In addition to the financial risks, insisting on transacting in U.S. dollars may pose a commercial risk. Take international franchisors as an example. In a competitive market for quality franchisees abroad, invoicing in U.S. dollars will burden operators who do business in their local currency by forcing them to pay for an FX conversion before they can pay royalties. The result is an increase in the cost of franchising, which could serve as a disincentive to choose that particular franchise.

We suggest that companies consider transacting in foreign currencies to avoid these and other problems. Here are some benefits associated with purchasing in local currency instead of U.S. dollars (USD):

• Reduce costs. When a supplier invoices in USD vs. local currency, the supplier assumes all of the exchange rate risk and may increase its USD-denominated prices to protect itself from currency market movement between the invoice date and payment date. Depending on the terms and the currency, this could be a premium of 10 to 15 percent or more. Any drastic movements in the currency also invite additional price negotiations.
• Improve visibility into FX rates. Obtain competitive exchange rates from the bank and know the exact amount of foreign currency paid to suppliers. The premium you pay for transacting in USD includes not only an FX risk premium, but also a sales premium that is applied by the supplier's bank. Paying in local currency gives the buyer control over the FX premium and a better understanding of the FX costs.
• Negotiate more favorable payment terms. Payments in a foreign currency typically post faster to beneficiary accounts. Also, buyers that reduce suppliers' costs for FX conversion and risk management typically can ask for better payment terms in return. For the supplier, transacting in the local currency is a significant benefit, which should give the buyer more leverage in negotiations.

What if a company is sourcing from a related entity, such as a parent company? Even in that case, it is important to consider where the exchange rate risk lies and which party to the transaction is best suited to manage it. For example, consider the U.S. subsidiary of a German company that purchases all its inventory from the parent company. The U.S. group represents 5 percent of the overall company, and the German parent sets pricing in U.S. dollars once per year. Finance managers in the U.S. business may want to ask how the parent company is managing each year's worth of exchange rate risk. Does the parent have a strategy in place to protect against market movement? Is there any situation in which pricing could change—such as if the market moves significantly? As only 5 percent of the overall business, this exchange rate risk may not be a priority for the German company, but it creates a significant risk for the U.S. entity and may create an incentive to over-purchase anytime prices are due to be reset higher.

We suggest discussing these factors with all the company's foreign suppliers—whether they're related entities or external organizations—and revisiting it regularly, to avoid a shock to your business from an unforeseen market change.

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Customer Payments

Companies that sell internationally may also prefer to have customers pay in U.S. dollars. However, customers in our increasingly global economy expect to see prices denominated in their local currency. Accepting payments in a foreign currency will open up new opportunities with customers that want—or potentially need—to make payments in their local currency. Additionally, selling internationally in USD makes products and services more expensive in a stronger dollar environment, so the company runs the risk of losing business to local competitors in the foreign markets where it does business.

For global commerce, everyone wants a local experience. The more an international company can remove the friction of cross-border transactions, the better positioned it is to compete in foreign markets.

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Closing the FX Trade

Once a U.S.-based company makes the decision to either pay or accept payments in a foreign currency (or both), it needs to determine the appropriate type of foreign exchange transaction for translating its cash flows from the foreign currency back to U.S. dollars. FX transactions are generally either spot or forward contracts.

• A spot contract is a legally binding agreement to sell one currency and buy another on the nearest standard settlement (value) date. The exchange rate is based on the prevailing market rate two days before settlement. In other words, this is a 'buy now, pay now' deal at the current market exchange rate. Some benefits of spot contracts include easy operation, 24-hour trade access, and their lack of deposit requirements.
• A forward contract is a legally binding agreement to buy one currency and sell another at some point in the future. The forward contract specifies the amount of the transaction, the settlement date, and the rate that will be used, which is based on the prevailing market rate. In other words, forward contracts are “buy now, pay later” products, which enable the parties to lock in an exchange rate for a set date in the future. Forwards involve one party that agrees to “buy” at a later date (taking the long position in one currency) and a second party that agrees to “sell” at a later date (taking the short position in that currency). The advantages of forward contracts include the ability to choose a rate that is advantageous, as well as the ability to manage and forecast cash flows without worrying about future FX volatility.

As the FX market evolves, new solutions continue to be introduced. One recent innovation is the introduction of a guaranteed FX rate program. If a company would like control over the exchange rate for future transactions but doesn't know the exact dates the FX payments will be sent or received, a guaranteed FX rate enables it to lock in a monthly rate for all its FX transactions without having to specify dates and amounts. New solutions like the guaranteed rate will continue to make global business easier to execute.

An alternative approach for mitigating exchange rate risk is to open a foreign currency account. This can be an ideal solution when an organization is both selling products and purchasing materials in the same currency. By using a foreign currency account, a company protects itself from currency volatility to the degree that its volume of receivables matches its anticipated payable needs.

However, opening a foreign currency account does introduce some additional risks. The potential for sovereign risk varies by country. There are also operational risks related to managing the accounts and the risk of holding idle foreign currency balances. Treasury teams opening a foreign currency account must determine whether the volume and transaction activity outweigh the costs and risks.

A finance professional or banking partner can be a crucial source of information for companies starting to expand globally. With the right guidance and planning, treasurers can make the best decisions for their organization on managing their out-of-country assets.

Doug Houser is the head of Cross Currency Solutions Sales for Bank of America Merrill Lynch. He is responsible for the strategy and execution for the distribution of BofA Merrill's FX payments product suite in the Americas. His team is responsible for designing and delivering best-in-class foreign exchange and transaction solutions to Bank of America Merrill Lynch's global client base.

Lesley White is the head of Global Commercial Banking International for Bank of America Merrill Lynch, based in London. She provides a single point of management across the full spectrum of solutions the bank provides to the subsidiaries of its U.S. headquartered Global Commercial Banking clients. In addition, she helps coordinate the teams in treasury solutions, credit products, and client coverage to best serve the needs of the bank's middle market clients globally.

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