Including foreign exchange in your budget
For businesses who have known outbound (or inbound) foreign exchange requirements, they will need to include this as part of their budgeting process. This can be difficult as although they may know they require a certain amount of foreign currency over a year they don’t know what the exchange rate will do during this time. This could lead to the Financial Director and other members of the finance team having difficulty in selecting an appropriate exchange rate to include in their budget.
Choosing an exchange rate
The importance of how international payments are budgeted is dependent on each business’s individual needs and how much of their yearly costs and profit have FX exposure. If a business only has fixed costs in foreign currency then setting a rate as part of a budget is much easier. For some businesses that have variable costs related to the stock that they sell in foreign currency, the rate included in the budget is that much more important.
When budgeting for the next year or a few years, a business can estimate the foreign exchange rates to set their budgets and therefore estimate their profitability based on these, which will also feed into the way they set their prices for goods.
We understand that each business is likely to already have its own tried and tested process in place when selecting a rate to include in a budget, often factoring in forecasts, the current rate, and trends over previous years. While Currency UK does not get involved in forecasting we can give businesses pointers on how to approach this process and offer support when it comes to creating your budget.
Securing your budgeted rate
Once you have a rate to include in your budget, how can you ensure that you get that rate over the next 12 months? The simplest way is by hedging, but the options available to you will differ depending on how close the rate included in your budget is to today’s available exchange rate.
If your budgeted rate is one you can get today then one option is to use a forward contract to lock that rate in for 12 months. This gives you the certainty that your budget is accurate and that your profits and costs are safe from exchange rate movements. However, the limitation of this is that if the market moves in your favour, increasing profit margins, you are missing out on this due to your currency for the year being bought at one rate.
If the rate you have factored in for the year is based on a forecast and therefore differs from the rate currently available you may instead want to use a market order to ensure that once that desired rate is reached, your required currency is automatically bought for you. This method is very useful but relies on the market reaching that rate and not moving against you.
Often then the best method is a hybrid of these different products. Choosing to lock in today’s available rate to mitigate risks as well as adding in a market order to maximise a desired rate and leaving a percentage of your requirement unhedged allows flexibility and protection. It is a difficult balance to get right and is often unique to each business based on risk appetite and profit margins. At Currency UK we focus on an approach that puts risk mitigation first but our team can talk finance teams through all available options that offer a balance of security and flexibility.
As the budgeted rate has such a crucial impact on the pricing of products or services, getting this right is important, but it is more important to ensure that if your budgeted exchange rate is significantly off over the course of a year, that you have the right support and methods available to protect your business and profit margins.
Ultimately it is key to include sensible rates in your budgets and seeking outside support can go a long way in helping you ensure rates are based on knowledge from reliable sources. It is also critical that Sales Teams are aware of what rates have been used to base the budget on to ensure everyone is on the same page when it comes to costs and profits and understands the implications of movements in the market.
Whether you want to introduce a hedging strategy or trade a currency at the current rate, the better equipped you are with the knowledge of different products that are available the more informed your decisions can be.
If you would like some support with setting an FX budget and hedging strategy or an independent to review your current budget and fx exposure for the next financial year our team of experts can help.