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Follow the Big Guys

Currency fluctuations can jeopardize cash flow or profitability in companies of any size. If your company is potentially at risk, consider currency hedging.
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Finance 101

The sagging euro got you down? Or are you profiting from it? It may be time to try your hand at currency hedging

If the term currency hedging evokes images of large corporations hell-bent on globalization, think again. "Foreign-currency risk management isn't a size issue -- meaning, Is your company too small to consider it or too big to be able to avoid it? It's a business issue, plain and simple," says Andrea S. Kramer, a partner at law firm McDermott, Will & Emery, in Chicago. "If you're doing business with any international customer or supplier, even in a country that's as close and relatively stable as Canada, you need to ask one question: Will currency fluctuations affect my business in ways that could significantly jeopardize cash flow or profitability? If the answer is yes, then you need to consider hedging."

While more young companies have started getting involved with international imports or exports, currency hedging has also become more accessible to them, thanks to a growing number of services offered by large banks as well as by business-to-business Web sites. For the novice, the place to start is with your regular banker, who can direct you either to the proper source within your bank or to a larger institution that's actively involved in currency exchange.

In the past, experts have said that the only way to truly avoid the risks of currency fluctuation is to transact all international business in U.S. dollars. But obviously some customers or suppliers won't go along with those terms, and for a small company that's looking for ways to break into competitive overseas markets, it may be hard to insist on those ground rules. Even companies that have successfully required customers to pay for their products in U.S. dollars are not necessarily home free.

That's the situation facing Lenel Systems International, located in Pittsford, N.Y., a provider of security-and-safety systems for hospitals, airports, and corporations. As much as 20% of Lenel's $38 million in revenues come from international sales. "We have employees at locations in the Far East, Europe, Latin America, and elsewhere," explains Elena A. Prokupets, president and CEO of the company (which ranked #39 on the 2000 Inc. 500 list and #128 on the 1999 list). "Depending upon the strength or weakness of their own local currencies, some people prefer not to be paid in U.S. dollars, which creates a financial risk for us that we choose to control through hedging techniques."

Put simply, hedging allows a business owner to greatly reduce or eliminate the uncertainties attached to any foreign-currency transaction. Since no one can accurately predict how much a currency will be worth against the dollar on the exact day that a company will need to convert it, hedging offers the best alternative. A company basically locks in a currency-conversion rate that will be available at a specified future date. Presto. The unpredictability is gone. And so is the possibility that profit margins will disappear if, say, a company's customers plan to pay in euros, whose value has dropped faster than an elevator in free fall. And businesses that cut paychecks in foreign currency can eliminate the risk that a swing in exchange rates will unexpectedly bloat labor costs. Like Lenel, such companies can assess their quarterly payroll needs and then lock in rates.

"If you look at the prolonged and unexpected decline of the euro, that gives a hint of the kind of problems a business owner can face," says Gregg Rusk, a partner at accounting and consulting firm Grant Thornton and director of its Miami International Business Center. However, European transactions are not the only source of currency headaches. "Many of our clients were hit earlier by problems tied to Brazil's and Argentina's currencies," Rusk says.

If your company is like many others that have international operations, it's probably juggling multiple transactions, with payments staggered according to different schedules and tied to the swings of different currencies. If that's the case, and you're not already engaged in hedging and want to get started, the easiest way to begin is with a "forward contract." Forward contracts guarantee that a company will be able to convert a specified sum of money (either into or out of a foreign currency) on a certain date. "That is the traditional, classic, old-fashioned way to do it, and it still works very well for most companies," says Andrea Kramer.

Transaction fees, which are sometimes embedded within the conversion terms, vary depending on several factors. One is clout. Large companies with hefty overseas operations are courted by traders and have the power to negotiate; small companies have to take pretty much what is offered. Typically, fees increase with the length of the contract. In the end, currency hedging makes sense only for companies that value predictability and whose profits could be significantly hurt by variations in exchange rates.

One other consideration: to handle even simple forward contracts, you need a high-quality internal finance officer. At Lenel, chief financial officer Peter Ciaccia and the company's controller manage the foreign-currency transactions together, and they have proceeded at a cautious but steady pace. "During one quarter we watched the whole issue," Ciaccia says. "We looked at a lot of what-ifs. What if we'd bought a forward contract at this point? Would we have been better or worse off? Would it have provided us with the predictability that we need in a fast-growth situation like ours?"

After the early period, recalls Ciaccia, "we got started slowly. We worked with our bank, because a company of our size can't devote significant resources or manpower to this activity. It made sense to us to leverage our lender's expertise." As the company gained experience with hedging it expanded its use of the practice. "We're currently hedging two currencies -- the Norwegian krone and the French franc -- and we're tracking the Canadian situation to see if that makes sense for us as well," Ciaccia says. He's also monitoring Hong Kong, since the company has a growing operation there.

What about doing some comparison shopping on the Internet? There are a growing number of sites, including www.fxall.com and www.currenex.com, that allow visitors to compare hedging prices offered by a range of traders. For small companies, Web sites can be a good educational tool -- a way to begin to get a grasp of what's involved in currency hedging. But the sites can't match the benefits of working with a banker. "Education is very important for a company that needs to decide which of its international transactions to hedge, and how much, and how far into the future," says Rusk. "But I'd tend to think that these Internet services really make sense only for bigger companies with very sophisticated CFOs coming from international-finance backgrounds." Ciaccia agrees. "It's incredibly important to be in a walk- before-you-run situation when it comes to hedging," he says. "We don't need to shop the Internet to find the absolute best deal here. We need to prudently make progress in our efforts to control our foreign-currency risks."

Jill Andresky Fraser is Inc.'s finance editor.


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