Hedging your bets

Any company currently doing business in the UK, the US or anywhere else outside the euro zone would be well advised to strike up a relationship with their bank’s foreign-exchange department.

Accountant Padraig Casey of Meade Casey & Co warns that simply allowing currency developments to take their course can seriously affect working capital and also mean selling at a loss for many businesses. “I believe in certainty,” he says. “If you are exposed to sterling you need to know what you will be getting and when, so you can work your costs accordingly.”

Thus, all companies that are buying from or selling into Northern Ireland or the UK regularly need to hedge their exposure. This may sound difficult but actually just means that you are booking the exchange rate ahead, usually by three or six months, although banks will quote you for any period you like.

Of course, you will need a good relationship with your banks to be able to do this as you are effectively promising to pay a certain price in the future. However, while loans may be thin on the ground and credit hard to come by, all banks are likely to be willing to set up a relationship with the foreign-exchange department. Larger customers may have accounts directly with their bank’s treasury department.

Failure to hedge your transactions could leave your business exposed on the cost side if you have large currency movements. Without hedging, you could find you have lost money on a transaction simply because of the currency movement.

For example, if you made a big sale into the UK and sterling then plummeted 20pc while you were waiting to be paid, the money you’d receive would be worth 20pc less. Not only would you have lost money on the deal if you are, say, operating a 10pc margin, but you would also have 10pc less going back into cash flow.

Casey says that most clients are happy with some sort of certainty and will go down the hedging route, which will provide them with the actual costs they are going to incur. “After all, most businesses are not in the business of playing foreign-exchange markets – they simply do not have the information or the expertise.”

Nonetheless, Casey says he does have some clients with a lot of sterling on their balance sheets, particularly given the explosion of business with Northern Ireland in recent years. “We are saying to use that sterling to pay sterling bills.” Many businesses also have euro costs and would normally increase prices if they were selling into the UK and sterling was falling. However, recession in that market makes such a course of action very difficult. One solution is to try to offset some of the burden by purchasing in sterling.

Of course one size does not fit all. Some businesses will arrange to buy or sell sterling from their bank’s foreign exchange department to cover a specific transaction. In other words, if you had to pay a sterling bill in 60 days’ time, you would call and book a rate for 60 days hence and cost it accordingly. If you had sterling coming in in 60 days’ time you could sell it forward – that way you could put it into your cash flow.

Rather than booking individual transactions ahead, some companies prefer to book all their exposure three or six months, or occasionally even a year, ahead. The problem, however, is that many are unsure how much business they will actually do in the meantime to satisfy this. Going down this route depends very much on your appetite for risk as the potential for it to go wrong is considerable.

Even Michael O’Leary got caught out twice in this way in recent years by firstly refusing to hedge the price of oil before it rose rapidly, and then hedging just as it began an even more rapid descent.

Ultimately, says Casey, the best advice is probably to go for about three months and, as and when you have sales coming through, book accordingly. “That way you are not putting yourself at risk of whatever trend the global foreign-exchange markets follow in the next few weeks. After all, there is at least idle speculation that sterling could hit €1.20, and if that were to happen almost all Irish businesses would be selling at a loss.”

However, hedging is not open to all as some banks have lower limits of as much as €40,000 to deal. As a result, businesses are pursuing a range of different strategies to survive. Many are now trying to do deals with their clients where they will be paid in euro, even in the UK. With the UK also in recession, it is surprising how many will agree to it and there are bargains to be had, says Casey.

Other strategies employed by some businesses include using milestone or regular payments in order to reduce the time between payments. However, with the credit crunch being felt globally, many businesses are simply not in a position to be able to facilitate this.

At the end of the day, if you have significant currency exposure you should think about hedging. Taking action by talking to your bank and setting up an account could make a big difference to your working capital.

Case study

Brockley group

Nicky Holmes runs the Brockley Group, an importation, manufacture and distribution company that imports from the UK as well as continental Europe. The company has a fair amount of exposure to sterling, both sourcing products in the UK, for which it must pay sterling, and selling Irish manufactured products such as BlueCat AdBlue into the haulage business there and in Ireland.

“We always hedge all our exposure – after all it’s not our core competency area,” explains Holmes. “We believe in hedging our complete exposure so that way we can manage our costs and our cash flow. There are times when people say that a particular currency is such good value, but we just have a simple rule, and that is to hedge 100pc of our exposure. Then there are no uncertainties.”

He warns that if a currency call goes wrong it can have a dramatic effect on your business and can easily wipe away all profit. “Our rule is to lock in the margins at the beginning. Far better to do that than be sitting there sweating, wondering if your currency call is going to come right. On a very odd occasion when it looks as if a currency will keep moving in a positive direction for us, I might say, ‘Sure, there is no urgency, I’ll call tomorrow’, but that is not at all frequent.”

And the procedure, it seems, is painless. “If I know that we are going to have some sterling in three months’ time, I simply ring my bank and ask what rate they can give me in that time. Sometimes we might call two or three banks and look for the best rate, as it can vary from bank to bank and indeed from hour to hour. The amount we pay is in the spread, so like any other business if you have a large account or if they know you call around you may get a better rate.

“What we also do on occasion is to offer varying incentives to customers to pay now. For example, we may have a 1pc discount for early settlement and 2pc for immediate cash. That’s best as that way there is no exposure at all.”