In any business which deals with imported products, you need to be sensitive to the rise of fall of the US Dollar. Its value in relation to the currency you’ll be buying products in will determine the final cost of your order. I used to own a foreign film video store, and I bought a lot of DVDs from Japan, Europe and Thailand. The value of the Japanese Yen, Euro and Thai Baht would often swing widely throughout the year and affect my movie orders dramatically. One month I spent an extra $300 on a regular order from Japan, simply because the US Dollar had fallen a great deal against the Yen. This change can also affect small orders as little as $900. The same $900 in products can cost from $775 to $1025 in a typical price swing. If you’re buying $5,000 in product each month, as I was, you need to protect yourself. Here are some ways to get insurance from currency swings.
Forex Broker Account
Most people think forex(foreign exchange) trading accounts are for investors and speculators only. But you can also use it to hedge your business needs in various currencies. The main feature of a forex trading account is the 100:1 leverage you get. The key is that you must not use this leverage to this high degree. Since you are not speculating, but buying some insurance, there is no need to go out on a limb.
For example, say you anticipate needing to buy product worth $5,000 Euros in the next 2 months, and another 5,000 about 4 months later. The Euro may move higher and cost you hundreds more. You want to help keep the price within this expected range of $10,000 for the budgeted quarterly purchase. In a forex account you can deposit $1,000 and buy 1 lot of Euro mini positions. Each mini position is worth $10,000 but only requires $150 margin deposit. Your $1000 is more than enough to cover it. If the Euro rises, you will gain an amount equal to what you will lose on the product orders. In other words, you have locked in the price now at today’s rate. Now you can budget for the quarter, knowing exactly what your product will cost you. Keep in mind, if the US Dollar increases, you won’t benefit from in gain in your orders, as you’ll lose an equal amount in the forex account. This is not a speculation strategy; it is a way to lock in your price for the quarter. No win, no lose. It does enable you to know exactly how much you’ll pay over the next several months for Euro products. This is an important factor for import businesses.
The same idea applies in an option account, except that an option is an instrument purchased for a set price and a set time period, such as 3 months. With an option, you are buying an insurance policy against any rise in the Euro. Here you will spend a small amount of money to lock in a price for a set time period, but you can also profit from a large gain in the US Dollar’s value. If the Euro skyrockets you’ll be protected, but if the US Dollar skyrockets, you will still benefit. Of course you must deduct the cost of the options from your profits, and this can be anywhere from $50 to $500 depending on your option size and time purchased. Nadex is a good starting point for this type of account in the US.
Foreign Bank Accounts
It is not practical to open a foreign bank account in every country you deal with. However, if all your business is with one specific country, then this might be an alternative to consider. If all your trades are with Belgium, then a Belgian bank account might benefit you. Keep in mind that the restrictions here are often more involved than you can handle. You may need an expert to help you set up the bank account. Also, this route will likely not be as easy as the first options above. Shifting money in and out of a foreign bank can be expensive, as the US banking laws have not yet caught up to the price gouging American banks still revel in. Most European banks prohibit over-charging, but American banks still charge from $17 to $100 for just receiving a wire transfer, which costs them 14 cents to complete. Expect to pay twice that for sending money. Be wary of this alternative, but explore what the banks in your trading region can offer. Also, offshore banking tends to raise attention with the IRS. I’m sure you’re running your business legally, but no business wants the extra attention or audit.
This is the least sophisticated, but also the least complex way to hedge your currency needs. Just walk into an international bank and exchange your dollars for the currency you’ll need in 3 months. Then when you place the order, you can re-deposit the cash at the new rate. This will cost you a few dollars in the spread (bid/ask between buying and selling) but ultimately it’s the easiest way to exchange small amounts under $1,200.
Regardless of the method you choose, make sure you do get some insurance for your future currency needs. Don’t fly blind into the year. Remember when the Euro shot from 1.21 to 1.59 in just one year? That kind of movement can cripple an import business. The Canadian dollar went from .78 to 1.09 in 2006 and become worth more than the US Dollar. Again, not preparing for these kinds of moves can be lethal to a small company.
If you’re not prepared for the worst, then you’re not prepared.