International Business

How Do Exchange Rates Affect Business?

With the world becoming increasingly interconnected through the power of globalization and the emergence of technology, business foreign exchangeor preferably known as business fx has taken on an entirely different dimension.

Meanwhile, due to the ad hoc nature of currency markets, exchange rates shift from day to day and even from minute to minute, sometimes in small increments and even quite dramatically. In practice, however, changes in exchange rates affect entrepreneurs  in two broad ways:

  • By changing the cost of supplies that are purchased from a different country
  • By changing the perceived value of their products to overseas customers.

What Exactly are Foreign Exchange Rates?

Simply put, the exchange rate (foreign exchange rate) between two currencies is the rate at which one currency can be converted into the other. Several factors influence the exchange rate between any two currencies, including the level of economic activity, market interest rates, the GDP, and the rate of unemployment in the countries involved.

In exchange rates, one currency can purchase a certain amount of foreign currency. Businesses that conduct domestic business should also be aware of changes in exchange rates because they can affect the wider economy indirectly.

In that regard, here are a few guidelines to grasp the full impact exchange rates have on businesses:

  1. Selling Overseas

The exchange rate will have a direct impact on your bottom line if you run a business that sells products or services abroad. This is largely determined by how invoices are issued.

However, in the case of invoices presented in foreign currency, if the exchange rate moves against you from the time the invoice is issued and the payment date, you risk receiving less money than expected. Consider these two scenarios:

  • Issuing invoices in your own currency will have a lesser impact since the overseas purchaser must convert their local currency into yours to pay.
  • If the exchange rate fluctuates, you’ll still receive the full invoice amount.

As a result of exchange rate fluctuations, your prices could become uncompetitive, causing you to lose market share to foreign competitors, who do not have to include transactional exchange rate changes in their pricing.

  1. Buying Overseas 

In the same way as when you sell overseas, if you deal with a supplier from a foreign country, exchange rates can fluctuate. For instance, if you are planning to buy goods from China and your contract requires payment of 300,000 Chinese Yuan for your next shipment in a month, at a current exchange rate of 8.74, your invoice would amount to £34,330.83 if paid today.

As a result, if the exchange rate moves to 8.8 a month later, the invoice would increase to £34,090.90, which is a reduction of £239.93 for the same shipment of goods. Whereas, if the exchange rate were to go in the other direction, the same amount of goods would cost more. 

  1. Indirect Impact

Changing exchange rates can also have an indirect impact on your business, even if you do not buy or sell foreign goods. In a situation where you transport goods across the country via delivery trucks and fuel costs increase due to changes in the exchange rate, you will incur greater transportation costs.

Similarly, currency fluctuations can also affect the competitive landscape. In the case of depreciation of your local currency, importing goods becomes more expensive and this could result in fewer imports. This should lead to an increase in sales, profits and jobs for domestic companies. 

To Conclude

Different ways of approaching the currency market use different methods and techniques. With spot contracts and short-term forwards, moving money between currencies is quick, easy, and efficient.

Nevertheless, this may introduce some risk to your business, since you can’t predict what the exchange rate will be on your future transfers. Ultimately, regardless of what you do, what matters most is your business, how you deal with foreign exchange, and the way you approach it.