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Payroll expenses are an important part of every business, and foreign exchange rate fluctuations can result in unexpected increases in payroll costs.
No one likes surprises, least of all when the surprise is an expensive one. That’s why business executives spend so much time and effort forecasting market demand, operating costs, turnover, profits – and perhaps most importantly in regards to operating continuity – payroll expense. When currency exchange rate fluctuations disrupt forecasted revenues and expenses for a business with international operations, the results can be catastrophic. Accurately predicting a business’s operating expenses is as critical as winning sales, as all the sales in the world would be for naught if the business’s operating expenses outpaced its turnover. If expenses are not accurately forecasted, a business cannot properly manage its operations, as it does not have an accurate grasp of how much those operational input increases or decreases will affect the business’s bottom line.
Payroll: Predictable, But Problematic?
Notably, for most businesses the largest operating expense is that of their human capital, in the form of their payroll expense. Luckily, a business’s payroll is fairly predictable: unless there is a sudden unexpected increase or decrease in demand for a business’s products or services, a business can be fairly certain of the number of employees it will have and how much their salaries (plus related expenses, such as payroll taxes and benefits) will cost. However, as predictable as the business’s payroll is for the year, there is uncertainty that enters the calculation when that business has employees in foreign countries. Fluctuations between countries’ foreign exchange rates can wreak havoc on the most accurately predicted payroll expenses.
For example, if a business has employees in a foreign country, that business will generally have an accurate estimate of the number of employees in that foreign country and how much each employee costs the firm. This means that the business’s local payroll obligation is fairly predictable in advance. However, the foreign exchange rate between that country and the business’s home country can be unpredictable. This unpredictability inherent in foreign exchange rates, when extrapolated across the numerous countries where a business might have its employees located, can mean that a business’s annual profits can be wiped out if exchange rate risks are not accurately forecasted and properly managed. A business cannot choose to withhold pay from its employees for a week or a month if foreign exchange rates move in an unfavourable direction – its foreign payroll must still be funded, even when the foreign exchange rate means that the amount is much higher in the business’s home currency.
Hedging: It’s Not Just for Big Businesses Anymore:
When a business does not hedge against foreign exchange rate fluctuations, it can be exposed to significant losses due to increased currency costs or a fall in realised profits when its foreign income is repatriated.
An Easy Solution to an Expensive Problem
So how can a business protect itself from being blindsided by foreign exchange rate fluctuations? The first step is to partner with a well-established foreign currency transfer service provider. Such providers can help a business implement a plan to address its foreign payroll obligations, as well as helping to execute the currency transfers necessary for a business to keep its employees around the world paid in a timely fashion. That same foreign currency transfer service provider can also help a business to repatriate its foreign currency holdings. It is important to understand that every country will have its own unique foreign exchange rate fluctuations and that predicting those fluctuations can be difficult, even for professionals who specialise in foreign-currency exchange.
But there are ways for a business to “lock-in” its foreign currency obligations. For example, consider a multinational business with employees in Vietnam. On average, their payroll obligation in Vietnamese Dong (VND) is VND 1.7 billion per month (approximately AUD 100,000). The business knows that every month, it must have VND 1.7 billion available in its local bank account in order to pay its employees in Vietnam. The problem is that some months, that obligation may mean that it must transfer AUD 100,000; in other months, AUD 90,000; and still others, AUD 115,000. These monthly variations can be unpredictable, making accurate forecasting difficult, if not impossible. This business can utilise a foreign currency transfer service to set-up future currency transfers at a locked-in foreign exchange rate. The business can enter into a future contract guaranteeing that it will have to transfer exactly AUD 100,000 every month, regardless of the then-current VND-AUD foreign exchange rate, to meet its VND 1.7 billion obligation. In this fashion, the business can accurately budget for its monthly foreign payroll obligations, avoiding expensive surprises.
The Takeaway
A business spends time and effort carefully planning and forecasting its expenses and sales. All that planning can be for naught if foreign currency exchange rate fluctuations are not taken into account, and adequate measures are not taken to protect itself from those changes. Surprises are best left to birthday parties, not payroll obligations.
The Author
Phillip Silitschanu
Phillip Silitschanu is the founder of Lightship Strategies Consulting LLC, and CustomWhitePapers.com. Phillip has nearly 20 years as a thought leader and strategy consultant in global capital markets and financial services, and has authored numerous market analysis reports, as well as co-authoring Multi-Manager Funds: Long Only Strategies. He has also been quoted in the US Financial Times, The Wall Street Journal, Barron's, BusinessWeek, CNBC, and numerous other publications. Phillip holds a B.S. in finance from Boston University, a J.D. in law from Stetson University College of Law, and an M.B.A. from Babson College.
