CALCULATION OF COSTING RATE AND PROTECTING IT WITH CURRENCY FUTURES
(EXPORTER’S POINT OF VIEW)
In the era of global market economy and fierce competition, importance of accurate costing of product is of core importance. Export pricing is most important tool for promoting sales and contesting in international competition. Exporter has to compete with producers in other supplying countries and domestic producers. Cost, demand and competition are the three important factors that determine price. Costing of products depend from industry to industry. During the initial evaluation, establishing the cost of exporting within a limited price range may be sufficient to estimate the viability of a transaction. Exporters must determine the cost of exporting products as precisely as possible. They must consider actual costs to be included and add the profit margin.
Let us understand the process one needs to follow while quoting price to buyers.
- Receipt of order: After the receipt of the ‘Quotation’, if the prospective buyer finds the information suitable to him, he places the ‘Order/Indent’ for the import of goods.
- Local procurement : The exporting firm has to either procure ready-made goods from the market or procure raw materials and start producing the goods according to the specification of the importer.
- Processing Cost : Cost of processing of raw material to readymade goods.
- Packaging cost : Once goods are ready then they need to be packed into boxes for export. Export of goods require special packing, marking and labeling of products.
- Cost of transportation up to port : from place of procurement / production till the port
- Shipment time : The time taken for goods to reach from port of shipment to the Buyer’s port. It takes 30 – 60 days.
- Credit period : Time given by Exporter to the buyer, as buyer needs time to sell the products in their country .
The above is the process one needs to follow while costing a product. The time gap between buying locally in INR and realization of foreign currency poses risk. While costing, a cushion has to be kept for currency fluctuation. The risk increases if shipment gets delayed or the importer delays the payment or cancels the contract.
CASE STUDY
M/s Risa Exim is a Rice Exporter. He gets an order to Export 1000 tons of rice. He buys Rice from domestic producer at a cost of Rs. 71 per Kg. He spends 25 paise on processing and packaging of that rice . He further spends 50 paise on transportation & shipment. So the total cost for M/s Risa Exim from purchase till transportation is Rs. 72.75 per kg. He gives a credit period of 30 to 45 days to his buyer. The total time from costing to realization is normally 90 days.
In Current Scenario, the current market rate is 73.50 and the costing to M/s Risa Exim comes to Rs. 72.75. The Rice Exporter normally takes 1 Dollar = Rs 73.00 (50 paise less than current Rate) and will give a quoting price of $1 per kg . Company is expecting to receive its remittance in March 2021. For 1 ton, the price will be $1,000 and total cost of 1000 tons will be $1,000,000.
| When the exporter hedges the position | When the position is unhedged |
| If the exporter hedges the position and wants to protect its cost against currency fluctuation in market then he will sell future of Feb 2021 at 73.93 . This is Rs. 1.18 more than the total costing. | In this case, the exporter cannot afford dollar rupee to move below 72.75 . He will be bearing a loss from his pocket if Dollar Rupee goes below 72.75. |
| He is not sure when he is going to receive money in March so he sells the Feb end Futures, which he can rollover to first weekly future of March 2021. He can keep on rolling over every week and convert it in bank when actual export is realized and cancel the future contract. |
| Cash Flows | ||||||||
| 71.00 | 72.00 | 73.00 | 74.00 | |||||
| Bank | Exchange | Bank | Exchange | Bank | Exchange | Bank | Exchange | |
| Hedged | 71 – 72.75 = -1.92 | 73.93 – 71 = 2.93 | 72 – 72.75 = -0.75 | 73.93 – 72 = 1.93 | 73 – 72.75 = 0.25 | 73.93 – 73 = 0.93 | 74 – 72.75 = 1.25 | 73.93 – 74 = -0.07 |
| Un Hedged | 71 – 72.75 = -1.92 | – | 72 – 72.75 = -0.75 | – | 73 – 72.75 = 0.25 | – | 74 – 72.75 = 1.25 | – |
From above charts we come to know that when an exporter hedges his position in currency futures at 73.95, profit margin is protected irrespective of dollar rupee moving in any direction say from 71 to 74 but in case of unhedged position, he will be in loss if Dollar Rupee is below 72.75.
In current global scenario no one knows about the future fluctuation so it is better to safeguard its costing in market by doing Risk Management activity.
©Prashanti Forex
