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Currency fluctuations can cause financial risks to companies, and they have three options to mitigate the risks.....
Since the start of the Covid-19, a lot of businesses have abandoned their offices and changed to remote working. And this happened globally. Employees all around the world have upgraded their home offices and purchased better computers. The pandemic has made working online easier and remote working became more competitive.
More and more companies are looking for talented individuals to work remotely. Companies have access to an increased online workforce and can save a lot of money by hiring employees from remote locations. Moreover, workers save a lot of time and money as there is no more need for commuting.
Hiring people from around the world has created another challenge that was not so obvious before. In most areas of the world, both employees and employer companies prefer the salaries to be paid in local currency.
Exchange rate risk simply means that when revenue is in one currency and expenditure is in another, changes in currency valuation can instantly cause damage to the company.
Exchange rate fluctuations can have a negative and positive impact on companies' revenue. For instance, if an employer's income is in US Dollars and an employee is paid in the Great British Pound, the stronger GBP/USD pair will benefit the employee and damage the employer.
When salaries are in local currency, planning the future becomes easier for both: employees and employers. Remote workers might have a bank loan in local currency, and bills are certainly in a local one. As for the businesses, businesses are interested in keeping their employees satisfied. And increased volatility in currency valuation doesn’t really help. Salaries need to be renegotiated very often when currency volatility is high. Which usually takes a lot of mental energy and can result in disputes. It should also be mentioned that short and medium term contracts are not typically challenging as currencies are more or less stable in a short timeframe. However, when the job contracts are longer than 6 months, it is important to think about offsetting exchange rate risks.
Forex market exposure is essential to companies with a global workforce as it helps hedge currency exchange related risks. For example, if the company’s income is in US Dollars and the workforce is living in Europe, it makes perfect sense to hedge risks on the FX market. Consequently, currency fluctuations won’t become an issue when paying out salaries.
Forex market has many participants. Some are there for market speculation and profits, like retail and institutional traders, investment funds, mutual funds and wealth management companies. And some are there for exchanging currencies such as banks, governments and global (goods) trading companies. In fact, many globally operating corporations purchase currencies on the FX market to pay out salaries to their foreign workforce.
For businesses predictable market conditions are often more essential than high profits. In the business world, as in life, risks and rewards are positively correlated. Higher risks translate into higher potential for rewards.
● Companies can negotiate to pay salaries in the companies’ own local currencies, which takes all the exchange related risks away. However, as already mentioned, this method can become problematic in the future, as salaries need to be renegotiated more frequently. On the other hand there are countries where local currencies are so unstable, workers actually prefer to be paid in Major global currencies such as Euro or US Dollar.
● Use forward contracts to obtain a more favorable rate of exchange by locking it far in advance. However, it should be mentioned that not all companies have enough capital to secure salaries in far advance.
● Use the Forex market to hedge the risks and pay out salaries in respective local currencies.
One way businesses with a global workforce can offset currency volatility related risks is by hiring a professional FX trader. For every company decisions must be made individually, based on each employee and company’s requirements. Hedging strategies in the FX market are complex to implement. They require a high degree of precision and attention to detail.
The main goal in risk management is not to increase profits. Instead, the main goal is to limit risks. And therefore FX exposure should be around a simple goal to make the company’s financial planning more predictable and stable.
If the majority of the workforce is from a certain area, this might be an opportunity for businesses to expand their offerings there and create additional revenue streams in the same currency.
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