We talk a lot about internationalisation: new markets, new customers, new distributors. We talk much less about what happens to the money on its way home.
The moment you sell or buy in another currency, your profit depends partly on an exchange rate you do not control. A good year on paper can turn into a loss once the pounds actually land in your bank account.
The good news is that SMEs do not need complex trading strategies to manage this. They need to understand one idea and have a few simple tools in place: Currency Hedging
Currency hedging is like insurance for exchange rates.
it stops a swinging currency from quietly shrinking our sales or making our stock more expensive.
What hedging is, and what it isn’t
Currency hedging is a way of fixing, or at least steadying, what a future foreign-currency payment will be worth in pounds.
You know in advance what you will receive or pay, so you can price and budget with confidence.
- It is insurance: It protects your margins when you invoice customers or pay suppliers in euros, dollars, or any other currency.
- It is not gambling: Speculating means betting on which way a currency will move. Hedging means taking the surprise out.
- It has a trade-off: If you lock in a rate and the currency then moves in your favour, you miss out on the extra gain. In return, a bad swing cannot wipe out your profit.
The aim is not to beat the market or gamble with it; not at all! It is a strategy to make sure the margin you planned is the margin you actually get.
An example: the whisky trap
Given our commitment to always offering a Scottish viewpoint, let’s offer the example of a Scottish whisky producer selling into the US.
Its costs are in pounds: distillery staff, bottling, energy, packaging. Sales are in dollars, and they arrive months later, once the whisky has been shipped, stored in a US warehouse, and bought by distributors.
During this time gap, the dollar can go down, then up, then down again. A bottle sold for $150 might convert into far fewer pounds than planned. The business thinks it has made money, but once the dollars come home, the sales do not even cover the cost of making the product.
What we have in this situation is transaction risk: the gap between agreeing a price in one currency and settling it in another.
The longer the gap, the bigger the risk. Any business with long production, shipping, or payment cycles is especially exposed.
“But we already fixed our rates at the start of the year!”
Many SMEs agree on an exchange rate with their accountant at the start of the year, and use it unless there is a major shift. This is a sensible practice. This is what we usually call a budget exchange rate (or plan, standard or internal rate).
It keeps budgets and management reports consistent, so you can judge how the business is performing without the numbers jumping around every month. Many firms add a review rule too. For example: if the market rate moves more than 5% from the budget rate for more than two weeks, the forecast is updated.
But a budget rate is an accounting tool, not a hedge. It changes the rate in your spreadsheet, not the rate your bank gives you.
When the real money is converted, the difference shows up as a foreign exchange gain or loss, often only when the year-end figures are reconciled. That is how a paper profit turns into a cash shortfall. The fix is to use real hedging tools so the money in the bank matches the plan.
Most SMEs only need one or two of these. Start at the top: the simplest tools are often the most effective.
| Tool | What it does | Good for | Watch out for |
| Natural hedge | Pay foreign costs with foreign income, so the money never needs converting | Businesses with costs and sales in the same currency, such as US warehousing, duties or marketing paid from US sales | Rarely covers everything; your main costs may still be at home |
| Multi-currency account | Hold dollars, euros, and other currencies instead of converting every payment as it arrives | Receiving and paying in several currencies | Holding currency to “wait for a better rate” is speculation, not hedging |
| Forward contract | Fixes today the rate for a payment on a set future date | Confirmed orders and invoices with known amounts and dates | You must complete the deal even if the order falls through; the rate is set by the market, not your budget; some providers ask for a deposit |
| Flexible (window) forward | Fixes a rate for a total amount that you draw down in parts over a period | Regular sales or payments where the exact timing is uncertain | You still need to use the full amount by the end of the period |
| Currency option | Gives you the right, but not the obligation, to exchange at a set rate | Uncertain deals, such as tenders, where you want protection without commitment | Costs an upfront fee (a premium), so it is often less suited to very small businesses |
In the whisky example, a sensible mix would be: receive US sales into a dollar account, pay US costs straight from it, and use a flexible forward to bring home the amount needed to cover UK production costs.
Five steps to get started
- Map your exposure. List every invoice, bill and contract in a foreign currency. Note the amounts, the currencies and how long the money takes to arrive or leave.
- Work out what you can absorb. How far could the rate move before your margin disappears? That tells you how much protection you need.
- Match first. Before buying any product, see which foreign costs you could pay directly from foreign income.
- Hedge what is certain. Use forwards for confirmed orders and invoices, not hopeful forecasts. Many businesses hedge only part of their expected exposure, such as half, to keep some flexibility.
- Write it down and talk to a specialist. Agree a short currency policy with your accountant: which tools you use, when, and what triggers a review. Then compare what your bank and specialist payment providers can offer for transactions of your size.
Internationalisation is about more than finding customers abroad. It is also about making sure the money you earn there is still worth what you expected when it comes home. A budget rate keeps your reports tidy. A hedge keeps your profit.
If your business is expanding abroad and you want to talk through where currency risk sits in your plans, get in touch with the NorthStar Consulting team.
