If you’re an international business, then you may have heard of the term FX floating around. Unlike other types of businesses that trade just locally or nationally, international businesses have a distinct challenge in that they are dealing with lots of different currencies. Here, we’re taking a look at FX for business and what the key components of this are.
What Does FX Stand For?
FX stands for forex, which is short for the foreign exchange market. This is a global marketplace and is one of the most liquid in the world. With no authority overseeing this, it is the place where national currencies are exchanged. The market is made up of a variety of financial institutions such as banks, brokerages, traders, and investors. FX sees trillions of dollars being exchanged on a daily basis and sets its rates as one vs. the other (known as currency pairs). This is a significant amount of money being passed through the exchange on a daily basis and consists of everything from consumers to banks and traders.
How Does This Impact Businesses?
FX impacts businesses in a variety of ways. First of all, due to the ever-changing exchange rates, businesses that deal in multiple currencies need to be aware that they are subject to the constant movement of currencies. So if the value of a currency was to skyrocket or fall dramatically, this would impact their business. For example, if an American business is operating in Europe and the value of the Euro drops against the dollar, then the collection may be worth a lot less one day than what it is the next.
International Businesses In Forex
International business owners will use the foreign exchange market in a number of ways, depending on their business processes. Some of these ways include:
- Simple currency conversion when receiving money from an international buyer
- Paying an international supplier
- Hedge positions and prices against fluctuations
There are a few terms within these that you may be unfamiliar with, which we can break down for you.
Spot Contracts – In Forex, a spot contract is when a formalised contract is put together between two parties to agree to convert currency at the market rate and at pre-determined settlement date. This settlement date could be today, tomorrow or years from now, but the two parties agree to exchange at the market rate.
Forward Contract – A forward contract on the other hand is a pre-determined exchange rate and a pre-determined rate. This is important for businesses that have payment terms set in place where they may not be receiving payment for 1-3 months’ time. Using forward contracts can help to limit your exposure particularly if you feel the market value of a particular currency isn’t going to be as strong as it is now. This can help to protect the business.
Futures Contracts – Futures contracts are very similar to a forward contract, but these are instead managed on an exchange keeping this safer and more standardised.
As you can see, there is a lot to know when you’re a business dealing with FX. Understanding the history of the exchange and the different ways that you can take part can give you the advantage to help protect your business when dealing with multiple currencies.