Grabbing at the export business: looking deep into the value of the dollar and finding fiscal strength for doing business in the United States, regardless

Print Action, Jun 2003 by Goss, Al

As the dollar raced above 70 cents, I spent the week swapping e-mails with colleagues, discussing the impact of its rise on Canadian printers. As we discussed exchange rates, interest arbitrage and purchasing power parity, I started thinking about one of the less obvious aspects of the issue. The root cause of the rise in the Canadian dollar is not so much the strength of the Canadian economy as it is the weakness of the American economy.

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With a current account deficit of over four per cent of Gross Domestic Product, and more deficits being projected, what we are witnessing is a fall in the U.S. dollar, not a rise in the Canadian one. You might argue that it's all academic. After all, whether the U.S. dollar is falling or the Canadian dollar is rising, the net result is the same - there are fewer Canadian print exports. But there is another issue worth considering.

In a weakened U.S. economy, how safe are your U.S. receivables? There are two issues to be considered. The first is that an increase in the value of the Canadian dollar during the cash collection cycle will mean you are being paid in less valuable U.S. dollars. Secondly, there is always the risk that a weakening U.S. economy will increase default risk and you won't be paid at all.

The first problem is really only an issue for printers with large foreign currency exposures or long cash collection cycles. Suppose you have a large contract with a U.S. firm worth $100,000 Canadian. You quoted the job in January and converted it to U.S. funds at the prevailing rate of X. You finished the job in April and sent an invoice for $X, net 30. In May, your customer pays you US$X. But when you convert this figure back into today's exchange rate of X, you only have $X. The fluctuation in the exchange rate has cost you $X.

Hedge your bets

There are two ways around the problem. The first is to begin quoting the job in Canadian funds. This removes the foreign currency risk by transferring it to the customer. That's a great way around the problem if you can do it. Unfortunately, it's rarely practical from a sales perspective, so the alternative is to hedge your foreign exchange exposure using derivatives.

Used routinely by larger printers, many smaller printers have steered clear of this strategy because of the perception that derivatives are risky. In fact, using derivatives as a hedge removes risk and using them is neither as exotic or as difficult as some would believe. Your banker can help set up a forward or futures contract that locks in exactly what you will receive at a future date. You are transferring your risk to a currency speculator.

Here is how it works. In January, you know that you will be receiving US$X in May. You agree to exchange your U.S. dollars for Canadian in May at an exchange rate that is determined in January. That rate is called the forward rate and it is published in the financial press. The person on the other side of the trade is called the counter party. They either have some Canadian dollar cash flows that they are hedging, or they are speculating on a fall in the Canadian dollar.

Their motivations are irrelevant, because your aim is to hedge your exposure. Regardless of what the exchange rate is in May, you have locked in your exchange rate today. Of course, you give up any windfall gains if the Canadian dollar falls, but you avoid suffering the losses that printers with big foreign exchange exposures suffered during the first few weeks of May as the loonie rose.

Customer health

Another issue worth considering is the financial health of your customers and your default risk. More than one printing company has been forced out of business when a big customer couldn't pay its bills. The health of the U.S. economy should give you pause to consider how healthy your U.S. customers are, but you should be vigilant about the health of all your customers, regardless of where they are. You might be surprised that one of the best ways to do this is to give them better credit terms.

This means that when you bring on a new account you go through a lot of effort to make sure they are creditworthy. You check references. You run credit checks. But once you have granted credit, how can you tell when they are getting into trouble? Often the first time you notice a problem is when they pop up on your aged debt report. By then, it is often too late. Wouldn't it be better to have an early warning system to alert you to potential cash flow problems in your customer's business? Well, giving discounts for prompt payment will do just that.

Instead of sending invoices net 30, institute a two per cent/10 net 30 credit policy. Invariably, all of your customers will take the discount. Looking back at the $100,000 job we discussed earlier, the buyer can either take the discount and pay $98,000 in 10 days, or wait 20 more days and pay $100,000. The cost of borrowing $98,000 for 20 days is $2,000, making the effective interest rate on the loan 44.6 per cent. Little wonder then that all of your customers will pay in ten days! After all, 44.6 per cent is a pretty expensive loan.