As the world becomes increasingly interconnected through the forces of globalization and the march of technology, the role of the small business owner has changed dramatically. Once upon a time, most small businesses were essentially local businesses, producing goods and services for, and acquiring supplies from, a network of customers and vendors that were located close to home, usually in the same city or state, and always in the same country.
While globalization has provided entrepreneurs with a host of benefits, including an expanded marketplace into which to sell their products and the opportunity to comparison shop for goods from around the world, it has also presented a host of new challenges. If your business is attempting to sell to a global customer base then you are no doubt familiar with the trials of understanding the idiosyncrasies of different markets and cultures—in addition to the sometimes-daunting task of attempting to communicate in a foreign language.
With all of these things to worry about in today’s global environment for small-business owners, many of you may not have had the time to fully understand how foreign currency exchange rates, which are a truly global phenomenon touching all international transactions, affect your business. So let’s take a look at how the foreign exchange markets work, their effects on business owners, and some strategies for coping with fluctuations in the exchange rates that affect your business.
Simply put, the exchange rate between two currencies is the rate at which one currency can be exchanged for the other. For example, if the U.S. dollar to Japanese yen exchange rate is 80, then 1 U.S. dollar will buy you 80 Japanese yen, and of course it follows that it will take 80 Japanese yen to purchase 1 U.S. dollar.
The level of the exchange rate between any two currencies is determined by a host of factors including the pace of economic activity, the level of market interest rates, the gross domestic product, and the unemployment rate in each of the countries in question. Exchange rates are set in the global financial marketplace, where banks and other financial institutions trade currencies around the clock based upon their views on the above-mentioned factors as well as their own financing needs and investing strategies. Because of the twenty-four-hour global nature of currency markets, exchange rates are constantly shifting from day to day and even from minute to minute, sometimes in small increments and sometimes quite dramatically.
For entrepreneurs, changes in exchange rates affect their businesses in two main ways: by changing the cost of supplies that are purchased from a different country, and by changing the attractiveness of their products to overseas customers.
In our next post we will explore these effects in greater detail and propose some solutions to help cope with fluctuations in the exchange rates that matter to your business.