Whether you do your business locally or in international trade, learning how the exchange rate affects your business will help you make better business decisions.
We’ve highlighted all you need to leverage exchange rate fluctuations to do business safely and profitably. This guide explores the exchange rate, how it affects businesses in the UK, and how to minimise its risks.
What is the Exchange Rate?
The exchange rate represents the precise worth of one currency in terms of another, indicating the rate at which it can be interchanged. The exchange rate is mostly used in the forex market, where individuals, banks, and financial institutions engage in forex trading.
Forex trading involves buying and selling different currency pairs, which determines a currency’s value and exchange rate. In the forex market, exchange rates are quoted between two fiat currencies.
For example, how many US dollars can be exchanged for one British Pound (GBP)? The exchange rate as of late September 2023 is 1.26, which means that 1.21 USD is equivalent to 1 GBP.
This shows that the British Pound is stronger than the US Dollar, but that can change very quickly. Because trading forex happens all the time, the exchange rate is never static. When factors like economic growth, inflation, interest rates, demand and supply, and political events favour a currency, it gains strength, but when they don’t, it devalues.
How the Exchange Rate Affects Businesses in the UK?
Whether you sell products imported from other countries or local goods in foreign countries, you must understand how to work efficiently with exchange rates. If you don’t stay on top of the price changes, your profit margin could be severely reduced, and you could incur a loss.
To illustrate how exchange rates affect your business, let’s assume you buy some products worth $50,000 from the US at the exchange rate of 1:1.25 GBP/USD. It means you’re paying the supplier £40,000.
Now, imagine the pound gets stronger against the dollar, and the new exchange rate is 1: 1.30. It means you’re paying the supplier £38,462, meaning you’re saving about £1500.
But if the pound gets weaker against the dollar and the exchange rate becomes, for example, 1:1.20, you’ll pay the supplier £41,667. This means you’re paying an extra 1667 pounds to buy the same worth of products.
Overall, the impact of the exchange rate on imports and exports is a major factor that determines selling prices, profit margins, and consumer spending behaviour.
How Exchange Rate Affects International Businesses?
If you engage in international trade, you must understand how exchange rates affect supply and demand. Here’s a brief outlook on the impact of exchange rates on imports and exports.
Impact on Exchange Rate on Imports
If your business relies heavily on importing products, when the value of your currency drops, the price of imported goods rises, meaning you’ll have to pay more money for the same goods.
Because of how expensive the goods become, most times, you’ll be compelled to buy less. In addition, your selling price will rise, which could lead to less demand for the products or services.
On the other hand, if your currency appreciates and increases in value, you can buy imported goods and services at cheaper prices. This means you can buy more products for the same price, maintain your selling price, and make more money.
Impact of Exchange Rate on Exports
If your business sells a product or service in a foreign country, any change to the exchange rate impacts the buying behaviour of your target market.
When the pound becomes stronger against that country’s currency, your customers will have to pay more of their local currency for your product or service.
This can lead to lower sales because many will find your products more expensive. On the other hand, if the pound gets weaker against the country’s currency, your customers will find your product or services cheaper, and you may experience increased sales.
How Businesses Can Minimise Their Exposure to Exchange Rate Risks
Exchange rates change rapidly based on the forces of supply and demand in the forex market. Here are a few tips to shield your business from losses due to price volatility.
Use Forward Contracts to Your Advantage
Forward contracts allow you to hedge against inflation by providing an avenue for you to lock in a specific exchange rate for a future time.
For example, as a UK-based company expecting payment in US dollars in three months, your client can enter a forward contract to pay those dollars at an agreed rate. This removes the risk of the pound weakening before the payment date.
Limit the Number of Currencies You Trade With
A simple and effective way to manage fluctuations in exchange rates and prevent significant financial losses is to reduce the number of currencies your company uses.
Reducing the number of currencies used can improve the ease of tracking exchange rates to adapt to fluctuations in value more efficiently.
Don’t Rely on One Supplier
To guarantee smooth and efficient international payments, it is crucial to take a proactive approach and plan ahead of time.
If your business deals mainly in the importation of goods, you must have suppliers from different countries so that you can always secure your goods at good rates should the exchange rate of the country you usually import from become unfavourable.
In conclusion, exchange rates can positively or negatively impact businesses in the UK. If your business imports goods and services from other countries, the cost and selling price will decrease if the pound strengthens, leading to higher demand and more sales.
And if your business exports goods and services to other countries, you can benefit from the pound weakening because your products will become more affordable to your overseas customers.
However, you should be aware that several factors come into play to determine the overall effect of exchange rate changes on your business.