The Brexit vote in the UK has cause a dramatic fall in price of Sterling (the UK currency) which has or potentially will cause a good deal of reduction of the cash flows (both direct and indirect) of firms based in the UK. Given that this shift was both unexpected and large how best should firms plan for the future to protect their cash flows?
Due to the financial uncertainty around Brexit, firms must look to ways they can protect their cash flows. One way to do so involves investing in foreign short-term securities. These securities may have higher interest rates than domestic rates in certain periods in the future, providing diversification in a firm’s cash flows. Investing in foreign currency through derivative contracts is another method of preserving cash flows which observes a similar process of protection as do the securities.
Another way to protect cash flows from uncertainty is to pay suppliers in advance or at the purchase order date, which can prevent a firm from facing insolvency issues due to rising debt. Along with this, firms can focus on engaging with domestic supply chains as domestic suppliers and buyers will face the least disruptions further preventing possible disruptions to cash flows. Along with these methods, there are clerical factors that can protect the company if properly accounted for. Such factors include developing a comprehensive cash flow strategy ensuring optimal efficiency. Storing receipts in an organized fashion and ensuring all transactions are properly documented protects a firm from discovering unknown debt or losing track of assets.
Firms can use the strategy of currency hedging to protect their cash flow in the future that is likely to be affected due to the voting of Brexit, which can lead to currency fluctuations. When businesses use that strategy, they will not only secure their cash flow but also prevent their firm from unnecessary losses. To implement this strategy, they will need to set up a financial instrument that secures the business from expected and unexpected events that lead to currency fluctuations exchange rates. Hedging reduces risks and guarantees a steady and predictable cash flow, which is the essential thing to firms, and it can be likened to the insurance policy of the business.
The hedging strategy involves several other approaches that enable firms to protect their cash flow effectively. The forward contract approach consists of an agreement between the seller and the buyer to sell a currency at a specific time and price in the future. Both parties are protected from any fluctuations in the future as they are no longer tied to the current exchange rate, thus worry less about their cash flow(Staff, 2016). Currency option also helps in planning for protecting cash flow in the future as it is anagreement that gives the purchaser a right to purchase or sell a particular currency at a precise exchange rate. Firms can choose the currency they need to exchange and the exchange rate as well as the date for the event. This allows the firm to protect its cash flow in the future since they have the power to decide what they prefer.
In response to the dramatic fall in the price of Sterling following the Brexit vote, UK firms should take on adequate practices to avoid hitting cash flow crises. In such times of economic uncertainty, good cash flow management practices deem ever-important especially for smaller businesses. Companies ought to continue to monitor their cash flows closely and review regularly. They should work on improving accountability and visibility in cash management by systematically organizing receipts and ensuring that all financial transactions are properly documented. They might also need to consider sourcing alternative, domestic suppliers if importing was involved.
In order to protect their cash flow, UK firms should minimize any potential loss that can occur due to fluctuations in currency exchange rates. Two most common currency risk hedging strategies include forward contracts and currency options. Both contracts allow the business to buy or sell currencies at a predetermined-rate on a future date. However, the company is not forced to do so with a currency option. Because it is a right rather than an obligation, companies are further protected from unfavorable currency movements compared to a forward contract.
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