This guide is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. FX hedging products carry risk, including the risk that rates move against you and that you may be asked to provide collateral at short notice, which could affect your cash flow. Comments from Toby Osborne, CFO at Alt21 are contained within the article. As an Alt21 employee, his comments reflect his own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary. Please read the full disclaimer at the bottom of the page.
What does your business FX exchange rate have to do with the price your sales team quotes a customer?
Potentially, quite a lot.
The same rate can sit underneath a supplier agreement, next year’s budget and the margin you expect to make on a contract. Yet FX is often treated as a finance concern that only becomes relevant when it’s time to move money.
Knowing the rate you’re planning around earlier changes what you can do with that information. You can use it while there’s still a price to set, a commitment to approve or a forecast to build.
In this blog, we look at what knowing the exchange rate you’re planning around can mean for pricing, commercial commitments and financial forecasts.
Planning future costs starts with the FX rate
An exchange rate can sit behind a business decision long before any currency changes hands.
Say you’re preparing a quote for a customer. Some of the costs behind that quote will be paid to a supplier in euros six months from now.
To work out what the contract could be worth to the business, you need to translate those future euro costs into your home currency. That means putting an exchange rate somewhere in the model.
You might use today’s rate or the rate finance has set a budget for the year. Perhaps you deliberately use a more conservative assumption.
Whatever you choose, that number can influence the margin you expect to make and, potentially, the price you’re prepared to offer.
The same thing happens elsewhere.
Foreign-currency assumptions can sit behind purchasing decisions, budgets, forecasts, international hiring plans and expansion into new markets.
In some circumstances, businesses use products such as Forward Contracts to agree an exchange rate for an expected future transaction. That gives finance a known rate to work with for that portion of its expected currency requirement. Entering into a Forward Contract creates a binding obligation to transact at that rate, and removes the opportunity to benefit if the market later moves favourably – so it’s worth weighing that trade-off against the certainty it provides.
Once the rate has been established, it can become a useful input into pricing, purchasing and forecasting.
For finance teams, that planning rate may already exist in the annual budget.
Toby Osborne, Alt21’s Chief Financial Officer, points out that a sales plan or budget P&L will often have been built using an exchange-rate assumption.
That gives finance a useful reference point when thinking about future currency requirements: what rate sits behind the financial plan the business has already agreed?
The answer won’t determine how every future transaction is managed. But it can help connect currency decisions back to the revenue, costs and margins the business is planning around.
Price sharper
Imagine you’re quoting a customer £500,000 for a project that will take nine months to deliver. You expect to spend €200,000 with an overseas supplier along the way.
Your sales team wants to know how competitive it can be on price. Finance wants to know what margin the business expects to make.
Somewhere between those two questions sits an exchange rate.
If the future sterling cost of those euros is still unknown, your finance team has to make an assumption. They may also decide to build additional headroom into the numbers because the eventual cost could change before the supplier is paid.
Where an exchange rate has been established for some or all of that expected euro requirement, finance has a firmer input to use when modelling the deal.
That doesn’t necessarily mean offering the customer a lower price.
Pricing sharper means pricing with more information.
Finance can see more clearly what sits underneath the expected margin. Sales can understand how much of the quote is based on known costs and how much still depends on assumptions. Together, they can have a more informed conversation about the price the business is prepared to offer.
The FX decision has happened in finance, but its usefulness has travelled all the way to sales.
That also means the exchange-rate assumption behind a quote may need attention while negotiations are still taking place.
Toby gives the example of a sales process that lasts several weeks:
“A quote may have been built around one exchange rate, but by the time the customer accepts it, the market may have moved. If nobody has been tracking that assumption, the expected economics of the deal may have changed before the contract is even signed.”
Bringing finance into the process earlier may give sales visibility over the currency assumption sitting underneath the price they’re negotiating.
Commit faster
Pricing isn’t the only commercial decision that can contain a business exchange-rate assumption.
Imagine you’re considering a 12-month agreement with an overseas supplier.
You’ve negotiated the unit price. You have a reasonable idea of the volumes you’ll order. Operations is happy with the supplier, and the commercial case makes sense.
But the contract is denominated in another currency.
Finance therefore needs to understand what that commitment could mean in your home currency, not only today but across the life of the agreement.
You can model several exchange-rate scenarios. You can build additional headroom into the budget. Or, where appropriate, you might establish a rate for some of the currency you expect to need.
Doing that doesn’t make the supplier agreement a good decision. FX shouldn’t decide for you. It can, however, give you one less assumption to make the decision around.
The same principle can apply when you’re considering inventory purchases, overseas hires, longer-term customer contracts or other commitments involving future foreign-currency cash flows.
Capital expenditure is another example:
You might approve an asset purchase today that will sit on the balance sheet and be depreciated over several years, while the actual purchase price is denominated in another currency. If the exchange rate moves between approval and payment, the home-currency amount you ultimately pay for that asset can change.
Toby’s point is simple:
“The accounting life of the asset doesn’t change the amount of cash the business needs to spend when it buys it. Understanding the currency assumption earlier gives decision-makers a clearer view of the cost they’re approving.”
When one of the variables becomes known, decision-makers have firmer information to work with.
That can help finance spend less time answering “but what happens if the exchange rate changes?” and more time evaluating the commercial decision itself.
Forecast credibly
Forecasting gets particularly interesting because a spreadsheet can make assumptions look surprisingly permanent.
Suppose your business expects to pay €3 million to suppliers over the next 12 months.
You need to translate that into your reporting currency for your forecast, so you choose an FX business exchange rate.
Now imagine that six months later the market has moved significantly.
Your euro invoices haven’t changed. Your purchasing plan hasn’t changed. But their expected cost in your reporting currency has.
That doesn’t mean the original forecast was wrong. It means part of it depended on an assumption that subsequently changed.
For finance teams managing future currency requirements more deliberately, there’s an opportunity to make that distinction much clearer.
You can separate the amounts where an exchange rate has already been established from those that remain exposed to future market movements. For the remainder, you can show the exchange-rate assumptions currently being used.
In practice, the rate used for budgeting may also represent a blend of expected rates across a period rather than the exact rate attached to every individual transaction.
Toby explains that finance may ultimately present a single exchange-rate assumption for a currency across the budget, even though the rates associated with individual months or transactions differ.
The amount hedged matters too. If your policy allows you to hedge up to 80% of an expected exposure, for example, the remaining 20% is still subject to the rate available when it is eventually exchanged.
That distinction can be useful when presenting forecasts internally. Rather than treating the budget rate as though every future transaction has already been established at that level, finance can show how much of the exposure has a known rate and how much remains based on an assumption.
A forecast becomes more useful when you can tell the difference between what you know and what you’re assuming. It also gives finance a clearer way to explain eventual variances to the board.
Toby cautions against assuming that a more favourable market rate automatically means the business made the wrong decision earlier:
“‘We shouldn’t have hedged at 1.35. It’s moved to 1.30. We’ve lost money.’ Well, not quite — you hit the rate you budgeted for. What’s happened is you’ve missed out on a favourable movement that nobody could have predicted at the time.”
The question finance can answer is what information was available when the plan was made, which rates had subsequently been established and which parts of the exposure remained open.
Rather than treating FX as an unexplained variance that appears at month-end, finance can show which numbers were based on established rates, which were based on assumptions and where exchange-rate movements changed the eventual result.
Making those assumptions visible helps you understand which numbers are established, which could still change and where those changes could affect your forecast.
You might also be interested in our blog on exchange rate management.
The rate you use depends on the decision you’re making
There isn’t one business exchange rate that answers every financial question.
If you’re making an international payment today, the current exchange rate is directly relevant. If you’re building next year’s budget, you may be working with a budget rate or another internal assumption. If you’ve established a rate for an agreed future transaction, that rate can become part of the planning for that particular cash flow.
That’s why it’s useful to understand what the market is doing today without treating today’s rate as the answer to every future question.
For example, if your business works across euros and US dollars, you can check the current EUR to USD exchange rate and see what a conversion would look like at today’s rate. The same applies if you’re managing payments or receipts across currency pairs such as GBP to TRY, USD to ZAR or USD to SGD.
For finance teams looking further ahead, those current rates can provide useful context. But the rate you ultimately plan around will depend on the decision you’re making, when the money is expected to move and how you’re managing that future currency requirement.
Thinking beyond the business FX exchange rate
Establishing a future exchange rate won’t make sense for every payment, receipt or business. Its usefulness depends on what you’re planning around.
A £5,000 invoice due next week presents a very different planning question from a €2 million supplier programme spread across the next year.
Finance teams may consider how certain an expected payment or receipt is, how far into the future it sits and how material it is to the business. They may also look at how sensitive the expected margin or budget is to currency movements and how much flexibility they need if the underlying cash flow changes.
The product you use can change the trade-offs too.
A Forward Contract can establish an exchange rate for an agreed future transaction, but you’re then committed to exchanging the agreed amount at that rate. If the market subsequently moves in your favour, you won’t benefit from that movement on the amount covered by the Forward. Depending on the arrangement, collateral may also be required.
Forward contracts create a binding obligation to transact at the agreed rate, may require margin payments, carry counterparty risk, and remove the ability to benefit if exchange rates move in your favour before settlement.
Other approaches can offer different levels of flexibility, participation in favourable market movements, costs and obligations.
Which brings us back to what the rate is there to help you do.
You’re not managing exchange rates in isolation. You’re pricing contracts, approving purchases, agreeing budgets, building forecasts and planning what the business expects to spend and receive.
The exchange rate is one input into those decisions. The more clearly you understand the rate you’re planning around, the more deliberately you can use it when making them.
And when that rate is still an assumption, making the assumption visible can be just as useful as knowing the rate itself.
That’s what it means to think beyond the rate.
Manage today’s payments and plan what’s coming next
Alt21 brings international payments and FX hedging tools into one platform, so you can manage today’s transactions alongside future currency exposure.
See pricing before you commit, execute FX payments directly and access tools including Forward Contracts and FX Options, with specialist FX expertise available when you need additional information.
FX derivatives involve risk and may not be suitable for every business. Product availability and suitability depend on your circumstances, objectives and relevant terms.
ALT21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT21 Limited. Not all applications will be accepted.
