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Article: Corporate News -- Small Business: Small Firms Embrace Hedging --- Importers, Travel Agencies Rely on 'Forward Contracts' to Manage Currency Risk
Abstract:
For small-business owners, the most commonly used hedging tool is the "forward contract," which resembles a normal foreign-currency exchange, except that the exchange happens in the future and the exchange rate is adjusted for the interest-rate difference between the two currencies. With all the regulatory and marketing issues entrepreneurs face, "currency risk is just not worth the time and effort to deal with," said Jonathan Blum, an entrepreneur in San Francisco who has spent four years preparing for next month's launch of Shiso Soy LLC, an importer of artisanal Japanese soy sauce.
Full text:
When Henry Sidel founded his New York-based sake importing company in 2005, $1,000 bought him 125 bottles of sake from Japan. The same sum now buys just 77 bottles.
The yen has risen 30% since 2005, eating into his profit margins as Japanese sake costs more in dollars. The yen's climb hasn't been easy to predict, either. In the past seven years, a dollar has bought as few as 75 yen and as many as 124.
Mr. Sidel couldn't raise prices fast enough to counteract the exchange rate, and his company, Joto Sake LLC, had monthly losses as large as $10,000 in 2010. Mr. Sidel decided to embrace a new strategy: He would use a formal currency-hedging strategy to lock in yen rates ahead of sake payments.
Through hedging, Joto Sake has saved as much as $4,000 a month, he estimates.
As volatile exchange rates eat into their profits, more small importers and travel companies are turning to some form of hedging, a risk-management strategy traditionally used by big multinational companies.
Gary Wool, chief financial officer at 35-employee Preferred Plastics &Packaging Co., in Belleville, N.J., uses forward contracts to pay for shrink film imported from Ireland. Each month, Preferred Plastics signs a contract with currency-exchange firm Cambridge Mercantile Group to swap U.S. dollars for 120,000 euros -- worth about $157,000 at current exchange rates -- with the exchange happening three months later.
In this way, Mr. Wool knows exactly how much money he needs to set aside to pay his Irish supplier, and the payment amount is set, no matter how much the euro swings against the dollar over the three months.
The Irish supplier used to accept payments in dollars, but when it started to lose money on a weaker euro, Mr.
Wool offered to share the currency risk by paying in euros.
Associated Foreign Exchange Inc., one of many foreign-exchange service providers, says its small to midsize business clientele has more than tripled to 17,000 in the past six years. At corporate treasury consultant TreaSolution Inc., 40% of business clients with less than $250 million in revenue now manage their currency risks, up from 25% three years ago, according to its annual Treasury Survey.
For small-business owners, the most commonly used hedging tool is the "forward contract," which resembles a normal foreign-currency exchange, except that the exchange happens in the future and the exchange rate is adjusted for the interest-rate difference between the two currencies.
Forward contracts are convenient for small businesses because they generally don't have any upfront cost, and business owners can lock in a forward contract up to a year ahead.
Here's the catch: Preferred Plastics, for example, is obligated to pay the predetermined price for its euros, even if the exchange rate in three months is more favorable.
"I don't try to make money on foreign exchange," said Mr. Wool. "I'm just trying to ensure we know what our costs are. We know when we quote a price to a customer that we've locked in our profit."
Certainly many small companies are still uncomfortable with hedging. Startups, which are generally strapped for resources, typically can't afford it.
With all the regulatory and marketing issues entrepreneurs face, "currency risk is just not worth the time and effort to deal with," said Jonathan Blum, an entrepreneur in San Francisco who has spent four years preparing for next month's launch of Shiso Soy LLC, an importer of artisanal Japanese soy sauce.
Bill Boyd, owner of specialty foods wholesaler Epicure Imports in North Hollywood, Calif., said he bought forward contracts on the euro in 2007 to pay for food shipments from France but stopped a year later. Predicting the euro's movements became too risky. He decided instead to deal with the currency fluctuations by raising prices and reducing his imports.
"When you want to hedge, you hedge a substantial sum, but if you guess wrong, it can have a big impact on you," said Mr. Boyd, who manages 23 employees. "It's not something we have enough expertise in."
Travel companies also are trying to hedge their currency exposure. Paul Christopher, chief financial officer of adventure-travel company Butterfield &Robinson, which has 120 employees world-wide, said forward contracts helped his company save more than $1 million in some years, but in other years, "we would have done better if we didn't hedge."
But in the 20 years that Butterfield has used forward contracts, hedging has helped the company save "significantly" overall, Mr. Christopher said. "The world is becoming increasingly competitive, and currency risk is just not a risk you can afford to live with," he said.
Corinne Goodman said annual sales at her Chicago-based travel agency Down Under Endeavours Inc. quadrupled to $2 million in 2003 after she used forward contracts to pay for a 600-person trip to the Rugby World Cup in Sydney.
Ms. Goodman, whose seven-employee company offers individualized luxury travel packages, has executed 16 forward contracts so far this year. "Forward contracts have helped us keep a steady growth through a very volatile time," she said.
Mr. Sidel said he expects Joto Sake have $2.5 million in revenue this year, almost double what it brought in before he started hedging. "As an importer, you can survive without hedging, but you might have to sustain some serious losses," he said.
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Credit: By Nicole Hong