A Simple FX Risk Policy for a Small Business

[Fairman]

A Simple FX Risk Policy for a Small Business

A small business that buys or sells in foreign currency has exposure whether or not it thinks of itself as a trader. A written policy turns risk into something managed.

Start by identifying the exposure. List expected foreign-currency inflows and outflows over the next months, by currency. Net them: a business that both earns and spends in dollars has less exposure than the gross figures suggest.

Decide the tolerance. How large a move in the exchange rate could the business absorb without trouble? A five percent move may be manageable, a fifteen percent move may not.

Choose tools. The simplest is natural hedging: matching currency of costs with currency of revenue, such as paying suppliers in the currency customers pay in. Next are forward contracts, which fix a rate for a future date, available through banks and specialized providers. Options give protection with the ability to benefit from favorable moves, at a premium.

Set rules. For example, hedge 50 percent of expected exposure over the next three months, and 25 percent for months four to six. Partial hedging reduces regret.

Assign responsibility and review regularly. Document the policy.

Do not speculate. The aim is to protect the business's margins, not to profit from currency views.

Costs of hedging are real, but cheaper than the effect of a sudden move on thin margins.

Practical step: list your expected foreign-currency inflows and outflows for the next quarter, and compute the net exposure.

[Fairman]

Netting first is the step most small businesses skip. If you earn dollars from some customers and pay dollars to a supplier, part of the exposure already cancels itself out. Take an importer who pays 40,000 dollars a month for stock but also earns 15,000 dollars a month from export customers. The real exposure is 25,000 a month, not 40,000. Hedging the full 40,000 would mean hedging money that's already matched, paying costs for nothing. A simple monthly table with expected dollar inflows, outflows and the net figure for the next three months is enough to start. Update it when big orders or contracts change, because the net figure moves.

[Fairman]

Partial hedging is good for peace of mind. Hedge half and you're never fully wrong, which stops the owner from second-guessing the policy every month. If the local currency weakens 10 percent, the hedged half is protected and the business absorbs only half the hit. If it strengthens, the unhedged half benefits, and the business only missed part of the gain. Neither outcome feels great, but neither is a disaster, and that's the point. The worst pattern is changing the hedge ratio based on where the owner thinks the rate is going. That turns a risk policy into a currency bet, which the business didn't set out to make.