Let’s talk about a subject that doesn’t always get the spotlight it deserves but can make or break your international projects: managing currency risks in international construction sales.
Now, I know this isn’t the most glamorous topic, but trust me, ignoring currency risks is like leaving a window open during a storm—it invites trouble. Whether you’re selling to international clients or sourcing materials from overseas, fluctuations in currency exchange rates can erode your profits faster than you realize.
In this article, we’ll unpack the fundamentals of currency risk, explore its impact on your construction business, and—most importantly—discuss strategies to manage it. Let’s dive in, shall we?
What Is Currency Risk? And Why Should You Care?
Let’s start with the basics. Currency risk, also known as exchange rate risk, arises when the value of one currency changes relative to another.
For example, let’s say you’re a Canadian construction company securing a project in the U.S. If the U.S. dollar weakens against the Canadian dollar, your revenue in Canadian dollars could shrink, even if the project budget stays the same. That’s currency risk in action.
Here’s why it matters:
- Profit Margins: Fluctuations can eat into your hard-earned profits.
- Cash Flow: Unexpected rate changes can disrupt your payment cycles.
- Competitive Pricing: Managing currency risk can make your bids more attractive to international clients.
In short, poor currency risk management can hurt your bottom line—and no one wants that.
Understanding the Types of Currency Risks
Currency risk isn’t a one-size-fits-all issue. It comes in different forms:
- Transaction Risk
This occurs when payments in foreign currencies are affected by exchange rate changes between the invoice date and the payment date.- Example: You quote a client in euros, but by the time payment arrives, the euro’s value has dropped against the Canadian dollar.
- Translation Risk
This arises when consolidating financial statements of subsidiaries operating in different currencies.- Example: Your international branch shows lower earnings due to unfavorable exchange rate movements.
- Economic Risk
This is a long-term risk affecting your competitive position in the market due to currency fluctuations.- Example: Currency depreciation in a country where you source materials could inflate costs over time.
Understanding these risks is the first step toward managing them effectively.
How Currency Risks Impact Construction Sales
Let’s connect this to your day-to-day operations.
In the construction industry, currency risks can creep in through:
- Bidding on International Projects: Pricing your services competitively while safeguarding profits is tricky when exchange rates are unpredictable.
- Sourcing Materials and Equipment: If your suppliers are overseas, rate fluctuations can inflate your costs.
- Labor Payments: Hiring international subcontractors can expose you to wage discrepancies tied to currency changes.
A few years ago, one of our clients at N3 Business Advisors learned this the hard way. They underquoted a project in the Middle East without factoring in currency risk. By the time they received payment, the exchange rate had shifted, and they ended up losing 12% of their expected profit margin.
Strategies to Manage Currency Risks
Now that we’ve covered the risks, let’s focus on solutions. Here’s how you can protect your business:
1. Use Forward Contracts
Forward contracts allow you to lock in an exchange rate for a future transaction.
- Ideal for projects with predictable payment timelines.
- Protects you from unfavorable currency fluctuations.
2. Diversify Your Currencies
Don’t put all your eggs in one currency basket.
- Maintain accounts in multiple currencies to match your revenue and expense streams.
- This approach minimizes the need for frequent conversions, reducing exposure.
3. Set Up Currency Clauses
Negotiate contracts that include currency adjustment clauses.
- Agree on a base exchange rate and outline how cost variations will be shared between you and the client.
4. Work with Currency Risk Experts
Partner with financial advisors or currency risk specialists.
- They can provide tailored strategies and tools, such as options contracts or currency swaps.
5. Monitor Exchange Rates Regularly
Staying informed is half the battle.
- Use online tools or subscribe to alerts to track currency trends.
6. Build a Currency Risk Contingency Fund
Allocate a portion of your budget as a buffer against unexpected rate changes.
- This fund can cover additional costs without impacting your core operations.
Making Currency Risk Management Part of Your Business Strategy
Currency risk isn’t a standalone issue—it’s part of the bigger picture of financial management.
At N3 Business Advisors, we often advise our clients to integrate currency risk management into their broader financial planning. This includes:
- Project Pricing: Account for potential currency fluctuations in your bids.
- Client Communication: Be transparent about how exchange rates impact pricing.
- Training Your Team: Educate your finance and sales teams about currency risk mitigation techniques.
Real-Life Example: Learning from Success
Let me share another quick story. A client of ours recently won a major international contract in Europe. They used forward contracts to lock in a favorable exchange rate, partnered with a local bank for better insights, and set up currency clauses in their contracts. The result? They not only preserved their profit margins but also impressed the client with their professionalism.
Why Managing Currency Risks Matters
Ignoring currency risks is like leaving your project to chance. By taking proactive steps, you’re not just protecting your profits—you’re also building a reputation for reliability and professionalism in international markets.
Also read our previous article; How to implement virtual consultations for construction clients?
Disclaimer:
Any information provided here is for informational purposes only. It should not be considered as legal, accounting, or tax advice. Prior to making any decisions, it’s the responsibility of the reader to consult their accountant and lawyer. N3 Business Advisors and its representatives disclaim any responsibilities for actions taken by the reader without appropriate professional consultation.
