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Foreign Exchange

Dealing only in U.S. dollars can be limiting in more ways than one

In today’s global marketplace, plenty of middle market companies can expect to face the reality of conducting business in foreign currencies. For many, the complexity and perceived risk of buying and selling with anything but U.S. dollars (USD) can be daunting.

While the most comfortable route may be to transact solely in one’s local — or functional — currency, reputations and profits can suffer by not taking a more global view.

“Many companies think that doing business in USD is to their advantage because it simplifies recordkeeping and risk management. But from a customer’s point of view, they’re not getting what they want,” says Brian Petrak, Comerica Bank’s senior vice president, Global Capital Markets Foreign Exchange. “You’ve shifted all the foreign exchange risk onto the vendor or the customer who is buying products from you.”

Petrak says limiting transactions to USD can result in a foreign vendor charging higher prices. Many offshore firms will accept payment in USD, but to protect themselves from losses because of currency fluctuations, they often tack a “risk premium” onto their rates. Risk premiums are invisible to the buyer and can amount to a price increase of 5 percent or more. On the other hand, if a company that sells abroad insists on being paid in USD, it is at a competitive disadvantage compared to other firms that are willing to receive payment in the customer’s local currency.

Companies should also be aware of how their decisions are perceived in a cultural context.

“People are pretty nationalistic when it comes to finance,” Petrak says. “If you are doing business in Europe or Japan or Mexico and you insist on trading only in USD, you are, in effect, saying you don’t respect that country or that currency.

“If you’re happy to price and get paid in your customer’s local currency — or any currency they wish, for that matter — it can smooth negotiations and strengthen your ongoing business relationship.”

If a business is engaged in less than $10,000 of international commerce per month and simplified bookkeeping is a priority, ongoing currency risk management may not be necessary. But if volume tops $500,000 or more per year, the savings can be substantial.

Petrak recommends that companies buying from foreign vendors consider the price in USD and the foreign currency — as well as the amount of exposure to currency exchange risk that they are willing to accept — before deciding on payment terms.

“A customer might decide to deal in the foreign currency knowing that there may be some exchange risk, but it’s not material,” he says. “They know they’ll be getting a better price because they’ll avoid the risk premium. If the exchange flips, that’s the risk that they take.”

An alternative strategy for when prices are higher and the risk is greater is to establish a foreign exchange forward contract that converts a firm’s future foreign currency payables or receivables into a fixed USD amount. Let’s say a U.S. company wants to buy a machine manufactured in Germany for 500,000 euros, or about $690,000, but the machine will not be delivered for six months. The company buys 500,000 euros from its bank at today’s rate — for future delivery. The bank holds the euros for the company until payment to the vendor is due and assumes all the exchange rate risk. The contract locks in the dollar amount at the current rate of exchange, shielding the buyer from currency fluctuations that could raise the price in that six-month period.

Petrak recommends that middle market companies use banks instead of third-party foreign exchange brokers when buying and selling abroad.

“Brokers may first sell a customer on a marginally cheaper FX rate and fees than a bank to obtain the business and then change the pricing later on. They usually don’t have a bank’s market knowledge, contacts, or expertise on global transactional payments. They could also pose unknown counter-party and recourse risks to the customer after the transaction,” he says. “Since they are not a bank, you don’t know the financial standing of these companies along with what, if any, remedies you may have in the event of the payment not being made. Risks that you are unaware of can be expensive. While price and fees are an important aspect of foreign exchange products and services, this is one product where price should not be the determining factor of where you execute your business.”

By partnering with a bank that specializes in global foreign exchange risk management and being willing to pay and receive payments in foreign currencies, middle market companies can increase their global sales, grow their profit margins, and substantially reduce their risk on these transactions.

For learn more about how Comerica can help your company manage current or future currency risk exposure, contact Brian Petrak at 248-371-6808 or bjpetrak@comerica.com.

Comerica Bank. Member FDIC

Inventory Control

Right Strategy Can Reduce Costs, Enhance Profits

In an accountant’s world, inventory is considered an asset, just like cash. Just as cash in the coffers must be managed to help a business succeed, companies that understand and apply the correct inventory strategy can reduce costs and increase profits.

“To understand inventory, you have to understand its goal: to meet or exceed the customers’ expectations of product availability with the amount of each item that’s going to maximize your net profitability,” says Jon Schreibfeder, president of consulting firm Effective Inventory Management in Coppell, Texas. “Everything you do with inventory has to directly relate to that goal.”

Schreibfeder says inventory experts divide the topic into two branches: management and control. Inventory management is the planning process that makes sure companies have the right quantity of the right item in the right location at the right time. Inventory control involves keeping an accurate count of what you already own, be it pallets in a warehouse or pencils in a drugstore.

“The first step in inventory management is determining what you need to stock,” Schreibfeder says. “The best way to budget that is to look at what you currently have in inventory, isolate those products that haven’t sold, and determine whether they need to be in inventory. Ask if your forecast came close to predicting what you were going to sell or use.”

Forecasting a firm’s inventory is too important a job to be left to one person or department. Inventory experts recommend using a “triangle of cooperation” that pools the input of sales and marketing, purchasing, and customers. If the plan was to sell 100 products last month but only four were sold, the people closest to that item can likely shed light on what went wrong. Knowing in advance about transportation hiccups, paperwork snarls, or supplier downtime can help avoid inventory disasters.

To allow for unexpected spikes in demand or for delayed shipments, either of which could result in unfulfilled orders, companies should maintain a “safety allowance” based on a percentage of anticipated demand, a certain day’s supply, or a multiple of the average deviation between the forecast and actual sales or usage.

Companies in North America can choose from more than 400 enterprise resource planning (ERP) computer systems to control their business processes, including inventory. But if what’s in your computer system doesn’t jibe with what’s on the shelf, examine your internal processes to see if all material movements have been properly recorded. Schreibfeder warns that many inventory systems announce shortages only as they occur. He recommends using those that offer an early warning system that alerts you if an item falls below the safety stock level or is selling faster than the forecasted demand.

In addition to products for sale, inventory also encompasses MRO — the materials needed for maintenance, repair, or operation of a physical plant or equipment. As maintenance is ideally performed on a scheduled basis, these products are easy to predict. The need for operations parts and materials can be tracked along with the forecasted demand of the products for which they are used. However, when and where repair items will be needed is unpredictable.

“In most MRO situations, you’re not looking to maximize profitability, you’re looking to lower overall inventory investment,” Schreibfeder says. “That’s done by eliminating ‘non-critical’ repair parts and reducing ‘somewhat critical’ parts. I will never touch my inventory of ‘very critical’ repair parts. Without those, you are shut down.”

To evaluate ongoing performance, all businesses must measure their processes — and assessing inventory performance is no exception. Schreibfeder recommends these metrics: customer service, the percentage of times an entire quantity of a product was available for immediate delivery; turnover, which calculates how often a profit is earned from every dollar invested in inventory; and gross margin return on investment (GMROI), which analyzes a firm’s ability to turn inventory into cash above the cost of that inventory. GMROI is determined by dividing gross margin by the average cost of inventory.

Schreibfeder stresses that inventory must be regarded as a profit center. “Inventory isn’t worth what you paid for it; it’s worth what someone is willing to pay you for it,” he says. “I tell my customers they’re not in the antiques business. Their inventory will not appreciate with age as if it were fine wine.”

Comerica Bank. Member FDIC

International Expansion

Due diligence essential before choosing a partner

Michigan businesses exported more than $56.9 billion worth of goods and services in 2012, according to the Michigan Economic Development Corporation. That included $25.4 billion to Canada, $10.5 billion to Mexico, $3.3 billion to China, and $753 million to the United Arab Emirates.

Clearly, overseas opportunities exist for middle market companies. However, the prospect of taking such a major step can be daunting. If a firm does decide to explore expansion into foreign markets, experts recommend that its leaders ask common-sense questions and secure professional advice before getting in too deeply.

“Is it really worth the effort, risk, and time if you want to establish a business presence in a foreign country? That’s the fundamental question any middle market business should ask,” says Thomas F. McLarty, III, chairman of McLarty Associates, an international strategic advisory firm in Washington, D.C. “It’s easy to get enamored with the potential of a foreign market — and that’s fine to a point, but you’ve got to be a steely-eyed realist.”

Research First
Performing due diligence to understand your potential partner is of paramount importance, says Ali Tulbah, McLarty Associates’ managing director.

“It’s not uncommon for us to talk to companies who shot first and aimed second,” he says. “They met somebody and they entered into an arrangement without really understanding their track record in that market, their ability to deliver and execute, and their overall reputation.” Tulbah says candidates must share your company’s goals, culture, and executional strategies. “You don’t want to discover too late that your partner wants to take five years to reach a certain goal while you want to make an impact today,” he says. “You must ensure a consistency of expectations, performance, and financial governance.”

One Size Doesn’t Fit All
Different countries and regions require different sets of expertise to unlock their markets. In much of the Middle East, having a partner with a prominent name and political connections is critically important for success. In Brazil, you need someone who understands how to navigate the taxes, codes, and local content rules of that highly regulated country. In Japan, the first steps are accessing a large Japanese trading company and understanding the do’s and don’ts of Japanese business culture, (e.g., do learn gift-giving rituals and don’t make excuses.)

Middle Market Advantage
While it’s important for larger companies to make investments and create jobs in their host countries, that’s not usually the case for smaller firms.

“Middle market companies don’t typically have the type of resources a large company has to commit — and frankly, there’s not that expectation on the part of the partner or the inbound country to see them make that commitment,” Tulbah says. “They would be more inclined at the outset to have a distribution relationship where they find a local partner to represent them. This model makes a lot more sense and allows companies to expand their capabilities and mitigate risk without having to make a direct investment themselves.”

McLarty says companies should take advantage of the U.S. Trade and Development Agency, the Export-Import Bank of the United States, the Overseas Private Investment Corporation, and other governmental agencies whose aim is to facilitate trade and investment.

“Call on the U.S. ambassador or the commercial services that are in every U.S. embassy in the world,” he says. “All of those are there to help you do the due diligence, the matchmaking, the partner identification. Don’t try to reinvent the wheel.”

It also makes sense to consult with a talented local law firm, either indigenous or an in-country office of a U.S. firm. Many Miami attorneys have relationships with firms in Latin America, while those on the West Coast can recommend firms in Beijing, Singapore, or Indonesia. “It’s always good to trust but verify,” Tulbah says. “These firms will help you think through the questions about marketing, supply chain, customs, finance, or repatriation that are unique to the market and what needs to be put in place to protect yourself.

“The overwhelming reason that more middle market companies are not exploring international markets is limited bandwidth — they don’t know how to do it and they’re scared of making a mistake. But by asking rigorous questions and using public and private resources as force multipliers, just about anybody could alleviate a lot of those concerns.”

More information is available from the following resources:
McLarty Associates
maglobal.com

U.S. Trade and Development Agency
ustda.gov

Overseas Private Investment Corporation
opic.gov

Michigan Economic Development Corporation
Michiganbusiness.org

 

Comerica Bank. Member FDIC

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