Currency risk in an importer's warehouse

An importer buys goods in foreign currency and sells them to the customer in local currency. Between the day the price is agreed and the day the money arrives, the exchange rate can move, and that move can eat the margin overnight. The warehouse's part in this risk gets little attention, yet the longer goods sit in stock, the longer the risk lasts. In this article we do not forecast the rate or quote real values: all figures are illustrative, taking "1 notional unit = 10,000 so'm". Before large decisions consult your finance specialist and your bank.

The exposure window

The risk lasts from the day the price is agreed until the day the customer pays. Break it into stages:

1. production and preparation;
2. transit and customs;
3. storage in the warehouse;
4. waiting for the customer's payment.

An example, hypothetical. 15 + 25 + 5 + 45 + 10 = 100 days. Of these only 45 days, the time in the warehouse, are directly in your management. Shorten that stage and the whole window shrinks. Slow-moving goods have the longest window, so they are also the weakest point for currency risk.

Payment timing changes the window. If you pay the supplier at shipment, you fix the rate for that day, but your money is tied up much earlier. If you pay after the goods arrive, the obligation stays in foreign currency and a move in the rate changes the amount to pay directly. Either way there is risk, only of a different kind.

How the rate eats the margin

The goods cost 100 notional units and the rate is 10,000: the cost is 1,000,000 so'm. The selling price is 1,250,000 so'm, a margin of 250,000 so'm, or 20 percent. Now you must buy the same goods again, but the rate has moved. If you do not change the price:

• rate +7 percent (10,700): replacement cost 1,070,000, margin 180,000 so'm, or 14.4 percent;
• rate +12 percent: cost 1,120,000, margin 10.4 percent;
• rate +25 percent: cost 1,250,000, margin zero.

The break-even move is the rate change equal to the mark-up. In this example it is 25 percent, so for goods with a small margin the threshold is much closer.

If payment is deferred there is another picture. Goods for 50,000 notional units bought on deferral at a rate of 10,000 cost 500 million so'm. If the rate is 10,700 on the payment day, you need 535 million so'm: 35 million so'm more, while the goods may have been sold at the old price.

What the warehouse can do

The warehouse does not control the rate, but it can shorten the window:

• cut back slow-moving goods and clear dead stock: they have the longest window;
• order more often and in smaller batches, if delivery cost allows;
• at every receipt record the cost both in currency and in so'm at the purchase rate: the item card must show the margin correctly;
• take orders from large customers in advance at a fixed price: if the goods are sold before they arrive, there is no risk;
• in management reports show replacement cost next to historical cost.

Price and contract

Write down in advance the rule for how price follows the rate:

• the validity of a price quotation is short (for example, a few days);
• if the rate moves by more than a set threshold, say 3 percent, the price list is updated;
• the contract with a large customer includes a price review clause;
• the supplier's payment term is close to the payment term on the sale.

See the size of the exposure

Before turning to complex instruments, calculate how big the exposure is: unpaid obligations in currency plus the value of stock bought in currency that has not yet been repriced. That sum is what moves with the rate. Compare it with the company's capital and with the loss you could bear in a quarter. Hedging instruments (for example, agreements that fix a future rate in advance) are complex and cost money, so consider them only together with a finance specialist.

Conclusion

The warehouse's share of currency risk is simple: the less stock sits in the warehouse, the shorter the window. The rest is the pricing rule and the contract. The OmborExpert specialists can help calculate turnover indicators, identify slow-moving goods and build the stress table.