Staying in control of hidden FX costs

Managing costs is at the heart of every finance and accounting professional’s responsibilities. Which means, in turn, that clarity, consistency, predictability and fairness regarding business costs are crucial qualities for those professionals.

Often this transparency and fairness are relatively straightforward to ascertain. Consider, say, the cost of hiring a new team member. Typically, the organisation in question will have a very good handle on what that cost looks like, and how it stacks up in the wider marketplace. It has a clear sense of salary, any technology or equipment that the new hire will need to be provided with, and any other costs associated with that role. It knows – or can easily determine – how those costs compare with the wider marketplace. And in turn, this enables intelligent and reliable business planning.

Other costs are rather more complicated to pin down, particularly for smaller businesses – and one such area is foreign exchange payments.

The importance of foreign exchange payments in the digital economy

It is no secret that we are operating in a globalised economy, and this means that being able to make and receive fast and reliable payments in international currencies is increasingly important, even for the smallest organisations.

Importing and exporting are probably the two most obvious related functions, and both are increasing. In November of last year, the ONS reported that the number of UK SMEs exporting internationally had increased by 6.6% to 232,000, representing around 9.8% of all SMEs. It also found that the number of companies less than two years old to have exported in the last year had increased by a hefty 19.9% to 47,000, indicating how start-ups and new businesses are increasingly likely to be focused on expanding into international markets, even very early in their business journeys. Meanwhile on the import side, HMRC statistics from last year place the total value of UK imports at just under £500m, and the total number of business importers of all sizes at 231,172.

There are reasons for international currency payments beyond import and export, too. Many businesses rely on foreign currency payments in order to support international partnerships, or to hire permanent or contract resources in foreign countries. Even simply attending an event overseas can involve foreign currency transactions.

In short, then, being able to make and receive payments in international currencies is increasingly important, even for SMEs. Such payments enable businesses to form relationships with customers, partners and suppliers globally, to seek out new markets and employees, to diversify and grow.

Navigating foreign currency exchange costs

Yet making and receiving payments in foreign currency can be both overly costly and remarkably complex – and small businesses are disproportionately affected. Let’s take a closer look at how and why.

The most obvious cost associated with foreign currency transactions is the fee levied by the organisation’s bank – and unfortunately, these fees can be substantial, particularly for small businesses. Nevertheless, they are at least presented in a clear and upfront way. Far more difficult to calculate are the costs hidden within the exchange rates offered, with smaller businesses generally presented with less favourable rates than larger organisations. Whilst the mid-market exchange rate is easily ascertained from newspapers or Google, many banks charge businesses a different, less favourable rate – and because the exchange rate is also constantly shifting, it is even more difficult for finance and accounting professionals to keep track. Where banks claim that foreign currency transactions are free, the exchange rate is typically where they recoup their costs. Ultimately, the clarity and predictability required by finance professionals are left wanting.

Studies have found total spreads of up to 3.71% being charged on foreign currency transactions including fixed fees for small businesses. Scale this out to cover the country’s SMEs as a whole, and it has been suggested that small businesses are paying around £4 billion a year to the major banks, simply for the privilege of buying goods and services abroad.

Currency hedging is another important issue to bear in mind. Any organisation, no matter what its size, is exposed to currency risk if it engages in transactions in foreign currency. In turn, this can have a significant impact on commercial margins. Once again, small businesses are particularly at risk because they are less likely than larger organisations to be offered currency hedging solutions by the major banks. As we saw in the aftermath of the Brexit referendum result, issues far beyond the control of individual businesses can cause currencies to suffer sharp devaluations, with substantial knock-on impacts on companies’ finances. Then, the pound sterling dived against the euro and many small businesses experienced subsequent double-digit losses, because their banks had not offered them a currency hedging option.

Another important cost associated with foreign exchange payments – and one that may be neglected by finance departments – is the impact on business operations or reputation by slow foreign transactions. Consider an overseas supplier waiting for a payment to be completed before they ship a crucial delivery. If that payment is overly slow, then not only will the shipment be affected, slowing down business operations and potentially cutting into the bottom line, but the relationship with the supplier could also be damaged.

The solution: innovative approaches to foreign exchange payments

So where do businesses go from here? How can finance and accounting professionals achieve the transparency and predictability they need when it comes to the costs of foreign exchange payments? How can they ensure that those payments are cost-effective and efficient – and that the costs in question are utterly transparent and clear from the outset?

Understanding the ‘hidden costs’ of foreign exchange payments can help businesses to limit their risks and optimise their cash flow – truly benefiting from globalised marketplace. In order for accountancy teams to prepare for the future, they need to look beyond the traditional foreign exchange transaction model offered by the major banks and take advantage of the latest innovations in the emerging area of fintech. Fintech innovations enable small and medium sized businesses to access real-time information on the FX market for making better, informed decisions to future proof their businesses for long-term growth.