exposure. However, the DEF obtains the materials from overseas. If DEF has to pay more in SGD terms to the overseas supplier, then it will pass on the cost increase to ABC.
APPRECIATION AND DEPRECIATION OF FOREIGN CURRENCIES
If the price of the soft drink changes from SGD2.00 per bottle to SGD3.00 per bottle, we say the price of the soft drink is getting expensive.
Similarly, if you discover that the price of GBP changes from SGD2.00 per GBP to SGD3.00 per GBP, we say the price of the GBP is getting expensive. In short, the foreign currency, GBP, is appreciating.
On the other hand, if you discover that the price of GBP changes from SGD3.00 per GBP to SGD2.00 per GBP, we say the price of the GBP is getting cheaper. In short, the foreign currency, GBP, is depreciating.
If we predict the price movement of foreign currencies correctly, we can help the company to reduce the risk of suffering cash losses due to foreign currency transactions.
If we predict that the foreign currency is appreciating, we should speed up paying our overseas supplier as early as possible. This is because we need more SGD to settle the foreign currency payment if it appreciates. On the other hand, there is no urgency to shorten the credit terms of overseas customers if foreign currencies appreciate.
If we predict that the foreign currency is depreciating, we should speed up collections from our overseas supplier as early as possible. This is because we may receive less SGD if the foreign currency payment if it depreciates. On the other hand, there is no urgency to pay our overseas suppliers if foreign currencies depreciate.
In short, the strategy to act early (paying or receiving the money early) is called “leading”, and the strategy to act later (delay in paying or receiving the money) is called “lagging”.
Foreign Currency Management Skills
In today’s fast-changing business development, it is very important for the management staff in any organization (private sectors, not for profit organizations, social services providers, etc) to acquire the following skills when managing foreign currencies:
• Understand the various factors influencing the foreign currency exchange rate
• How to predict foreign currency exchange rate movements
• Implement effective foreign currency hedging strategies
To know how to manage foreign currency, we have created an intensive 1-day workshop on “Effective Foreign Currency Risk Management” to enable participants to understand different foreign currency terms and hedging strategies.