Exploring 5 main functions of foreign currencies for business

Functions of foreign currency in business transactions

Foreign currency is an important tool in the global economy and international trade. As the currency of different nations, it facilitates the exchange of goods and services across borders and helps maintain economic stability. Below you will find some important functions of foreign exchange in business transactions:

1. Serves as a means for international payments

The main function of foreign currency is to serve as a means of payment for international transactions. When a company trades with another country, it must use the currency of the destination country as a means of payment. For example, if an Indonesian company imports goods from the United States, it must pay in US dollars (USD).

The use of foreign currency also simplifies cross-border payments. Businesses do not have to convert currencies over and over again, which saves both time and costs.

2. Simplifies global business transactions

Foreign currency facilitates cross-border transactions for companies operating internationally. Without a foreign currency, businesses would face considerable problems when buying or selling products and services abroad.

In essence, foreign currency opens the doors to global markets for companies. By using globally accepted currencies, businesses can easily do business with partners in different countries.

In addition, companies that employ staff abroad can pay their salaries directly in foreign currencies. This approach is more cost-efficient than paying in local currency and converting to foreign currency.

3. Protection against exchange rate fluctuation risks

Exchange rate fluctuations can pose a risk for companies involved in international trade. Unstable exchange rates can have an impact on import/export costs and overall profitability. Foreign exchange serves as a hedging instrument to mitigate these risks.

Foreign exchange transactions allow businesses to diversify their risk across several countries. If an economic downturn occurs in one country, the impact on the overall business can be minimized.

4. Helps with corporate planning

Major foreign currencies, such as the US dollar, are generally more stable than local currencies. This stability allows businesses, particularly those expanding internationally, to carry out financial planning, budgeting and target setting with greater certainty.

5. An instrument for financial portfolio diversification

Foreign currency is also a tool for diversifying a company's financial portfolio.

Diversification helps to protect the value of a company's assets from risks such as inflation and exchange rate fluctuations. By holding assets in foreign currencies via deposits or savings products, businesses can passively increase their asset value.

In addition, businesses can convert their foreign currency holdings into local currency in the event of a depreciation of the local currency, which increases liquidity in local currency.

Factors that influence the exchange rate

The value of foreign exchange, or the exchange rate of a country’s currency, can change rapidly due to various factors. As a business owner, understanding these factors is crucial to navigating international trade and effectively managing currency-related risks.

Here are some key factors that influence exchange rates:

1. Inflation

One of the most important factors affecting exchange rates is inflation. Inflation is the rate at which the prices of goods and services increase over a given period of time. When inflation is higher in one country than in others, its currency tends to weaken.

Conversely, low or stable inflation rates often strengthen the value of a currency. Low inflation strengthens purchasing power, which can increase demand for a country’s currency and thus increase its value.

2. Supply and demand

The balance of supply and demand for a currency has a significant impact on its exchange rate. If the demand for a currency exceeds the supply, the currency appreciates. Conversely, if supply exceeds demand, the currency depreciates.

The demand for a currency can be influenced by factors such as international trade, government intervention in the foreign exchange markets, foreign investment and tourism. For example, when foreign companies invest heavily in Indonesia, the demand for the rupiah increases, which can lead to an appreciation of the currency.

3. Economic growth

Strong economic growth usually attracts foreign investment and increases demand for the domestic currency. On the other hand, weak economic growth can make a country less attractive for investment, leading to a fall in the value of the currency.

4. Monetary and fiscal policy

Monetary policy refers to the regulation of the money supply in an economy, which is often controlled by a central bank. If a central bank lowers interest rates, foreign capital inflows may decrease, leading to a weakening of the currency. Conversely, an increase in interest rates can attract foreign capital and strengthen the currency.

Fiscal policy refers to government revenue and expenditure, such taxation. A sound fiscal policy can boost investor confidence and appreciate a currency, while an ineffective fiscal policy can lead to budget deficits that weaken the value of the currency.

5. Political stability

The political stability and political conditions of a country also influence the exchange rate of its currency. Countries with a stable political environment tend to have a stronger currency as they are seen by investors as safer for investment. Conversely, political instability can shake investor confidence and lead to a weaker currency.

Types of foreign currencies

As a medium of exchange in international trade, foreign currency comes in various forms, which are categorized according to their characteristics. Broadly speaking, foreign currency can be divided into two main categories: physical and non-physical foreign exchange. Below you will find a detailed explanation of each type:

1. Physical foreign currency

Physical currencies are currencies in tangible form, such as in the form of banknotes or coins. This type of currency can be used for everyday financial transactions, such as traveling abroad or for international trade.

Advantages:

• Direct usability for instant transactions.
• Suitable for cash-based transactions.

Considerations:

• Risk of physical damage, loss or theft.
• Limited portability due to security and convenience concerns.

2. Non-physical foreign currency

Non-physical currencies are foreign currencies in electronic form that are recorded in payment systems. This type of currency is commonly used for electronic transactions such as bank transfers and credit card payments.

Advantages:

• Simplified and secure business transactions.
• No need to handle physical cash.

Considerations:

• Susceptible to exchange rate fluctuations.
• Dependence on payment systems to process transactions.

Simplify international payments and get better FX rates with Aspire

Make international transactions and payments more efficient with Aspire’s Global Payments. Aspire gives you access to the best exchange rates with no hidden fees. You can send and receive international payments in over 30 currencies in more than 130 countries at rates up to three times cheaper than banks.

Aspire’s Global Payments allow you to make same-day transactions. In addition, you can use local transfers in USD, SGD, EUR and GBP to avoid conversion fees.

For added efficiency, you can seamlessly integrate your transactions with your company’s accounting software.

Aspire also offers a range of services to optimize your financial operations, including Payment Gateway, Payout API and Corporate Cards. Want to find out more? Get in touch with us today!