The sliding Canadian dollar has left most business owners in a tough spot.
While exporters likely have—or soon will—enjoy an increase in demand for their products thanks to the lower loonie, any entrepreneur that imports goods or services is surely experiencing significant bottom-line pain as a result of our currency’s tumble, one that doesn’t show any signs of reversing itself in the near future. Indeed, rising exchange rates are impacting many organizations’ bottom lines in ways not experienced in this country for more than a decade (perhaps longer).
That pain is exacerbated by the fact that, if you’re like most business owners, you probably don’t have a formal process or policy for managing exchange rate risk. And why would you? With a dollar that was at or near par with the U.S. Greenback for so long, there simply wasn’t a need to worry about hedging against currency fluctuations.
How times have changed. Now, it’s imperative to analyze your business operations and develop strategies to mitigate and manage foreign exchange risk. While there are a plethora of ways to deal with the challenge—and one is likely more appropriate for your business than another—each has its pros and cons.
Here are four of the most common approaches:
Build your business abroad—In some cases, it can make sense to set up operations in a foreign country rather than attempting to import raw materials to produce goods, and then ship them to markets overseas. This move not only has the potential to make your company more competitive, while also potentially driving growth, but can help reduce labour costs and minimize uncertainties with respect to Canadian dollar fluctuations. The downside is that doing so requires deep pockets and an overseas network of advisors (and potentially even partners) to make a venture successful. This strategy, although appealing, is not without its challenges.
Deal with foreign suppliers—If you buy and sell in the same foreign currency, you obviously remove most of the risk associated with our volatile loonie from the financial equation. The challenge, then, becomes finding reliable foreign suppliers in the markets in which you do business, that are capable of delivering needed products or services and can help your company hedge against currency fluctuations. If all goes well, the only thing you should be importing to Canada are profits.
Deal in foreign currencies—Opening a foreign bank account offers several advantages. The most obvious is that it allows you to help mitigate swings in the value of the loonie, but also to buy time before exchanging that foreign currency for Canadian dollars. While that latter approach requires sufficient working capital and significant patience, it can be an effective strategy—at least when properly managed.
Use hedging instruments—While far more complex, tools such as forward contracts allow you to buy or sell currency at a previously determined exchange rate on a date in the future. The downside is they tend to be relatively inflexible, are riskier and can tie up much-needed working capital. Currency options, on the other hand, offer the same benefits, but without the fixed-date purchase or sale obligations of forward contracts. But beware: if you don’t exercise an option, you forfeit the cost of purchasing it. Still, that could be cheaper than locking into an actual contract, if the currency moves in the wrong direction from what was anticipated. Lastly, currency futures are similar to forwards, but are exchange traded and generally more stable, given that they’re standardized contracts. But again, these instruments are complicated and are best left in the hands of an experienced financial manager. Always contact your financial advisor before considering a hedging option such as these.
What’s the best approach? The short answer is: it depends. The only viable strategy is the one that addresses your short and long-term business needs and goals. Understand that the loonie will probably continue its wild—and likely downward—ride for the foreseeable future, so that means the time to act to insulate your bottom line is now. Waiting another six months or a year before adjusting or developing a hedging strategy could introduce the kind of unnecessary risk and volatility that your organization simply doesn’t need.
Marshall Egelnick, Partner