When to Pay Vendors in a Foreign Currency Versus US Dollars
You may be paying a premium and creating reconciliation headaches by paying international vendors in US dollars. Use these practical considerations to help optimize foreign transactions.
BY: Charles Darwall, Executive Director, Treasury Product Solutions, J.P. Morgan Commercial Banking
Perhaps you've been paying your overseas vendors in US dollars for decades, and they've never complained. Your company may even require international payments be denominated in US dollars, a common treasury policy among US businesses buying from abroad. However, it’s worthwhile to reexamine policies like this—the costs of dealing in dollars are often overlooked, and misconceptions abound over the risks of foreign currencies.
Of course there are some instances when paying in US dollars is best. Certain industries have dollar-functional supply chains where currency conversion should not occur. Multinational vendors may want dollars for their own operations, or they may have an arrangement to convert currencies in bulk using preferred exchange rates. But if these considerations don't apply to your business, there can be significant benefits to changing your approach.
Here’s what you should know when deciding which currency to use with overseas vendors.
The major benefit of paying in local currency is improved cash flow. When you make a payment in US dollars, your bank immediately withdraws the funds from your account. This ensures the dollars are sent to the vendor’s bank right away. By contrast, when you make a cross-currency payment, funds are not wired until they've been converted from dollars to the vendor’s currency. Your bank may be willing to delay withdrawing the dollars from your account until the conversion is complete, which could take up to two business days. Two days of funds availability can be meaningful in terms of earnings credit and cash flow availability.
Your vendor could expect prompter payments and an easier account reconciliation process if you choose to pay in its local currency. The reason for this is that when you make a foreign payment in US dollars, the vendor’s bank automatically converts it to the currency of the receiving account, often without contacting the recipient. This creates two likely challenges for your vendor’s accounts receivable (A/R) team:
- Delays in receipt of funds: Many banks take two business days to post cross-currency payments to accounts, even for currencies that allow delivery on the same or next day after receipt. You may be able to deliver funds more quickly with no disadvantage to you if you pay in the vendor’s currency.
- Difficulty matching credits to invoices: If your vendor’s A/R ledger is in euros, for instance, its reconciliation team may struggle to match your payment credit because the converted euro amount won’t match the amount on the invoice. They can only hope the invoice reference details you provide in the wire transfer appear on the account statement.
Case Study: Importing From China
A wholesale distributor based in the southeastern US imported machine tools from China for more than 80 years and always paid in US dollars. However, beginning in 2010, the liberalization of the Chinese currency allowed for the distributor to make payments in CNH, the Chinese currency traded outside of mainland China. By agreeing to pay in CNH, the wholesale distributor was able to negotiate more favorable pricing from their vendor.
- Vendor risk: You're likely already paying a risk premium when transacting in dollars because your vendor will account for possible currency fluctuations when quoting you a price in dollars. You can take control of pricing by asking vendors to generate invoices that show prices in both US dollars and the local currency. Then consult with your bank to determine which currency option is better.
- Changes to accounts payable processing flow: Most banks include the option for foreign currency payments in the same web screen as dollar payments, so the user experience likely won't change. The wire instructions will change only slightly and can be provided by your vendors to ensure accuracy. If needed, you can work with your bank to streamline payment processing.
- Additional help: Simple payments in a foreign currency shouldn't be confused with foreign exchange trading and hedging. More experienced treasury practitioners will employ FX risk management instruments—such as forwards, swaps and options—to support cross-currency payments. These treasury professionals will collaborate closely with specialists on their bank’s FX desk to tailor appropriate solutions for their business.