At least you can budget on an exchange rate that won’t change

Many small business owners have spent a lot of time and energy worrying about the recent federal budget, and rightly so.

Some have put off making decisions preferring instead to wait and see. But now that there is some clarity around the future and what it means for business it’s time to do some more forward planning.

Much has already been said and written in regards to the winners and losers from the budget, but it is clear that some businesses stand to benefit from the proposed changes, the bulk of which are expected to pass through the senate.

Part of the planning process for small businesses involved in international trade should include some exchange rate modelling or forecasting. Sadly, many of these businesses either don’t know how to go about this or don’t pay enough attention in the planning stage.

Set an internal budgeted exchange rate

In order to get an accurate picture of future cash flows, businesses should set an internal budgeted exchange rate (IBER) and value their cost of imported goods or overseas revenue according to this benchmark. To do this, a business can determine their IBER on forecasts or use the current exchange rate, but neither of these is the most reliable. A better way is to use a market determined forward exchange rate. This is a rate that can be booked today for a future international money transfer up to 12 months in advance.

Because this is a rate that can actually be secured for a future date it is an accurate exchange rate to use for budgeting and if a buffer is added, of say 5% or 10% then one can plan around an exchange rate on a relatively constant basis.

Avoid cash flow mismatch

The time frame, however, should reflect the tenor of your cash flows though, so if, for example, you are on a 60 day billing cycle with your suppliers, use the 60 day forward exchange rate to project cash flows in Aussie dollars on a quarterly basis. Then use a new IBER based on the 60 day forward rate each quarter into the future. Not only is this good risk management, but with a buffer included should ensure your hedging costs are somewhat predictable with a relatively small variance.

So although you never know what challenges and changes are ahead for the federal government’s budget, you can budget on a constant basis exchange rate.

Jim Vrondas is chief currency strategist, Asia-Pacific, at OzForex, a global provider of online international payment services and a key provider of Forex news.