Currency Risk in Procurement Strategies

Currency risk poses a significant challenge for importers and exporters who operate across borders. Fluctuations in exchange rates can affect the cost of goods, profit margins, and overall financial stability. Understanding how currency risk impacts procurement and learning practical ways to manage it can help businesses maintain competitive pricing and protect their bottom line.

What Is Currency Risk in Procurement?

Currency risk, also known as exchange rate risk, arises when companies buy goods or services in a foreign currency. Since exchange rates change constantly due to economic, political, and market factors, the amount paid in the home currency can vary between the time a contract is signed and when payment is made.

This unpredictability complicates budgeting and pricing decisions, making currency risk a critical factor in procurement strategies. Ignoring this risk can lead to unexpected losses. For instance, a European company importing raw materials from the US might face higher costs if the euro weakens against the dollar, squeezing margins.

How Currency Risk Affects Procurement Decisions

• Cost Uncertainty: Fluctuating exchange rates make it difficult to predict the exact cost of goods, which can disrupt cash flow planning.

• Supplier Selection: Companies may prefer suppliers invoicing in their home currency to avoid risk, even if prices are higher.

• Contract Terms: Procurement teams might negotiate contracts with clauses that share or transfer currency risk between buyer and supplier.

• Pricing Strategy: Exporters must consider currency risk when setting prices for international customers to maintain profitability.

6 Questions Imports Must Ask

Managing currency risk also requires identifying where the currency risk sits and who is in control of setting the rate.

1. What currency are the imports quoted in?

Paying in the supplier’s preferred currency can avoid added margins. A supplier is likely to add margins to the exchange rate when determining a quote in an alternate currency.

The often large margins are embedded to protect against the risk of the alternate currency depreciating by the time the payment is made, and to cover costs of exchanging it.

2. Is the quote fixed, or varies based on FX movements?

Unless paying for goods in the supplier’s preferred (origination) currency, FX risk margins may be built into fixed alternate currency quotes by suppliers.

Similarly, contract variation clauses may be used to change the price of the goods, based on changes to a benchmarked exchange rate. This prevents budget and cost certainty.

3. Does the contract specify a bank's benchmark rate?

Suppliers often use bank exchange rates published on the bank’s website to benchmark FX rates in contracts. This is an easy way for the supplier to add at least 4-5% without any

effort. Banks publish retail rates (larger spreads) on their websites.

More exotic (non-major) currencies may see spreads greater than 10% above market rates. If benchmarking is needed, consider sourcing exchange rates from central banks.

4. Has the contract benchmarked against a spot or forward rate?

When payments are due in the future and a benchmark rate is used, consideration should be given to applying relevant forward exchange rates, rather than market spot rates.

Forward exchange rates may be more favourable, depending on the forward curve, and are a better reflection of payment periods.

5. Is exchange rate risk hedged for future payments?

The foreign exchange market is incredibly volatile, especially during times of geo-political and economic uncertainty.

Adverse market movements can drastically impact the overall cost of goods when the payment is due.

Not hedging a known exposure is speculating on future exchange rates. Do you focus on cost and budget certainty, or rolling the dice on future exchange rates.

6. Where can I get top rates, products and service?

Our team has introduced many businesses, large and small, to some of the biggest non-bank providers globally.

Businesses usually use their lender/bank for this service, not knowing the alternative options and potential impact on cost.

Introductions almost always result in the business moving away from using their bank for foreign exchange services. Contact us for more information.

Seeking Transparency

Suppliers and vendors often apply significant margins to invoices priced in a currency different from their own. This is also found when domestic resellers source goods from overseas.

If a tender/quote needs to be in a currency different to the origination currency, also seek a quote in the supplier’s preferred currency. This allows the supplier to provide an alternative quote which eliminates currency risk passed to them.

Two quotes will increase transparency and provide you with an opportunity to assess which option is cheaper at prevailing exchange rates.

Why businesses don't hedge

Currency volatility in cross-border transactions can weigh heavily on the bottom line. Yet, businesses often choose to not manage certain risk and roll the dice on related costs.

Excluding those that aren't familiar with the concepts or don't know how to access reliable hedging to mitigate market risk, studies reveal two common theories as to why businesses avoid hedging.

1. PROSPECT THEORY

Prospect theory studies show that people generally take more risk to avoid a loss and take less risk to protect a gain.

As a result, businesses will risk budget/cost uncertainty, just to avoid potentially ‘losing’ against better spot rates.

This natural tendency can lead to inconsistent and costly decisions. Risk management is about protecting gross margin.

2. BUSINESS FINANCIAL HEALTH

Firms with limited funds avoid risk management with collateral requirements.

Similarly, households with financial difficulty may reduce certain insurance policies to reduce expenses.

The puzzle, firms with limited funds should actually be more concerned about budget certainty. Evidence shows firms with stronger balance sheets and capitalisation hedge a lot more often.

Key Takeaways for Importers and Exporters

Contact us to find out more about better positioning the business by leveraging our relationships to top tier global non-bank providers, offering sharper exchange rates and risk management to navigate the volatile geopolitical and economic environments.