Analysis - Importer

As an importer, the exchange rate establishes the amount that you must pay for your foreign supply. The exchange rate also intervenes in the calculation of your sales price on the domestic market.

At that point, several options are available to you. You can wait until the invoice settlement date to purchase the foreign currency through a cash transaction. You must then be aware that, in case of an unfavorable market move, you support all the risks. The real cost associated with these risks will not be known until you proceed, at a later date, with the currency conversion. On the other hand, this approach gives you the possibility to benefit from a favorable market move.

On the opposite, you can cover the risks, as soon as they appear, through a future contract. Between these two extremes, numerous other approaches are to be considered. How do you establish which approach guaranties that your objectives will be met? To answer this question, you must analyze and understand the nature of your business operations.

The exchange rate volatility creates a risk that is present throughout the supply chain. Longer is your operating cycle, higher are the risks that an unfavorable market move could affect the profitability of your operations. However, one should not conclude that a relatively short operating cycle means that exchange risks are non-existent. Markets sometimes move unpredictably over a very short period of time.

The currency risk is constantly present

Take for instance, the situation of a Canadian importer who sells domestically products purchased in the United States. Whether the Canadian Dollar rate of exchange exceeds the parity as in 2007, or reaches extremes such as those recorded at the beginning of 2000, the value in Canadian Dollars of the foreign supply varies together with the market fluctuations. The benefits expected from the sale of imported products are always at risk regardless of the currency relative strength or weakness.

The situation is the same on other markets where currencies such as the Euro, the Sterling Pound, the Swiss Franc, the Japanese Yen, the Australian Dollar, the Mexican Peso, the Brazilian Real, etc. remain highly volatile and unpredictable.

The following table illustrates that the currency market volatility is a recurrent phenomenon that threatens the profitability of your operations.

Exchange rate consequences (CAD/USD)
Margin target: 20%
PeriodExchange rate
(beginning of period)
Exchange rate
(end of period)
Fluctuation
(CAD)
Targeted marginReal marginMargin fluctuation
June/July '030.77000.7046-8.5%20%9.8%-51% (1 month)
Jan/May '040.78850.7142-9.4%20%8.7%-56.5% (4 months)
Nov '04/May '050.85370.7855-8%20%10.4%-48% (6 months)
Aug '06/Jan '070.90660.8475-6.5%20%12.2%-39.1% (2 months)
Nov/Dec '071.08690.9779-10%20%8%-60.2% (1 month)
Sept/Oct '080.97080.7692-20.8%20%-4.9%-124.6% (1 month)

A potentially devastating leverage effect

This table highlights the major impact of currency fluctuations on profit margins. For instance, between June and July 2003, a decline of 8.5% in the value of the Canadian dollar resulted in a deterioration of 51% of the expected margin. The rest of the table illustrates similar examples, all related to factual market moves. Over the years, the Canadian Dollar fluctuation has sometimes exceeded 20 %! In this context, importers should consider how much they will have to spend to continue purchasing supplies from abroad.