FX Risk 101: The strong USD vs EUR

The U.S. Dollar Index, which tracks the dollar against six other important currencies, is hovering at levels it hadn’t reached in 20 years. The Consumer may not have noticed if s/he hasn’t travelled abroad and exchanged euros for dollars or Swedish kronas, which goes hand in hand with the dollar. But many Controllers, CEOs, currency traders, S&P 500 company executives and economists certainly have.

This is EUR vs USD from the start of 2022 by European Central Bank

EUR vs USD from the start of 2022 by ECB

Fundamentally, a flood of foreign money into U.S. businesses and investments has been driving up the value of the dollar. At the same time, euro’s status has been knocked back by its closeness to the conflict. The Federal Reserve’s latest moves to tighten monetary conditions are likely to spur the dollar further.

FX gain/(loss) in your Profit and Loss: are you a seller or a buyer?

The strong dollar means that it can buy more of a foreign currency than before. For example, the strong dollar is making travel to Europe from the U.S. that much more affordable right now, but puts foreign tourists visiting the U.S. that much more expensive.

Goods produced abroad and imported to the United States will be cheaper. If you’re based in Europe and you sell in US dollars, the strong dollar increase your competitiveness and you’ll may record FX gain in the P/L. If you make purchases or investments in US dollars, your costs are increasing and you’ll may record FX loss in the P/L.

Good time to connect all your live FX bank accounts to a Power BI

If you operate in multiple countries, it’s now a good time to connect bank account balances and live money flows to Power BI for a live follow up. riskrate can do it for you using an API when you can extract your own financial information across the banks in an encrypted, a standardised and real-time way. It only takes 8 min to sign up and you’ll instantly see the results.

Gone are those days to log in to multiple business bank accounts and manually record the balances in a spreadsheet several times per day.

The longer the payment time, the higher the FX risk

FX transaction risk occurs if your customer pays in a different currency (like US dollars) than your bank account (like EUR) is. The longer the payment time, the greater the risk. Payment time is the difference between the value date (when money flows to your bank account) and invoicing date (when you’ve sent an invoice).

The risk is higher, because the longer payment time means that there are more days between these two exchange rates (EUR against the US dollar) to change values against each other. Value changes can be positive or negative — the higher the upside potential, the higher the downside potential and the higher the risk.

How much in euros is a realised/unrealised FX risk?

If you sell or buy in US dollars, the FX gain/ loss is the difference between the invoiced amount in euros and the paid amount in euros.

For example, you make a deal with a Customer and you send an invoice of USD 10 000 on March 30, 2022 (EUR 8 987,96 when EUR/USD rate is 1,1126) and Customer will pay USD 10 000 to your bank account on May 12, 2022 at (EUR 9 634,83, when EUR/USD rate is 1,0379). You’ll get more euros on bank account than the invoices amount was and you’ll book a FX gain in book-keeping: 646,87 EUR.

If the payment was done to your US dollar bank account, you have (the unrealised) FX risk as long as you sell these US dollars to get euros. If the payment is done into your EUR bank account, you don’t have the FX risk anymore because bank has converted it to Euros.

What is a natural FX hedge and how does it works?

In small amounts, FX risk is nonsense, but for bigger amounts and repeatable payments FX risk starts to make sense. The bank’s spread, which is the difference between the buying price and the selling price, is not under your control.

A Good rule of thumb is that if your incoming or outgoing FX cash is worth more than USD 100 000 per month, it’s good to open a currency account, change bank details, BIC and IBAN on the invoices and start to collect incoming cash in the currency account.

A natural hedge is a cost-efficient alternative to consider. It simply means that you start making purchases in FX currency, in this case in the US dollar. It is a more cost efficient alternative than to make a FX deal with your bank, because you always lose a spread.

FX hedges are something you should always think twice. If your FX cash in or FX cash out are based on a payment plan, an investment plan or a loan repayment plan, which has a strict schedule, that’s OK. Otherwise, if the time risk still remains, FX hedges can have a negative impact (or a positive impact) on your cash and money flow, which is the most important funding source of your business. The environment is changing rapidly right now. If you need to make better decisions faster, we’d love to serve you - fast.

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