At the time of writing this article, the foreign exchange rate is Sh153 to 1 US dollar. In comparison, earlier this year the rate was Sh137 to 1 US dollar. There have been a lot of currency fluctuations in the recent past caused by a number of reasons.
These currency fluctuations have affected businesses directly and indirectly. Businesses engaged in a lot of international trade have borne the brunt of foreign currency fluctuations especially when the host currency loses value. It leads to significant losses for the business otherwise known as foreign exchange losses.
Supposing a business enters into a contract with an international supplier for the supply of goods at $10,000. If the business entered into this contract earlier this year, it means it would pay Sh1,370,000 in local currency. However due to loss of value, today it would cost the business Sh1,530,000 to purchase the same goods hence making a loss of Sh160,000.
A foreign exchange loss is a loss that happens due to unforeseen currency fluctuations. A foreign exchange gain on the other hand, is a gain enjoyed by a business due to unforeseen currency fluctuations.
In the case above, supposing the value of the Kenya shilling to the dollar was Sh50 to 1 US dollar, then it means it would cost you Sh 500,000 to purchase goods worth $10,000 therefore making a handsome profit of almost Sh 1 million.
Foreign exchange losses are risks that need to be managed. This is especially so where the business engages in a lot of international trade or contracts in different currencies. Foreign exchange losses can lead to significant losses and can even threaten the survival of the business.
How then do you manage risk arising from foreign exchange losses? Financial advisors can advice on the type of arrangements that can be entered into so as to mitigate the foreign exchange losses.
Foreign exchange loss can be mitigated by drafting in clauses that mitigate risk that arises from foreign exchange losses.
Experts’ advice parties that it is better to trade in your local currency so that price remains unaffected by foreign currency fluctuations. If possible, let the contract price be in the local currency. It may not always be possible to trade in local currency especially in the international trade market where stronger currencies are preferred.
If it is not possible to trade in local currency, then you can have your lawyer draft a foreign exchange clause. A foreign exchange clause specifies how currency fluctuations will be handled by the parties. The first thing is to identify and list the different currencies involved.
Supposing it is a Kenyan firm trading with an American firm, then the two currencies would be the US dollar and the Kenya shilling. Parties need to set the payment terms in so far as currency is concerned. This clarity is important to avoid disputes.
The foreign exchange clause also sets a mechanism on adjusting the contract in the event of severe currency fluctuations. Perhaps parties can state that if the currency fluctuates beyond a certain percentage, then they can renegotiate the contract, or terminate the contract.
It would not be fair to entirely penalise one party due to currency fluctuations, therefore a mechanism of risk sharing can be drafted.
Ms Mputhia is the founder of C Mputhia Advocates | cathymputhia@gmail.com
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