Whether it be for business or personal reasons, there’s a good chance you’ve bought something from an international seller.
As international shipping and logistics have improved, there are more opportunities to buy something abroad and get a comparable experience and product for a lesser price.
When you buy from abroad, you’re using an FX payment.
These types of payments may seem like an inevitability, a necessity that’s beyond your control, but that’s not the truth. In fact, understanding and managing FX payments are a way of keeping your costs in control, racking up savings, and boosting the overall profitability of your business.
What are FX payments?
FX payments (or foreign exchange payments) are payments where the money is sent in one form of currency, but deposited in another. This occurs when sending a payment to a vendor or supplier in another country.
In some cases, an FX payment is as simple as using a credit card on a website based in another currency. In fact, you may have made or received FX payments over the course of your business without knowing it.
FX payments undergo a currency exchange as part of the process, typically facilitated by a bank or the payment processor. This is when one form of currency is traded for another at a set exchange rate.
Since exchange rates are constantly fluctuating, businesses need to keep an eye on how rates are trending to understand the real cost of FX payments. In some cases, you may find a payment to be more or less expensive than you initially planned for.
With global trade growing over time, FX payments have become an essential part of a business’s toolbelt.
Why are FX payments important?
Billions of cross-border payments are processed per year and the number is trending upwards. This is partly due to businesses using global sourcing, meaning they’re looking for opportunities to reduce costs or receive better products from foreign suppliers as opposed to domestic ones.
If you’re going to work with suppliers outside of your base country, you need to know how to manage FX payments—exchange rates and transaction fees can be the difference between saving money or spending more than expected.
You can get by without knowing the ins and outs of a single payment. But the more you look to source from abroad, the more you’ll need a scalable process to do so.
How do FX payments work?
FX payments are processed by either banks or third-party providers.
The first step of the FX payment processing is setting the payment amount. The payment provider will tell you how much money in your local currency you’ll need to send for it to land at the agreed-upon amount.
Once a payment is agreed to, the money is withdrawn from your account in the local currency. The payment provider is then responsible for converting the local currency to the destination currency and rerouting it to the recipient.
Your payment may make multiple stops along the way. These stops are called “intermediary banks.”
However, the currency will not be converted at each stop. Generally speaking, payments are converted to the destination currency either at the beginning or the end of the payment process.
Intermediary banks will only affect the FX payment cost through some additional fees, but that is dependent on the payment provider.
Understanding currency exchange rates is an essential part of FX payments. It’s important to make the most of FX payments when the US dollar is strong and know when to pull back if it starts to fall off.
Looking at the exchange rate of US dollars to euros over time, the peaks are when one US dollar can buy the most amount of euros. This is when you’ll get the most bang for your buck when buying from a European supplier.
Types of FX payments
There are multiple options for managing FX payments, each suitable for different needs. What you choose will depend on the frequency and amounts of FX payments you process in your day-to-day operations.
Spot contracts
The most commonly known FX payment type is spot contracts.
Spot contracts are one-time payments with exchange rates set on the day of initiating the payment. Processing times are typically within one to three business days.
If you’ve used a credit card in a foreign country, you’ve completed a spot contract FX payment.
Spot contracts make the most sense for businesses with a low volume of FX payments. While the volatility of exchange rates makes them riskier and costs inconsistent, they are simple, one-off payments that can be done with minimal know-how and legwork.
Forward contracts
Forward contracts are similarly one-time payments, however, they are set to be processed sometime in the future. The exchange rate is set at the time of initiating the payment.
Businesses use forward contracts to avoid the risk of an exchange rate changing and making a payment more costly. However, if the exchange rate improves, you’re still locked in at the agreed-upon rate.
For example, if the value of the euro dips such that a US dollar is worth 1.10 euros on February 15th, you could set up a forward contract FX payment to be processed on March 1st. If the exchange rate bounces back such that a US dollar is worth 0.90 Euros by then, you’re still locked in 1.10 Euros.
If the payment is for 1,000 Euros, you lock in a payment at $909.09 US versus $1,111.11 US, over $200 in savings.
Forward contracts are a great way to make the most of a strong exchange rate even if your due payments are a ways out.
Currency swaps
Currency swaps are completed by businesses before sending money, allowing payments to be sent in the destination currency.
There are three steps to the currency swap process:
- The initial exchange is completed based on the exchange rate at the start of the contract
- Both parties make interest payments throughout the lifespan of the contract at the agreed-upon interest rate, usually determined by interest rates in each currency. One party may pay a fixed rate, while the other pays a variable rate like LIBOR.
- Once the contract is complete, the same exchange is completed at the initial exchange rate
Currency swaps effectively operate as a two-way loan where both parties are paying interest on the amount they’ve received in the foreign currency. This allows each party to access the currency they need while benefiting from more favorable borrowing terms in foreign markets.
Typically, the agreement is between one party that needs to make FX payments and another that’s receiving FX payments. However, the swap might also be used by parties that simply need to borrow foreign currency for other purposes, such as investments or financing.
For example, a US company procuring goods from Europe in Euros may connect with a German company that’s selling to US customers in USD.
The US company needs Euros upfront to pay their suppliers. They want to keep their expenses predictable so they agree to a currency swap to avoid the effects of any exchange rate fluctuation.
The German company has USD they want to convert into Euros. Throughout the currency swap, they are swapping their USD for Euros at a stable rate which makes their revenue more predictable.
Currency swaps are most suitable for businesses that are expecting to make a large volume of FX payments in a given time period. For example, if you know you’ll be making payments of 100,000 euros over the next six months, it’s worth looking at a currency swap for that amount.
FX options
FX options are an agreement that gives the buyer the option (but not the obligation) to buy some amount of a currency at an agreed-upon exchange rate at any point in the future. The FX option provider charges a premium on the swap to make their money.
Expiration dates prevent you from holding onto the FX option forever. If you don’t pick up the option by then, it expires, and you lose the premium paid. At this point, a new FX option contract could be drafted at an updated exchange rate.
For example, say the current exchange rate nets you 1.1 Euros per 1 US dollar. A potential FX option contract might be the ability to buy 110 Euros for 100 US dollars that expires in six months.
Six months down the line, the value of the Euro improves and 1 US dollar is now worth 0.9 Euros. If you were to exercise the swap option, you’d get 110 Euros for 100 US dollars instead of 90 Euros.
But if the value of the Euro dips and 1 US dollar is now worth 1.3 Euros, you’d let the option expire since you can get more Euros at the current exchange rate than the previously agreed upon rate.
Benefits of FX payments
Getting familiar with FX payments opens up new possibilities that can reform how you conduct business. These are some of the biggest benefits you’ll get from FX payments.
Tapping into global markets
Procurement from global sources opens up the possibility of getting higher quality goods and services or lower prices. But if you’re going to take advantage of the global market, you’ll need to know how to make payments abroad.
Having an FX payment process ensures you’re never going to miss out on a new opportunity because of an inability to render payment.
Keeping costs down
Working with suppliers in other countries opens up opportunities to get the same goods or services for a lower cost.
There are multiple factors that contribute to your potential savings:
- Difference in labor costs: Some countries will value labor in a sector less than how it’s valued domestically. This means they’re setting lower prices on a good or service to reflect that.
- Difference in currency value: If a foreign currency is weak, the converted value of a price will come in lower than the domestic price.
- Difference in natural resources: When there’s an overabundance of natural resources, countries set lower prices to move their stock at a faster rate.
- Difference in trade agreements: Countries impose taxes and tariffs on imports and exports that influence the costs of goods or services. You may find certain goods or services are cheaper to get landed than others.
How you manage your FX payments is an essential part of maximizing your savings. For example, setting up a forward contract or FX option helps take advantage of favorable exchange rates even if your payment is occurring weeks or months in the future.
Improved cash flow management
Inefficient FX payment systems impact how money enters and exits your business. The payments you send or receive could get stuck in processing making it unusable for days or weeks on end.
That’s why savvy businesses make use of multiple FX payment systems to control their cash flow with incoming and outgoing payments.
Take currency swaps, for example. They allow businesses to lock in exchange rates and schedule regular payments at a consistent rate rather than waiting for the entire amount to get processed and deposited. This smoothes out cash flow and reduces the risk of exchange rate volatility.
Diversifying the business portfolio
You should always be mindful of how currency exchanges are changing over time. Whether you’re selling or buying abroad, exchange rates impact the value of what you hold.
However, if you diversify the business’s assets with FX options or forward contracts, you minimize the risk of exchange rates impacting your operations.
Being smart with which FX payment options you use minimizes the possibility of having to stop conducting business abroad because of a currency value dipping.
Challenges of FX payments
Using FX payments is not without its challenges. But if you’re aware of the following challenges and take our actionable recommendations, you’ll minimize their impact on your operations.
Navigating changing exchange rates
Exchange rates are constantly in flux. You could agree to a favorable deal one day and by the time you’re ready to process the payment, the advantage might be lost due to a changed exchange rate.
This can impact FX payments with long processing times. Once the payment is finally landed in the receiver’s bank account, it may have cost you more than initially anticipated.
Businesses that are risk-averse often find ways to manage exchange rate fluctuation by leveraging forward contracts or currency swaps. They may not benefit if exchange rates change in their favor, but they also aren’t blindsided by increased costs if exchange rates change for the worse.
Understanding the associated costs
Some FX payment methods aren’t crystal clear in how they’re charging you money to process a payment.
While you can find associated fees for some spot contract methods like wire transfers, you could still get dinged on the exchange rate being offered.
As you’re testing out different FX payment methods, draft an expected cost based on the advertised fees and exchange rates. If the actual cost comes out above that, there’s a chance you’re getting hit with some unlisted costs.
International regulatory compliance
Sending money abroad opens up a whole new world of regulatory compliance. You need to know how to report your expenses and revenues, but you also need to know what documentation you’re obliged to provide and keep.
It’s worthwhile to talk to an accountant to understand your responsibilities and considerations before starting to process FX payments.
Be sure to keep a clear paper trail for all payments including any purchase orders, invoices, receipts, and communication. This will pay off if there are any errors that need to be amended or an audit takes place.
Managing processing times
As a business, you know that timely payments are incredibly valuable.
With FX payments, you have to account for how much additional processing time is required before the money is landed. Keep this in mind as you’re navigating due dates from your suppliers.
While some suppliers may give you the benefit of the doubt if the money is in transit, others may not be so gracious and only care about if the money is in their bank account.
The future of FX payments and automation
FX payments may seem complicated at first glance, but they become simplified when you invest in the right technology.
Payment platforms are better equipped for processing FX payments than they’ve ever been, often offering multiple options to automate, analyze, and optimize your FX payment process. Consider adopting a different payment platform if your current option doesn’t support international payments.
Ideally, your payment platform integrates seamlessly into your accounts payable (AP) platform and accounting software.
Together, these three platforms simplify the payment process while providing crystal clear transparency into associated costs and exchange rates. This helps keep data consistent while also allowing you to manage your costs when procuring from abroad.
An emerging technology to keep watch of is cryptocurrency and its use of blockchain technology. These types of currencies would be universal across the globe, simplifying the process by allowing you to focus on a single form of an alternative currency.
Regardless of whether it’s a new software, currency, or emerging trend, it’s important to keep an ear to the ground about best practices with FX payments. Talk to your suppliers and people within your industry to learn how they’re managing the world of international commerce.
Seamlessly incorporate FX payments in your business
Managing FX payments feels complicated with the prospect of having to learn new payment methods and platforms. But that doesn’t have to be the case.
With BILL, you get an international payment platform that easily integrates with your accounts payable to give you absolute clarity into payment amounts, exchange rates, and associated costs.
Our one-click payment process simplifies FX payments and even allows you to make payments in bulk at the same time as your domestic payments.
Request a demo to learn how BILL can help you save time, save money, and keep everything in sync without a worry.
