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FX Averaging: Pros and cons for your currency hedging

FX Averaging: Pros and cons for your currency hedging

This article is written by HedgeFlows FX Averaging helps remove the risk of picking the wrong timing for your FX transactions.  Instead of risking the uncertainty of selecting the wrong day or time for your currency purchase, where you may encounter an unfavourable exchange rate, FX averaging breaks down the transaction into smaller increments, spreading them evenly over a designated period. Businesses commonly opt for monthly averaging, although the timeframe can be adjusted to suit individual business requirements. This approach ultimately results in more consistent exchange rates, steering clear of the short-term highs and lows of currency fluctuations: Using FX averaging in practice Utilizing an averaging strategy proves beneficial for businesses experiencing consistent FX exposures over time. Take, for instance, a retail e-commerce enterprise where daily foreign currency sales flow steadily and predictably. Rather than incurring substantial (2%+) FX conversion fees through payment processors like PayPal or Stripe, businesses have the option to accumulate funds in foreign currencies and employ FX averaging with a provider such as HedgeFlows. This approach not only saves on FX conversions but also eliminates the FX risks associated with holding foreign currency balances. By leveraging cloud-based technology and API integrations, averaging contracts can align seamlessly with the frequency and settlement timing of payouts from e-commerce platforms, ensuring currency proceeds are converted at stable and foreseeable rates. What’s wrong with FX averaging for medium- and long-term currency risks While averaging proves effective in managing short-term timing risks, its effectiveness diminishes over longer periods, spanning months or quarters. Despite this, some businesses still rely on averaging for their extended currency management needs, often overlooking the real FX risks they face. Consequently, these businesses remain vulnerable to currency fluctuations over prolonged durations.  For example, raising capital in foreign currencies often creates the financial risk that the foreign currency depreciates, making the raised funding worth less in the home currency. Thus, this leads to a reduced runway. As explained in this post, these risks are greatest for longer periods, where currencies may have more time to move unfavourably. In this scenario, the averaging strategy would delay fixing exchange rates until future periods, focusing on spreading out transactions over a set timeframe, such as one month before the settlement date. Consequently, this leaves the business vulnerable to long-term FX fluctuations – a predominant risk in such situations. For more effective currency management in these cases, a static FX forward strategy or a more sophisticated, layering approach proves to be significantly more robust and beneficial. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

The Do’s and Don’ts of Payment Runs

The Do’s and Don’ts of Payment Runs

This article is written by HedgeFlows Managing accounts payable is a critical component of financial operations for businesses. Efficiently handling numerous invoices and payments can be a daunting task, but with the right process it becomes streamlined and automated. This article delves into the world of payment runs, shedding light on its benefits, best practices, and potential pitfalls to avoid. Five Practices for Optimal Payment Runs Five Payment Runs Mistakes to Avoid After a Payment Runs is Made Following a payment run, there is typically a reconciliation step where payments are recorded in the accounting system and reconciled against the bills that have been settled. Modern accounting systems and payment automation software can automatically reconcile payments and invoices. It is common practice to send remittance notes or emails to notify a recipient when their payment is being processed. This provides details regarding the bills or other payables that the payment encompasses. This practice is optional but fosters stronger relationships with suppliers and mitigates the risk of miscommunication down the line. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

FX Gains and Losses and Balance Sheet Hedging

FX Gains and Losses and Balance Sheet Hedging

This article is written by HedgeFlows Most businesses that trade internationally have FX gains and losses in their accounting systems and, if they are material enough, in their statutory reports. Their accountants often shy away from explaining these numbers to them. Even fewer would dare to guide their clients on minimising such losses. Yet, the answer is often simple – a straightforward Balance Sheet hedging programme. Understanding FX Impact At the core, it’s essential to grasp how foreign currencies affect business finances. Fluctuating exchange rates can lead to significant FX gains or losses, impacting the bottom line. These numbers are automatically produced by accounting systems, rarely looked at in great detail unless there is a big problem and thus rarely understood by business owners and their finance teams. A Well-Trodden Path – Balance Sheet Hedging Balance sheet hedging programmes have been used by businesses to minimise the impact of currency fluctuations on financial statements for years. Such a programme can be contained on a single-page document and have a simple goal – a zero number in the FX gains and losses line. The principle is simple – identify any material balance sheet items in foreign currencies and take steps to remove the sensitivity to FX swings, usually by hedging with FX forwards. Effective Hedging Strategies A few different techniques are worth considering when deciding how to deal with FX gains and losses: Data-Driven Decision Making Timely and accurate financial data is the backbone of successful hedging. It allows for precise risk assessment and informed strategy formulation. Systems like HedgeFlows can streamline this process by connecting to existing data in ERP or accounting systems. Pitfalls to Avoid Overhedging and underhedging are common mistakes. Balance is key to avoiding unnecessary costs or exposure to risk. Conclusion 2024 promises to be another uncertain year. Mastering balance sheet hedging is essential for avoiding FX gains and losses. It’s not just about mitigating risks; it’s about empowering your clients to thrive in a global market. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

Top 5 Mistakes Businesses Make With International Transfers

Top 5 Mistakes Businesses Make With International Transfers

This article is written by HedgeFlows International money transfers are a critical component of global business operations. However, the complexities of cross-border payments often trip up even the most experienced financial managers. Here are the top five mistakes businesses make with international transfers, along with essential tips to avoid them and ensure your money reaches its intended destination efficiently and securely. 1. Failing to Verify Recipient Details Mistake: Not confirming the recipient’s details can lead to funds being sent to the wrong account—a costly and sometimes irreversible error—or, even worse, becoming a victim of fraud. Prevention Tip: Always double-check all recipient details, including their name, bank account number, bank name, and country of residence. Consider implementing a verification call or email to ensure everything is accurate before you transfer. Implement a robust approval process to reduce the risk of wrong or fraudulent transfers. 2. Incorrect Recipient Name Mistake: In certain countries, such as China, the exact spelling of the recipient’s name is necessary. A minor discrepancy can lead to transfer rejection. Prevention Tip: Be extra cautious with the spelling of recipient names. Always request written confirmation of the recipient’s full name and ensure it matches their bank records exactly before initiating the transfer. 3. Confusing Correspondent and Recipient Bank Details Mistake: It’s easy to mix up correspondent and recipient bank details when sending SWIFT payments, which can send your money into banking limbo. Prevention Tip: Focus on the intended recipient’s bank details and use only those for the transfer. Correspondent bank information is not usually required but consult with your bank or payment provider if in doubt. 4. Using Expensive Swift Transfers where Cheaper Alternatives Exist Mistake: SWIFT transfers come with additional fees, which can add up if you make many payments. In many cases, alternative payment routes, such as SEPA for payments in Euros or ACH for USD payments to recipients in the US, can save money and often time. Prevention Tip: Explore different payment options and compare fees before making a transfer. In general, direct and local payments tend to be more affordable than SWIFT transfers. 5. Overlooking Transfer Fees and Hidden Costs Mistake: Businesses often focus on the convenience of the transfer without considering additional costs, which can pile up and make transactions more expensive. Prevention Tip: Understand the fee structure of your chosen payment provider, including the difference between flat fees and percentage-based charges. Comparison shopping and negotiating better terms with providers can lead to significant savings. Remember, due diligence and attention to detail are paramount when dealing with international transfers. By avoiding these common mistakes and following the prevention tips, you can ensure your business’s funds reach their destination safely while minimizing unnecessary costs and delays. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

The Allure and Pitfalls of Natural Hedging

The Allure and Pitfalls of Natural Hedging

This article was written by HedgeFlows As finance managers, directors and business owners tap-dance their way around the whims of the international currency market, the term ‘natural hedging’ serenades as a harmonious solution for currency management. It’s appealing, it’s suave, and it puts up a dazzling front of cost-savings—yet, as we slip behind the curtains, we unveil the unnoticed missteps that could cost the finale. Understand Natural Hedging Natural hedging is an intriguing dance with foreign exchange (FX). It’s the art of planning your business’s currency inflows and outflows—namely payables and receivables —to counterbalance each other within the same currency bracket. In an ideal situation, this would eliminate the need for currency conversion completely, leaving you immune to currency fluctuations. Effective natural hedging involves two primary steps like a well-choreographed step dance routine.  The Appeal The promise of natural hedging is a siren’s call—reduce transactional costs, evade conversion fees, and sidestep the volatile tango of the Forex market. Who wouldn’t be seduced by the prospect of skirting hefty hedging contracts or options, all while seemingly cutting down the currency risk? Three Missteps to Avoid 1. Holding Currency Balances: Working Capital Lock-In The first misstep in natural hedging is the lock-in of capital. It’s a subtle yet critical aspect often overlooked in the initial glow of potential cost savings. Due to the inherent unpredictability of business operations, cash flows can rarely be perfectly matched. You might receive payment in a foreign currency today, but your corresponding expenses in the same currency might not be due until the next month or even later. This discrepancy requires you to hold onto the foreign currency balance, effectively locking in your working capital. This phenomenon can restrict your liquidity and limit your capacity to quickly respond to other financial needs or investment opportunities. 2. Asking Suppliers to Change Invoicing Currency: A Hidden Cost The second misstep in natural hedging involves supplier invoicing. It may seem convenient to ask your foreign supplier to invoice in your local currency, eliminating the need for you to deal with currency exchange. However, this approach often comes with a hidden cost. While it’s true that you won’t have to worry about conversion rates and fees, your supplier will. To cover their risk and any currency conversion fees they incur, suppliers often embed a 2-3% currency exchange fee, or mark-up, into their invoicing. This additional cost is subtly woven into your payable amount, effectively increasing your expenses without your express knowledge. So, while it might seem like you’re simplifying your accounting, you’re actually paying more in the long run. 3. Matching Uncertain Cashflows: The Unseen Risk The third misstep in natural hedging is trying to match highly predictable cashflows with speculative cashflows. This approach seems tactical in theory, but it can backfire with serious repercussions. Let’s consider a scenario: your business has a probable inflow in a foreign currency from a dependable client, and you plan an outflow in the same currency, contingent on a speculative deal yet to be finalized. If all goes according to plan, these cashflows offset each other, and you’ve successfully implemented a natural hedge. However, should the speculative deal fall through, your business is left holding the foreign currency from the inflow, exposing you to the unpredictable swings of the currency market. Not only does this situation strain your company’s financials, but it also undermines the primary objective of natural hedging—for protection against currency risk. Hence, while matching cashflows, it’s critical to ascertain the certainty of both inflows and outflows to reduce potential exposure to currency risk. Alternative Steps One cannot ignore the allure of natural hedging, but it’s worth considering raised eyebrows at the simplistic beauty of this method. As an alternative routine, small steps like low-cost prebooking guaranteed FX for specific foreign invoices can equip businesses with the agility to maneuver through the FX market’s highs and lows, much like a planned adagio in a high-stakes ballet performance. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

REAL-TIME RECONCILIATIONS: THE CORNERSTONE OF FINANCIAL GROWTH AND SECURITY

REAL-TIME RECONCILIATIONS: THE CORNERSTONE OF FINANCIAL GROWTH AND SECURITY

This article was written by HedgeFlows In the often labyrinthine world of finance and accounting, real-time reconciliations may seem like another industry buzzword. Clumsily thrown around by those keen on the latest bells and whistles for their balance sheets. However, beneath the jargon lies an indispensable foundation for organisations aspiring to safe, agile, and robust financial operations. It’s more than technological fashion. It’s about securing a future for your business that is as dynamic as it is secure. THE BLUEPRINT FOR SAFER GROWTH Picture the mile marker in a marathon race—your reconciliations are exactly that in the financial journey of your business. They mark the progress with precision, and when every second counts, staying updated is not a luxury; it’s a necessity. Real-time reconciliations hold the key to a financially agile enterprise. This is due to an increasing global market and the advent of digital transactions. For accountants and finance managers, the need for precision is non-negotiable. Traditional methods, like manual data entry or delayed bank feeds, no longer keep pace with the relentless surge of transactions across the world. Delayed reconciliations are not just a bottleneck for daily operations. They can lead to costly errors and oversights that reverberate across the fiscal calendar. Timely reconciliation means better risk management, more informed decision-making, and, crucially, can unlock hidden capital within your operations. THE RISKS OF A RECONCILIATION DELAY The risk posed by outdated reconciliation processes is multifaceted and unforgiving. Financial discrepancies, whether in your sales pipeline or supply chain, can have a lasting impact on your standing in the market. A one-time error can lead to prolonged fallout in terms of client trust and investor confidence, which are currencies more valuable than any monetary capitals. Furthermore, the delay in recognising these discrepancies can lead to erroneous financial statements and misdirected funds, often with expensive trickle-down effects. It’s akin to trying to navigate a dense forest with an outdated map—not impossible, but certainly unwise, and downright costly in terms of efficiency and resources. SEIZING THE MOMENT: REAL-TIME APIS AND AUTOMATION The guard changes forever in the world of finance, and technology has heralded a new dawn for reconciliation processes. APIs (Application Programming Interfaces) that enable two-way communication between your financial systems and banking/merchant transaction feeds are empowering businesses to reconcile in real time. Automation is streamlining the once arduous task of matching volumes of transactions with unprecedented speed and accuracy. Imagine your banking data and your accounting ledger dancing in sync, providing a performance that is not only prompt but pristine. REAL-TIME RECONCILIATION CASE STUDIES Case studies are powerful exemplars of the transformative power of real-time reconciliations. Take a look at a travel company client of HedgeFlows, which saw a 60% reduction in errors and an 80% saving in resource hours by switching from manual to live reconciliations. On the other hand, a logistics company, after automating their reconciliation processes, noticed a marked increase in their working capital efficiency and a surge in their liquidity ratios, all due to the transparency and cash visibility in multiple currencies that real-time reconciliation affords. The stories are compelling—real-time reconciliations are not just a convenience; they’re the lifeline to a financially resilient business model. EMBRACING THE CHANGE For those pioneering the shift towards real-time reconciliations, the results are not just gratifying but can be paradigm-shifting. It’s about harnessing every transaction, every cash flow, as an opportunity to bolster the financial integrity of your enterprise. Organisations must no longer treat recon activities as just another back-office chore but as a strategic player in their growth trajectory. The takeaway is clear. In today’s dynamic economic landscape, being diligent and being delayed are as different as success and obscurity. Modern accounting technologies and systems exist not only to automate but also to amplify the competitive edge that real-time financial insights provide. TAKE THE FIRST STEP Real-time reconciliations are not speculative foundations for the future of finance. They’re a current-day imperative for a safe and sustainable financial future. The question is not if you can afford real-time reconciliations. But whether you can afford not to have them as your business grows. THE ROAD AHEAD The journey towards real-time reconciliation might seem daunting. But it’s a path paved with reductions in financial risks. Efficiencies that translate to the bottom line, and a compass holstered for strategic decision-making. For accountants and finance managers who seek to drive value and elevate their businesses, the time for real-time reconciliations is now. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.

FX Hedging is not Gambling

This article was written by HedgeFlows Many finance professionals in small corporations find dealing with foreign currencies quite challenging. Surprisingly, only 4% of UK SME exporters hedge their currency risks, while some businesses still consider FX forwards to be a form of gambling. This raises a question: why do most major corporations adopt FX hedging strategies while smaller companies often see it as an unnecessary expense? This article delves into the most common mistake made by finance teams when it comes to hedging and presents a more structured and robust approach to understanding this complex practice. The most Popular (and often wrong) Reason for Buying FX Forwards Numerous finance professionals view the primary aim of “hedging” using FX forwards as securing a more favourable FX rate for future transactions. While this notion holds some truth, it fosters a decision-making framework that is too flexible, leading to unpredictable incentives and behaviour. Traditional FX forwards are by far the most popular hedging instruments and enable businesses to fix today’s exchange rates for a specified amount of currency to be exchanged in the future. By entering into FX forward contracts, parties agree on a predetermined exchange rate for future transactions, shielding themselves from fluctuations in exchange rates. This fixed rate mitigates uncertainty and provides stability for both parties involved in the contract, regardless of FX market movements. When asked why they use FX forwards, all too often, people say they do it to get a better exchange rate, reduce their costs, or boost their revenues. Unfortunately, setting the goal of achieving a superior FX rate through hedging requires individuals to forecast future exchange rate movements, a task fraught with difficulty. Even the most skilled FX traders in leading banks and hedge funds struggle to consistently predict currency fluctuations correctly, a feat made more challenging for small finance teams lacking the resources and information flow available to top traders. Attempting to outsmart the foreign exchange market by aiming for preferential rates when buying and selling currencies is akin to challenging a casino at its own game. The unpredictable nature of FX rates contributes to the perception of hedging as a gamble, as individuals attempt to foresee future market conditions without a crystal ball. The fear of making incorrect decisions driven by current market rates is a significant concern for inexperienced finance managers and treasurers, who worry about the potential impact on their careers. Experienced finance teams mitigate this unpredictability by aligning their hedging strategies with well-defined and communicated internal objectives and metrics and implementing processes to effectively manage uncontrollable factors like FX risk fluctuations. Clear Internal Objectives Although the primary objective of FX hedging may vary for each business, key common goals and strategies can provide stability to your hedging approach despite the fluctuating nature of exchange rates. The prevalent strategies include Balance Sheet Hedging and Cashflow Hedging. Balance Sheet Hedging A balance sheet hedging programme aims to safeguard profit margins against currency fluctuations, reflected as FX Gains & Losses in accounting records. Typically, balance sheet items like foreign currency bank account balances, AP/AR, and other assets and liabilities in foreign currencies can lead to FX Gains & Losses for any accounting period. Often, foreign invoices are accrued at one exchange rate and settled later at a different rate, resulting in such FX Gains & Losses. The significance of hedging is better understood when it is directly linked to underlying exposures. Assessing hedging performance accurately necessitates considering hedges together with underlying assets or liabilities in foreign currencies. For many businesses, FX risk may be unidirectional. For instance, a company might solely buy or only sell in a foreign currency. In such scenarios, mitigating the impact of currency fluctuations on profit margins is achieved by hedging any contract or invoice denominated in a foreign currency promptly upon commitment. Nonetheless, understanding when FX risks arise is crucial. FX risks often emerge as soon as a contract is signed or even earlier, but accounting only captures a part of these risks when invoices are recorded in the ledger. In the above case, the exchange rates moved unfavourably from the time the sale invoice was entered until it was paid, and thus, the person who would have made the hedging decision looks like an unsung hero, even when the performance of the FX contract is viewed on its own. However, market exchange rates could also move in a favourable direction, in which case, the decision to hedge may seem like a wrong one – it would be better to wait and exchange currencies later. If the decision to hedge or not to hedge is based on an individual’s views of where the exchange rates are going, the company risks ignoring the key fact. The company is exposed to currency risks in a specific direction, and it must hedge if it wishes to remove FX gains and losses from the income statement. This is why it is important to view the hedges combined with the underlying risks to demonstrate their value: simply by fixing a predictable value of foreign invoices and thus protecting profit margins from unexpected currency swings. In the above example, the result FX Gain & Loss is nil, exactly the desired outcome. Cashflow Hedging Imagine that the above-mentioned company decided to hedge such an invoice even earlier, when the sales contract was signed. This means the company would enter into a FX forward contract, locking in a guaranteed exchange rate of 1.2525 (1.2500 and a small cost that often needs to be paid to purchase a FX forward). As a result, the company would lock in the value of £79,840.32 ($100,000/1.2525). More importantly, when the client pays $100,000 a month later, the cash flow can be exchanged at the guaranteed rate, and the company can collect the full £79,840.32. However, in this case, the hedge existed even before the invoice appeared on the balance sheet. Until the invoice date, this hedge relates to a forecasted transaction. Such a hedge is called a cashflow hedge because it does not…