Solutions to Managing Foreign Cash Flows

Over the past few decades, the structure of the global economy has changed dramatically as unprecedented political and technological developments have made geographical distance increasingly irrelevant. A world of opportunity has opened up, and the impact on international businesses has been profound. More companies are spending and earning money in foreign markets than at any previous time in history - and this trend is only accelerating.

As this revolution has occurred, the financial system has adapted to an exponential increase in international trade flows. Across the planet, payment networks have become more integrated, many legal and taxation barriers have been removed, and underlying technological infrastructure has undergone a complete transformation. It is easier to move money around the world than ever before.

However, an evolving global economy requires an evolving cash flow strategy. US companies have relied on outmoded tactics for many years and have been slow to adopt more advanced practices. Many businesses continue to price their transactions purely in US dollars, effectively forcing their foreign partners to handle exchange rate risk - at great cost to themselves. Multinationals often maintain expensive banking relationships around the world, sacrificing balance sheet efficiency in order to achieve a smooth transfer of funds through the financial system. Many are still managing processes manually and very few are taking advantage of the enormous technological improvements that have been made in the last few years.

Against this backdrop, it is important to remember that US's financial infrastructure is among the most advanced in the world - the average business has access to tools and tactics that are completely inaccessible in many foreign markets. Those companies that leverage this infrastructure effectively can build a key competitive advantage by making international transactions simpler, safer, and far more profitable over the long run.

An evolving cash flow management strategy can provide an essential foundation for your company's success in global markets.

Solutions

Implementing a more effective framework starts with breaking foreign cash flows down into their constituent parts. Broadly, companies move funds internationally for two reasons: to manage transactional cash flows, or to improve balance sheet performance.

Transactional Efficiency

International transactions typically trigger foreign cash flows, and often create inefficiencies on both sides of trading relationships. Fees and transaction costs, exchange rate risks, and procedural complexities can sap value from the process - and diminish your profits. Changing this starts with recognizing that your trading partners often experience the same problems you do.

In fact, many counterparties are located in parts of the world with far less developed financial infrastructure, meaning that they cannot access the same range of tools and capabilities. This means that, more often than not, you can deliver mutual benefit by managing cash flows yourself.

The most successful international companies apply an iterative treatment to their cash flows, simplifying processes, managing associated risks, and leveraging technology on a continual basis.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

Simplifying Processes

Leonardo Da Vinci once said, Simplicity is the ultimate sophistication. With respect to foreign cash flows, nothing could be more accurate. Whenever funds are converted into another currency, or are handled by an intermediary, costs rise. As much as the financial system gains from generating these costs, your company loses. The simpler the transaction, the more money can be shared between you and your trading partners.

Streamlining the cash flow management process so that unnecessary steps are eliminated not only shrinks your workload, but also cuts down the transaction costs that are incurred within the international banking system.

Doing this successfully involves removing as many transaction points as possible. Funds should be sent and received directly, and currency conversions should be kept to a minimum.

The most sophisticated companies achieve this by denominating their agreements in the currencies of their foreign trading partners. This may seem both more risky and more complex, but if managed correctly, it can create significant value and actually simplify processes.

Removing Risks

Typically, US firms avoid denominating transactions in foreign currencies because they wish to eliminate exchange rate risk. They are concerned that they will lose money in the event that currency rates move against them.

This is sensible, but the hard reality is that companies involved in global trade are almost always exposed to exchange rate risk. If this risk isn't immediately visible, you are effectively paying your trading partner to handle it - translating potential exchange rate losses into very certain price-related losses.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

To understand why, consider the exchange rate risks and process complexities from your trading partner's perspective.

Imagine that you've sold a widget to a company based in South Korea. Would you prefer to be paid in your own currency, or in Korean won? And assuming that you do accept won for payment in 30 days, will you base your price on today's exchange rate, knowing that it's likely to fluctuate - potentially quite significantly?

Probably not.

Most likely, when receiving a payment in a foreign denomination, you will add a buffer to the selling price to protect yourself in case the currency in question moves against you. In our experience, this can range from 5 to 15% of the sales price, depending on how high the risk is perceived to be. The more exotic and unknown the currency is, the larger this buffer will be.

Fixing this problem is much easier than it may appear. Using very simple tools, uncertainty can be effectively stripped out of a transaction, leaving you to focus on streamlining processes and payment mechanisms so that the complexity is removed as well. The solution is to manage the exchange rate risk yourself.

An ideal instrument for accomplishing this is known as a forward contract.

Forward contracts work by locking-in a price today for a transaction, or series of transactions, that will take place in the future. Accordingly, they can be used to eliminate any risk of negative currency movement between the time that your trading arrangement is agreed to and the time that the funds are eventually transferred.

Conveniently, forward contracts are some of the most cost-efficient and flexible financial tools in existence. The difference between the price paid for the foreign currency today and the rate paid for delivery in the future is called the interest rate differential. This differential is simply based on the difference between the interest rates in both countries, rather than on the market's view of expected exchange rate movements. What this means is that this differential is most often far smaller than the buffer that your trading partners use to protect themselves against negative fluctuations.

Since the world of international trade does not work like clockwork, most businesses use open contracts. With an open forward, payments can be made in any amount, and on any date until the contract expires. These contracts are usually booked so that the expiry date is several weeks or months after the expected payment date. This provides flexibility in the event that shipments are held up or delayed as they so often are.

When applying these tactics, it is important to work with a foreign exchange provider who can offer forward contracts in all of the world's major currencies and most of the more exotic ones as well.

Once this framework is in place, you can remove foreign exchange risk from most of your trading relationships with relative ease, which will often put your company in a position to negotiate more favorable terms.

Bottom Line: Forward contracts can make foreign currency transactions as safe and efficient as those conducted in your domestic currency - allowing you to increase profit margins without taking on additional risk.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

Streamlining Transactions

Historically, the fractured nature of the global financial system meant that businesses needed to maintain an extensive network of banking relationships around the world in order to simply move money across borders. The legacy of this persists today, with many companies continuing to maintain these facilities in an effort to make transactions more convenient for their trading partners.

Unfortunately, this sort of framework creates unnecessary expenses on both ends of the transaction. It costs money to maintain these facilities, and additional fees are triggered every time funds touch intermediary accounts. Because processing times are longer, payment terms must become shorter.

And guiding this type of transaction through the system generally requires greater resources on both sides of the transaction. In our experience, payables and receivables personnel regularly get involved in tracing payments that go awry. Of course, all of these costs are passed on in the form of higher purchase prices, reduced receivable values, or increased processing times. Clearly, it is in the interest of both parties to eliminate these transaction points, if possible.

As negative as this seems to be, it actually represents an opportunity for your company to streamline processes and strengthen its negotiating position. The leading foreign exchange providers maintain extensive international banking relationships in a wide range of currencies that can be leveraged to both receive and remit funds directly, without going to the trouble and expense of setting up your own accounts.

With this infrastructure at your disposal, international payments effectively become local ones, moving within domestic clearing networks rather than across the global banking system.

This can also give you the option to denominate transactions in your trading partner's home currency, helping to reduce the number of times that the banking system touches the transaction. And because foreign exchange providers frequently move large volumes in and out of these countries, they can also provide invaluable expertise when it comes to routing payments so that delays and problems are minimized.

Money moves faster, fewer intermediaries are required, and fewer errors occur. It's as simple as that.

In the event that both you and your partners are having difficulty quantifying the benefits of this process, you may wish to consider a practice called double invoicing, which has been adopted by many mid-sized companies. This is done by requesting invoices with two prices on them - one in your own currency, and the other in your counterparty's currency. By comparing the two and talking to a foreign exchange provider, you can see how much is being charged to offset transaction costs and exchange rate risk. If you can execute a forward contract and streamline the transaction process so that costs are eliminated, do so. If not, denominate the transaction in your own currency. It really can't hurt to ask.

Bottom Line: Taking control of the payment process yourself can be mutually advantageous for you - and for your trading partners.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

Leveraging Technology

By allowing you to reduce processing costs, exert greater control, and capture vast amounts of data, online payment platforms can add value throughout the cash flow cycle. Ultimately, technology can put greater control in your hands.

When manual processes are automated, costs are reduced significantly and the likelihood of errors decreases dramatically. The most sophisticated online platforms will store beneficiary coordinates so wire information does not need to be re-keyed every time a payment is initiated, and allow multiple payments to be made and received simultaneously, reducing workloads substantially. Digital information capture allows for payment data to be reviewed throughout the process by payment experts, who can help to ensure the accuracy and completeness of routing information, cutting delays and reducing additional fees.

Transferring funds electronically is much safer and more reliable than more traditional means, and checks and balances can be created - allowing you to segregate internal duties without resorting to time-consuming procedures such as requiring dual signatures on outgoing payments. As new regulatory regimes come into effect, automated real-time reporting capabilities become an absolute necessity - while contributing to a sharp reduction in audit and compliance expenditures.

The most advanced platforms provide automated email confirmations with reference numbers to both parties when funds have been received - or are en route. These communication capabilities can help you maximize account balances by fine-tuning the cash flow cycle, confirming receipt more quickly and sending outgoing payments closer to deadlines. Settlement and reconciliation times improve because all the necessary information is transmitted along with the payment, including details such as invoice number, purchase order number and additional notes.

Accounting accuracy improves, and inefficiencies are removed. Again, both partners in a trading relationship gain considerably.

But perhaps the greatest value that technology can offer is the ability to monitor, record, and analyze foreign cash flow data. As the world changes and your company evolves, having ready access to complete and comprehensive payments information can be the key to driving improvements across all areas of your cash operations.

Bottom Line: A strong online platform is the key to maintaining direct control over your global cash flows.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

Improving Balance Sheet Efficiency

Globally distributed organizations often maintain a range of deposit, investment and borrowing facilities in different currencies. While this sort of framework can be enormously beneficial in transactional terms, it can also create significant and costly balance sheet inefficiencies. By making it difficult to move money around, this structure can compromise a company's ability to gain from interest rate differentials.

At its most extreme, this can mean that companies hold cash balances in one jurisdiction while borrowing money in another - clearly an inefficient practice. More subtly, the law of comparative advantage means that many companies can borrow and lend at better terms in their domestic currencies, or where the bulk of their operations are located. This means that foreign banking facilities are often far less efficient than those closer to home.

These issues have driven a rise in the number of corporations which have begun pulling funds out of less efficient corners of their balance sheets, and depositing them in short-term domestic sweep accounts to capture yield differentials - or using them to pay down borrowing facilities.

Of course, this practice carries foreign exchange risk. When these funds are initially moved, an exchange rate applies. When they are moved back, rates will have changed. The potential loss can wipe out any yield advantage that has been gained.

Currency swaps were developed to manage this risk.

A currency swap is essentially two foreign exchange transactions combined. The first step involves the conversion of your primary currency into a secondary currency, for settlement immediately (or in the short term). The second step involves the opposite transaction occurring at a predetermined time in the future when the secondary currency is converted back into a preset amount of the primary currency.

The swap exchange rate is based on the spot rate when the first step is executed, with an adjustment based on the difference between the prevailing interest rates in the two currencies. This adjustment is called the forward differential and is known from the outset. This forward differential may be positive or negative, and is often more favorable than the difference between interest rates on the balance sheet itself.

In essence, the exchange rate for the entire transaction is fixed when the first step in a currency swap is executed. This means that companies can move funds around globally, achieving an optimal balance sheet structure without triggering foreign exchange risk in the process.

Bottom Line: Currency swaps can improve balance sheet efficiency substantially, without incurring foreign exchange risk.

Learn more about the specific tools and strategies that can be used to manage your global cash flows

Opportunities

Charles Darwin once said, It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.

A world of opportunity beckons to those companies who can apply all three characteristics to their foreign cash flows. A strong technological foundation can support international growth by ensuring that funds are transmitted safely, promptly and efficiently. By providing built-in reporting capabilities, an online platform can also vastly reduce accounting costs and generate the data required to make processes more robust over time.

Intelligently analyzing your cash flow framework can help you identify profitable opportunities across the global payments system. Eliminating transaction points and managing risks yourself can generate substantial savings - while helping to build the mutually beneficial relationships that all smart trading partners strive for.

And adaptability? This is where a foreign exchange provider can truly add value. By providing the information, the tools, and the expertise required to make the right decisions, currency specialists can help your business evolve to meet new challenges - and ultimately, survive and thrive in the world of international trade.