Currency Risk In A Business

I'm in europe this week, using euros for everything instead of dollars. So I thought it would be an appropriate time to talk about currency risk in a business.

When you have a business that only generates revenues in your local currency, you don't have to concern yourself with the fluctuations of one currency versus another. But if you start generating revenues in other currencies, or if you open an office outside of your country and start generating expenses in other currencies, you will have to start thinking about currency risk.

First, let's talk a little about currencies and how they fluctuate against each other. Since I'm spending euros this week, let's look at the past 120 days of price action in dollar/euro:

Euro vs dollar

So let's say that 20% of your company's revenues are euro denominated. And let's say that your business is doing $10mm a year in revenues. So about $2mm in US dollars of your revenue is in euros. And let's say that was the case at the beginning of the year. At that time, the exchange rate was about .7 euros to 1 dollar. So your business was generating 1.4mm euros in revenues. Since the start of the year, the euro has dropped and now you get .8 euros for every dollar. So if your business is still generating 1.4mm euros in revenues, that is now only $1.75mm dollars of revenue per year. You are still selling just as much in euros, but your annual revenues in dollars has dropped $250,000 in six months. That is how currency fluctuations can impact a business.

Let's do the same analysis, but this time with expenses. If at the start of the year, you had $2mm in annual expenses in a euros because you have an office in europe with employees, rent, etc, then you had 1.4mm euros in annual expenses. By June of this year, those expenses have dropped to $1.75mm, saving your company $250,000 in annual expenses.

What this example shows is the primary lesson of currency risk in business. It is ideal to have your foreign currency denominated expenses and revenues be as close to each other as possible. Because if you can do that, they are a natural hedge. If our examples are combined, and you have $2mm of revenues and $2mm of expenses in euros (a breakeven business in euros), then your profits will not be impacted by currency fluctuations. Your revenues might go up or down, but your profits will be immune.

If you cannot match foreign currency denominated revenues and expenses, then you will have risk to your business. If the foreign currency revenues and/or expenses are small (measured in the millions or less), then you should not do anything about this risk. Just understand that you have the risk and live with it.

But if your unmatched foreign currency denominated revenues and/or expenses are in the tens of millions of dollars or more, then you can hedge the risk. As I explained in last week's post, there are a number of hedging strategies that you can put in place to manage this risk. There are currency desks at the major money center banks and global brokerage firms that specialize in hedging currency risk for companies and they will be happy to put in place currency hedges for you. Hedging currency risk can get expensive, which is why I don't recommend it for small companies, but for large companies with significant currency risk, it is standard business practice and it is very common.

For many entrepreneurs, currency risks are not going to be something to worry at the start of the business. But we see most of our portfolio companies start thinking about international expansion about five years into the development of their business. They open an office outside the US and start generating non dollar denominated expenses. In time, they start generating non dollar denominated revenues. At some point, these amounts become significant and the CFO has to start thinking about currency risk. If you get to that point in your business, think of it as a good sign. Something to manage for sure, but a sign that the business is on the right trajectory.

#MBA Mondays

Comments (Archived):

  1. Julien

    Luckily this is one of the financial risks that offers the most mechanisms for hedging :)the most obvious one would be Apple’s strategy and use a very pessimistic EUR/USD rate. For example the new Mini bought on the US Apple Store is at $699… and then, bought on the french Apple Store it’s at €799, which is $1001 at today’s rate : FAIL!

    1. fredwilson

      don’t you think that impacts their euro based revenues?

      1. Julien

        I wish it would, but we need the elasticity… One thing that it impacts for sure : the weight of my luggage when I travel from the US back to Europe 😀

    2. John Frankel

      You have to tax adjust. I.e. the $699 is before sales tax and the €799 is most likely inclusive of VAT which I think is 19.6%. If that is the case, then the disparity is still there, but much smaller.

      1. Julien

        You’re right… I should have mentioned this.

      2. Fernando Gutierrez

        VAT is different depending on the country. The main rate (there are reduced ones for certain products) in the EU ranges between 15% (Luxemburg) and 25% (some Nordic countries).

    3. Fernando Gutierrez

      That strategy is used extensively by consumer electronics companies. Last year I bought a camera in the US for $1025 while in Spain it was priced around 1100€ (back then that was almost $1600). I could almost pay the plane ticket with the difference.

  2. Farhan Lalji

    Doesn’t it make sense to minimise the expense risk and maximise the revenue side? If I’m earning 1M EUR and can get away with spending as little as possible in EUR isn’t that better than matching?

    1. fredwilson

      not if the euro falls, because those revenues will fall but your expenseswon’t

      1. Farhan Lalji

        agreed, but if I’m able to minimise, let’s say get 1M EUR revenue out of 200K EUR + 100K USD, as opposed to the same revenue out of 500K EUR or higher, wouldn’t it make sense to take the risk on the currency because with the costs saved the EUR would have to fall a whole heap to make the expenses costly.

        1. fredwilson

          that’s a different questionyou may decide to take currency risk to get other benefits

  3. Tim Panton

    One of the easiest ways to minimize a currency risk is to minimize the length of the payment cycle, then re-patriate the money to where your costs are as quickly as possible.Strategies for getting paid promptly vary from country to country, in the USA getting paid by creditcard seems to be quickest – even for large amounts. In the UK Direct Debit is best. In Holland giro-payments work well.The bank or card charges for getting quicker access to the money may seem high, but that’s growth money you won’t have to pay interest on, which reduces your overall costs.

    1. fredwilson

      great ideas Timthanks for sharing them

    2. Jim in Colorado

      This works if you are in an industry where you can demand quicker payments. Many EU countries net 90 is the norm and if you dont accept it you sometimes cant do business. There are good strategies to finance these receivables cheaply though through ExIm bank.

  4. RichardF

    Your getting more bang for your bucks at the moment too in Europe – Good time to go back to the US with a new Ermenegildo Zegna jacket then Fred and a new Fendi bag (or two!) for Gotham 🙂

    1. fredwilson

      i have already started buying stuff and i haven’t been on the ground formore than 12 hours

      1. Fernando Gutierrez

        🙂 Don’t go too mad, I think that for some categories (clothing, electronics, sport goods) the US is still cheaper. Only if you’re buying Italian products you are probably getting better deals.It’s interesting how we make purchasing decissions. I read a while ago a study, made by a company I was doing a project for (they were airport retailers), that said that when we are travelling we are willing to believe that things are cheaper even when they aren’t (they had some measures on that, but I don’t remember them). I’m proof of that assertion. I’ve been travelling monthly to the US for the last year and I’ve made most of my purchases there. My motivator was that the dollar was falling against the euro, but when I analyzed the prices, the commissions and the hassles, in many occassions I wasn’t getting the great deal I thought I was getting.

      2. ShanaC

        Sit down- enjoy a coffee and a gelato or a sorbeto. It’s supposedly hot there.

        1. fredwilson

          It is hot. But not any different than nyc to be honest

          1. ShanaC

            Even more so 🙂

          2. kenberger

            show up in Southern Italy in August or September and it’s likely you’ll feel different– i’ve been there 3 times in that time frame and it was “Africa hot” (to quote Biloxi Blues).

      3. kenberger

        Well, resist the urge to import a new Vespa. (talk to me, however, if you’re leaning Ducati).

      4. Aviah Laor

        Italy: The only country where men’s clothing is more important than women’s.

        1. fredwilson

          That was our experience ysterday

  5. riemannzeta

    Extra credit: Explain how lack of currency risk is part of the explanation for the trends observed by Andy Grove in his July 1 Bloomberg Businessweek essay, and how the loosening of the peg and regulation of derivatives could reverse the trends.

    1. fredwilson

      guess: the US isn’t selling enough product to other countries?

      1. riemannzeta

        I would give credit to both you and ShanaC. By assuming any currency risk associated with adding jobs in China, Chinese monetary authorities supercharged the scaling of manufacturing in China. With a currency peg removed, and exotic instruments like interest rate swaps getting more expensive or going extinct, there are will be no way for U.S. companies to hide from inflation of the dollar against the yuan over the coming decade. More manufacturing jobs are going to shift back to the U.S. The breakdown of our exports to China (agriculture, raw materials, scrap) will not be sustained in a world where scaling up production means assuming the risk of rapid inflation in the local currency paid workers overseas — and that’s without the increasing labor unrest.

    2. ShanaC

      Because it will suddenly become much more costly to do manufacturing in china compared to amount of what we sell there versus what we manufacture and sell here?effectively this de-pegged system is about arbitrary costs of currency versus goods- the costs in china/other areas of asia will rise to become roughly comparable?

  6. Vijaya Sagar V

    Fred, well said, especially about the natural hedge of expenses & revenues within the same currency. One more thing – currency fluctuation can affect startups while raising VC money too. Entrepreneurs who are raising money from an offshore VC should remember this and talk terms in local currency. We did and it made a significant difference. Even a 1% variation in currency value (between the time the terms are tentatively agreed upon, to the time the money comes to the bank) can be significant for a startup.

    1. fredwilson

      we have the opposite issue with our investment in Zemanta which is a UKinvestmentwe show currency fluctuations on our schedule of investments

    2. Fred T

      This is one challenge companies had to deal with when transactions do not clear into international bank accounts on the same day (which typically happens). We initially had to come up with the difference in Euros, and what more if this was a bigger FX amount, the fees directly correspond to this as well.I definitely see a startup coming up with a solution for this.

      1. davidmit

        This is a common problem, not just for startups but also expatriates.One solution is to ask the bank to transfer your target amount in the target currency, and charge the appropriate source currency amount to convert into that amount. The problem (for individuals, at least) is that banks tend to choose the least favorable exchange rate over the 2-3 days period that an international wire may take to transfer. With EURUSD volatility being so high, I’ve sometimes paid 3% more than I should.I now deal w/ this problem through my discount brokerage account. I make the wire transfer in the same currency as the target, and buy the target currency with negligible commissions and very tight bid/ask spreads.

        1. ShanaC

          Do you have spreadsheets for that- my family is hosting a number of expat families visiting stateside over the next two weeks (they made aliya, and are in the US visiting). I also know of a number of people who are commuting Israel/US out of JFK or Newark regularly (like back- forth 2-3x a month)- Currency fluctuations are important for how they handle funds.

          1. davidmit

            Hi Shana, I don’t have spreadsheets… I just compare the exchange rate on Google Finance to the one offered by the bank. As for my brokerage account, it is with Interactive Brokers. I’m afraid it’s not a good solution for tourists, but might work well for people needing to transfer large sums every few months.

          2. ShanaC

            No- these people are in it for the long term- family lives in one country,person works in another, etc.(Said set of people are interconnected to said other set of people based onlocation and neighborhood choices)

    3. Mark Essel

      Excellent point from the fund raiser’s perspective Vijaya.Given offshore investment, your runway can fluctuate rapidly.

  7. kidmercury

    this is the biggest risk in our current world because the allegedly unforeseeable financial crisis is a global currency crisis at its core. the only solution is gold, or perhaps something new some internet business comes up with. the globalists will propose their new global currency…..heaven help us if the youngsters fall for it again.on that note i would like to once again invite people to hate gold and make fun of it. remember this is all a setup for when gold rallies and all the other currencies become worthless, that is when i will cash in on my joke and rub it in. i am just investing in that comedic pay day at this point. so gold haters, please continue to publicly express your hatred for gold, preferably being as emotional as possible about it.

    1. Mark Essel

      I’d prefer real estate, and sustainable energy to gold. I was without real wifi for a few days and freaked out while in Maui. My power went out at home and I stared blankly at my computer (then hopped to my phone and tablet).

      1. kidmercury

        I like gold primarily for stagflation, not end of world. Meaning how do you hedge yourself for currency devaluation and things like $7 a gallon gas.In the event of hyperinflation, I also like gold and silver, but a whole slew of survival stuff is needed for such an event, not just gold and silver.Real estate is nice for end of world/hyperinflation, but other than that, not so much IMHO. The most recent bubble was in real estate. Have dot com prices recovered since their bubbble? No — nasdaq is less than half of its highs, and that’s in nominal terms; real value is even lower. Real estate will go through a similar form of embarrassment. Big bubbles typically take decades to recover from.

    2. kidmercury

      gold had a big down day today, and is now below $1200/oz. it is down over 2% for the past 30 days. given how much it’s rallied over the years while falling recently, don’t you think this bull market is done? my ego is too big and i can’t admit when i’m wrong, so i have to stick to my gold call. but here is your chance to embarrass me, to get me back for running my big mouth here in fredland for all these years. i hope you will step up to the plate and prove yourself to be better than me my making fun of gold. lord knows i deserve to be embarrassed — here’s your chance to do something honorable, and to win a beef as well.

      1. ShanaC

        Kid, if you are wrong, I wouldn’t make fun of you. I would tell you to get out while ahead.And you will learn what a big ego does, that’s all. Everyone gets it handed to them sometime or another.

        1. kidmercury

          i already know what a big ego does, that’s why i make fun of youngsters whose ego is too big to serve the truth, and why i always make sure to serve the truth myself. because i know it is greater than me, and that if i wish to be great, i should obey the truth — not be an ignorant coward who denies it.secondly, not everyone gets it handed to them. people who are mature, responsible, and good-looking enough to follow the simple rules of life do not “get it handed to them.” perhaps they will stumble at times, but that is not “getting it handed to them.” those who lack the maturity to obey the truth, who think they are above the truth, and who attack the more noble, evolved, and superior truthers are the ones who will get it handed to them. for they do not obey the real authority in the universe, and thus they will learn the hard way that such an authority exists, and that its name is Truth.

          1. ShanaC

            You would make a good preacher Kid.Someone really should steal that last line.(Though I disagree about being good looking enough)

          2. kidmercury

            outer beauty is a reflection of inner beauty, that’s why looks are more important than anything else. i’m fortunate that my mother’s love was entirely conditional on the basis that i be a good-looking person. without such conditional love, i would be a superficial person who focused on things that weren’t important, rather than more meaningful things like good looks.

          3. ShanaC

            I don’t believe in conditional love first off.Second off, I’m having trouble deciphering what you mean as beautiful. Themost beautiful woman I ever saw was amazingly plain. She had a child, andwhen she smiled at her daughter, she lit up a room in the most unusual way-you could tell she felt totally fulfilled as a mother, and it was etched inthe skin. Then there is the incredible beauty of looking past conventionalinto the ages and wizened and seeing how all of those lines come to formincredibly wonderful shapes that truly reflect the person. Like this: don’t think this is what you mean though?

  8. John Frankel

    It is not just currency risk, by the way, but can be commodity risk for manufacturing businesses. At one point Ford was making more on its precious metal “hedges” (for catalyst converters) than it made on cars. Of course, the next year they gave it all back.

    1. ShanaC

      Actually, it would be really interesting to see how to do this with commodities plus international currency. Commodities affect a lot more small businesses after all. (though perhaps not so many web businesses)

  9. reece

    Awesome lesson.I can’t wait to have this problem. 😉

    1. Mark Essel

      Same here Reece!

  10. Jim in Colorado

    The funny thing about running an internet business “mostly” started in one country but covering several is that you can end up with the majority of expenses in one currency but earning in another. Even though I didnt set out for that I did end up with a mostly non US business with majority of people and expense in the US.This is a problem for internet companies (we are online advertising) is you can easily start selling in the UK and Europe without setting up huge expenses (mostly people and technology) which you usually run out of a central location for all territories. Also, payment cycles outside the US can be traditionally slow and there is sometimes little you can do about it. Unless you are Google or Facebook and control the market it gets real hard to get scale without offering terms. If net 15 or net 30 are the norm in the US expect net 45-60 in the UK and net 90+ in places like Spain, Italy, and France. There you need to prepare for money to be worth different amounts once it is collected. Its also important to note that you probably dont want too much overhead or costs in Europe anyway since its probably much more expensive no matter what the exchange rate and you dont want to employ anyone in some of the EU countries unless absolutely necessary. For instance in France you need to add about 45-50% in costs to an employees salary to cover all the government costs and taxes.Our company has used forward contracts to help hedge against risk by locking in prices and are more often forcing our US suppliers to accept prices denominated in foreign currencies when we can. Also payments are more risky so credit insurance is recommended if you can get it. The US government offers help in insurance and finance for US exporters so that is something to look into.

  11. Tom Allason

    another thing to consider is the rise of outsourcing particularly for developers and call centres. most of these guys bill in $ regardless of where they are. whilst this absorbs the risk of their local currency fluctuation it can be a big pain (or bonus) when your local currency fluctuates. shutl is capitalised and bills customers in £ but has a decent sized dev team in pakistan who bills in dollars. this is our single greatest expense expense after in-house team… and has been a bit of a pain this last year!

  12. Ed Freyfogle

    Just curious, but do you think it’s still safe for a company to wait 5 years to develop an international strategy. My experience is that information travels so quickly, if you are succeeding in one market, clones will spring up in others. Either you move quickly or you lose your chance to expand. Depends on the sector of course, particularly if strength in market A provides an advantage in market B

  13. Ed Freyfogle

    Just curious, but do you think it’s still safe for a company to wait 5 years to develop an international strategy?My experience is that information travels so quickly, if you are succeeding in one market, clones will spring up in others. Either you move quickly or you lose your chance to expand. Depends on the sector of course, particularly if strength in market A provides an advantage in market B that will help you overcome being a late arrival.

    1. Mark Essel

      Great point Ed, I was concerned about the same issue. If you wait while showing local traction you’ll certainly face fierce local clones when trying to expand a web based business.

  14. daryn

    kind of a tangent from your main point, but just curious: did you get cash for your trip, when did you get it, and/or are you still trying to go cash-free when possible?

    1. fredwilson

      i cheat because the gotham gal is not cash free and i travel with hershe went to chase bank and took out 630 euros last weekcost her almost $800 US

  15. Evan

    this is definitely not what I was expecting your next topic to be, since your posts to this point have tended to focus on issues entrepreneurs my opinion, political risk is the most-important, most-ignored factor in international investing. I like using Argentina as an example: once the Arg peso was pegged 1 to 1 to the dollar. If a consulting company (picked for simplicity of operations and lack of fixed assets) opened an office in Argentina in 99 at 1:1, it then lost as the peso was devalued to 3:1 and currently sits at almost 4 to 1. hedging would have worked in the short-term, but in the long-term would probably have been pointless.

  16. Rahul Deodhar

    There is a strategic component to currency risk.There are businesses where currency valuation changes will impact competitiveness. Outsourcing is at a threat from this kind of variations. A Yuan revaluation will make it difficult for hardware manufacturers to sustain product prices. Similarly Indian IT industry (service outsourcing) is vulnerable to revaluation of Indian Rupee.Companies have to evaluate what their exact risk profile is – what currency movements will benefit them and what currency movements are likely.In that context, if your source of funds is dollar denominated (most are) then this is good time to invest in US / UK etc in businesses where depreciating currency will reinforce competitiveness.

  17. kenberger

    As someone who deals with this business issue on a daily basis, don’t even get me started. Besides up and down currency movements, you can’t imagine how significant a racket it is for banks to make tons (while you lose relative tons) on exchange and transaction fees. This happens even if the currency you’re dealing with is pegged to the dollar.It is key to have the right banking relationships. And I don’t mean necessarily paying an expert in FX and conversions, etc, although that can be well worth the expense depending on how global your company is. I mean simple things like receiving a wire transfer, and which bank does the exchange, which banks intervene as “correspondence banks” etc. You can lose a significant amount on every payment if you, and your well-meaning client and/or his well-meaning US bank teller isn’t experienced in simple nuances of international banking, even in modern times.

  18. Jerome Camblain

    As a former FX (Foreign Exchange) option trader in my early days, before venturing into startups, I can add few points to this great post.FX variations can be hedge through FX options, but options can also be used as a marketing technique:a company can buy cheap out of the money options (as a marketing investment) and give the benefits back to its clients. As for example, a travel software company can tell its SaaS users that it will lower the price of the service next month by X% if the USD dollar weakens, in order to compensate for the larger cost its client will suffer when travelling to Europe. The loss to the company due to this discount offered will be compensated by the gain on the option. Its a great marketing tool that will create a cheap buzz.You can do the same with an option on a commodity. With an out of the money call on gold, for a jewellery e-merchants…

    1. Mark Essel

      Very nifty Jerome.Just to clarify my understanding:1) out of the money options2) lower the cost if the USD weakens3) options gain covers lost revenueWhat are the downsides to this practice (options costs?)

  19. markmay

    “Natural hedge” – I know what you’re trying to get across w/ that comment, but as long as you have foreign PROFITS, you’ll always be at “risk” of a translation risk to your bottom line.

  20. Jason Bresnehan

    The Pursuit of Luck

  21. Rick Wingender

    Awesome post. I learned more about this topic here (including all the comments) than I did from my graduate corporate finance course!

  22. Mark Essel

    Accidentally went to due to the browser picking it first (just typed in avc) ;)I would like to disagree with the ideal revenue versus expenses portion of your post. I’d certainly take a much higher currency risk to have a billion dollars in overseas revenue versus a million dollar in expenses. I’d be even happier about this risk with the hedging you suggest later in the post.Ideal for me is revenues much much greater than expenses. That’s my simple decision making process.

  23. HowieG

    I know I am late to the party but I have a great but sad story on currency risk. Around 200-2001 Air Products and Chemicals (US and client of mine then) and Aire Liquide (France) agreed to purchase and split BOC Gases (UK). For Air Products to make the purchase BOC was requiring the payment in Pounds Sterling. So Air Products purchased Pounds Sterling using US Dollars and assumed since the sale was a go never HEDGED! Make a long story short the sale fell through and when they went to convert the pounds back into dollars Air Products lost $300million because at that time the US dollar had surged. I saw the Company Magazine with the Apology to employees and shareholders as the cover story.

  24. sk001


  25. sk001

    well done

  26. Roman

    Thanks. I congratulate you for this blog. I’ve really enjoyed. I sincerely thank you again.________________________ Liverpool Street Serviced Offices