As a U.S. manufacturer, it is important to be aware of the hidden and sometimes lofty costs you are likely incurring on every international payment. It is common for U.S. manufacturers that are operating internationally to overlook the benefits of paying their foreign suppliers in their local currency. Rethinking your strategy can help to extend payment terms, but also potentially reduce costs on imported goods, materials and equipment by up to 10%.
Although the value of U.S. imports continues to rise, most U.S. manufacturers continue to pay their suppliers in U.S. Dollars (USD). This approach essentially causes U.S. businesses to pay significantly more than market value for their imports, resulting in paying away unnecessary premiums that can otherwise be used to re-invest in their company.
Paying in USD vs. Foreign Currency
Why do so many U.S. manufacturers pay their international suppliers in USD? A likely reason is that for so long, the U.S. Dollar has been the world’s universal currency. It is a common misconception that overseas suppliers always prefer to be paid in USD.
Contrary to popular belief, paying in USD does not always mean your company is avoiding foreign exchange risk. It is crucial to note that within every cross-border payment lies exposure to currency risk and volatility. U.S. importers are typically unaware that their suppliers are carefully taking this into account when pricing goods, consequently at a premium.
How do suppliers protect their bottom line? Two preventative actions are to shorten payment terms and pad prices. Since foreign suppliers cannot be certain what value in their local currency they will be receiving from their customer, at the time of invoicing prices can be inflated by as much as 10 percent to ensure profitability in case the market moves out of favor.
How Can My Business Start to See These Benefits?
The most beneficial reason for US importers to consider paying foreign suppliers in their local currency is that it provides them the flexibility to negotiate better pricing and potentially extended terms.
After a U.S. company sends a USD payment overseas, the foreign vendor will need to convert those funds back to their local currency if they do not have a USD account with their bank. Because of this, the foreign supplier has to incur those conversion fees which cut into their profit margins.
Conversely, suppliers being paid in their local currency are able to lock in the contract’s local value. The supplier is given peace of mind that fluctuations between USD and their local currency, from the time period of when they invoice their customer until when they receive payment, will not have an effect on the value of their receivables.
Many times, just by simply asking your foreign supplier which currency they prefer to be paid in can help your business uncover more advantageous payment terms. By paying in their local currency, it is common that 30 or 60 day extensions can be negotiated.
Using FX Forwards to Hedge Risk
The U.S. importer is often positioned better to access more favorable exchange rates than the foreign supplier. As such, an importer can make use of hedging instruments in order to not be held captive by less-favorable rates set by their suppliers’ banks
The availability of hedging tools, such as FX Forwards, makes the local currency payments process easier and less risky. An FX Forward allows the importer to fix or lock in an exchange rate for a delivery date in the future, eliminating their exposure to fluctuations in the currency markets. Using FX Forwards for fixing exchange rates is typically less expensive than paying the premium that foreign suppliers often add to the cost of goods when they are getting paid in USD.
This is the second article in a series of three. Read the first article,
Reducing Risks and Costs for Your Global Business, first posted on February 15. The third article will examine how you can start keeping more of what you earn when exporting product overseas.
About the Author
GPFX Consultants LLC is a multifaceted international consulting firm based out of San Francisco specializing in the field of foreign exchange. GPFX can work with you to employ a proven cost-reduction solution to your international payment operations. GPFX clients have seen up to a 75% savings to this aspect of their business by engaging with us in implementing a strategy specifically designed to enhance growth opportunities across borders.
How Do You Start Saving?