By Phillip Silitschanu
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, sales volume, profits—and arguably 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. Being able to accurately predict a business’s operating expenses is as critical as earning sales, as all the sales revenue in the world can be for naught if the business’s operating expenses outpace its revenues. If expenses are not accurately forecast, 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.
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 each year, and how much their salaries (plus additional expenses, such as related 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, in terms of their payroll expense. 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 is unpredictable. This unpredictability inherent in foreign exchange rates, when applied to that country’s payroll obligation, and 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 forecast and properly managed. A business cannot choose to withhold pay from its employees for a week or a month if foreign exchange rates change in an unfavorable direction for the business – its foreign payroll must still be funded and paid, even if the foreign exchange rate means that the amount to be paid is much higher in the business’s home currency.
When a business does not hedge against foreign exchange rate fluctuations, they can be exposed to significant losses due to increased currency costs, or a decrease in realized profits when their foreign sales revenue is repatriated. For example, in the second quarter of 2013, one of the largest “big box” retail chains in the United States lost well over half a billion dollars because it did not hedge against foreign exchange rate fluctuations, and the US Dollar became stronger. In contrast, a large web portal and search engine firm in the United States reported that thanks to its foreign exchange rate hedging strategy, during the same quarter it realized a gain of well-over USD$150 million-bringing its gains from foreign exchange rate, hedging to nearly half a billion dollars.
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. They can help a business to 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, to assist in transferring the revenues from clients in those foreign markets back to the business’s home country, into their home currency. 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 professional who specialize in foreign currency exchange.
But, there are ways for a business to “lock-in” its foreign currency obligations. For example, a business has employees in Vietnam. On average, their payroll obligation in Vietnam is VND1.7 billion per month (approximately AUD$100,000). The business knows that every month, it must have VND1.7 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; or sometimes AUD$90,000; sometimes AUD$115,000. These monthly variations (sometimes larger, sometimes smaller) can be unpredictable, making accurate forecasting difficult, if not impossible. This business can utilize 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, and irrespective of what the foreign exchange rate is between Vietnam and Australia, that the AUD$100,000 it transfers will equal exactly VND1.7: the exact amount necessary to pay its employees in Vietnam. In this fashion, the business can accurately budget for its monthly foreign payroll obligations—avoiding those expensive surprises.
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.
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.
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