Foreign exchange, what it is and how it affects your international payments to suppliers

Payments to international suppliers often involve a currency exchange that not everyone takes into account and it can cost you thousands of dollars. We tell you all about currency exchanges and the options available to pay your cross-border suppliers.

What is foreign exchange?

FX is a financial transaction where money is converted from one currency to another. This is the case, for example, of an international transfer made from Spain to a non-Eurozone country, when a bank customer goes to his bank to buy money in a different currency or when you pay with your card in a country that does not use the Euro as legal tender.

This operation involves an exchange rate, i.e. the price of one currency in relation to another. This rate is an indicator that expresses how many units of one currency are needed to buy one unit of the other. When a currency exchange is carried out, this exchange rate is applied.

For example, imagine you want to convert euros to dollars to travel to the United States. The EUR/USD exchange rate is 1.20, which means that 1 euro is equivalent to 1.20 dollars. In this case, if you want to exchange 1,000 euros for dollars, the bank will give you 1,200 dollars.

Why is foreign exchange important?

Foreign exchange is a fundamental operation in international trade, especially when transactions take place between countries using different currencies. Its importance is such that, at present, transactions involving foreign exchange account for a large part of all financial operations worldwide.

This is why the FOREX market, which is where these currency pairs are traded, is the largest market by trading volume, with a daily volume of $6.6 trillion, according to the Foreign Exchange and OTC Derivatives Market Survey 2019, conducted by the International Bank for Settlements.

In reality, currency exchange is an operation whose importance involves different subjects:

Commercial, in regards to payments to suppliers, collections from customers and the intervention of other intermediaries. It is usually related to import and export operations linked to international supply chains.
Investment is especially related to internationalization processes and business growth.
Financing in different contexts, such as short and long-term financing or internal financing through contributions from partners or shareholders.

How foreign exchange affects your business relationships?

The exchange rate significantly affects your business, especially if you have an eCommerce business. Some of the most significant effects are the following:

Currency risk. The constant fluctuation of currencies can generate a potential loss for the company, although it can also generate profits. Normally, hedging instruments such as derivatives are used to neutralize its effects.
Exchange rate commissions are a cost generated when exchanging one currency for another.
Operations with deferred payments may generate losses if the value of the currency used has changed when the payment is made.
Commodity prices: In international trade, most of the raw materials required for many business activities, especially oil, are paid in dollars. In these cases, the risk is also latent.
Uncertainty in accounting information. In the case of using an exchange rate that is not constantly updated, the accounting information may not be as accurate as the business would require, which may cause problems in the company's finances in the medium and long term.

How do traditional banks handle foreign exchange for international payments?

Traditionally, international transactions involving foreign exchange are pretty complex and involve a large number of parties. These payments apply at least the following steps:

A company goes to a bank (or its bank's website) to make an international wire transfer. All information, including the company's name, its bank account (IBAN) and SWIFT, as well as the amount, the invoice and the concept, is shared with the bank.
The bank applies the daily exchange rate to the transaction and charges a fee, which is usually charged implicitly with an unfavourable exchange rate for the client.
The company approves the transfer conditions and the bank initiates the transfer. At this point, the company's funds are debited and traceability over the transaction is lost.
Subsequently, a series of intermediary banks intervene in the operation, carrying out the transfer of funds.
The supplier receives the funds in its bank account, in the currency in which the bank account was opened.

This entire process takes three to five business days to complete. And in most cases, international bank transfers are only processed during business days as long as they’re requested in time.

How to pay your international suppliers in their local currency?

In today's globalized environment, most companies deal with foreign suppliers or customers working in different currencies. This circumstance has been accentuated by the explosion of eCommerce thanks to the pandemic, causing a spectacular growth of online shopping.

For suppliers, receiving the transaction amount in their local currency is most desirable and in most cases a requirement. In this way, they will avoid exchange rate fees and achieve stability in their income. But what options are there to pay your suppliers in their local currency? Some options are:

International bank transfers, which is the most common and usual option, and one of the safest, as we have already seen. However, it takes quite a long time to process and involves commissions, which discourages many providers.
Paypal is an option that allows you to pay suppliers, using only your email address. Paypal is faster than international transfers and provides great security. However, there are some fixed and variable costs and fees, depending on your account and payment settings.
P2P payments, are an option that uses an application or a website to transfer funds from one company to another. In the case of international payments, P2P payments allow you to find buyers and sellers with different currencies. These types of platforms offer fast payment, but they are not the most secure and, more often than not, do not offer the most competitive exchange rate.
Third-party solutions. The opening of the banking infrastructure has led many third-party applications to develop applications that enable payment to international suppliers. These include Alipay for payments in China, Upwork, RITMO or MineralTree, among others.

Manage your currencies with RITMO and pay your international suppliers

Using RITMO, the financial platform specialized in eCommerce, you will be able to pay your international suppliers in the currency of your choice through a multi-currency account.

To pay your supplier you only need to complete their bank information and select when you want the payment to be made.

With RITMO you will save up to 90% of the commissions associated with this type of transaction with traditional banks.

In addition, you will be able to finance your supplier invoices with one click. RITMO takes care of paying your suppliers and you benefit from an extension of payment terms (from 4 to 12 weeks more). This way you can assume costs such as purchasing inventory in advance and start paying when sales occur, improving your working capital cycle.

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