Most SMEs treat FX risk as a treasury execution issue. A payment is due in USD, EUR, or another currency, and treasury steps in to hedge. This common view misses a deeper truth: FX exposure often originates inside credit and working capital structures long before any treasury intervention.
When a business borrows in one currency and incurs costs in another, it embeds FX risk into its balance sheet. Exchange rate changes then become not just a timing issue for payments but a driver of margin volatility and credit risk.
The structural origin of FX exposure
FX risk exists because exchange rates fluctuate between the time a cost is agreed and the time it is paid. That is the classic transaction risk often highlighted in guides on currency risk. FX risk arises whenever a business has financial exposure to a currency other than its base currency, creating potential financial loss as the rate changes over time.
This is well understood at the transactional level. Less recognised is how lending practices create exposure. When a working capital loan is drawn in GBP to pay a USD supplier in 30 days, the borrower has effectively created an unhedged position. If sterling weakens in that interval, the cost base automatically increases before treasury even looks at the exposure.
Academic research supports this balance sheet view. FX balance sheet shocks driven by the mismatch between assets, liabilities, and foreign currency exposure have been shown to reduce profitability and constrain investment, especially for smaller firms. The implication is clear: FX risk is not merely a matter of hedging when a payment date appears. It is about how credit decisions influence exposure.
Working capital structures as a risk lever
Traditional treasury tools focus on derivatives to limit volatility around known cash flows. These tools are necessary but insufficient if exposure is structurally baked into the way companies use credit. Studies have shown that domestic borrowers can be subject to currency risk even if they do not directly engage in cross border transactions, simply because of FX borrowing and trade credit linkages within supply chains.
Instead, some companies are starting to align funding currency with cost currency at the outset. Supplier payment financing, where working capital facilities fund supplier payments directly in the supplier’s currency, locks in FX at drawdown. This changes both the economic exposure and the credit profile.
How funding structure quietly destroys margin
Take a UK SME with £20m annual turnover that funds a quarterly inventory purchase via a £2m working capital loan while owing $2.7m to US suppliers. At GBP USD 1.35, the expected cost is £2m. If sterling weakens to 1.25 before settlement, the same USD cost becomes £2.16m. That £160,000 erosion of margin is purely a function of FX movement between drawdown and payment dates and it sits in the financing decision, not in headline treasury operations.
By converting GBP to USD at drawdown and paying suppliers directly, the company fixes the currency cost at the start. That certainty unlocks additional value. Early payment discounts of 2 percent reduce supplier costs by $54,000. Bulk purchasing becomes viable, lowering per unit costs. Inventory can be held slightly longer without cash strain, improving service levels and reducing rush orders executed at poor FX rates.
What this means commercially
For lenders and CFOs, the lesson is unvarnished. FX exposure cannot be effectively managed by treasury hedges alone when credit structures create exposure before hedging even begins. A business that treats FX as a treasury afterthought invites avoidable volatility into margins and cashflow. Legacy approaches that separate lending, payments, and FX are increasingly misaligned with the realities of global supply chains and multi currency costs.
As the literature on FX exposure and working capital efficiency highlights, exchange rate gains or losses moderate capital structure decisions and ultimately financial performance.
In the end, FX risk is a credit problem because it changes the economics of funding and cost. Treat it as treasury alone and you will pay for it in margin and cashflow volatility. Treat it as part of how you fund and operate your business and you reduce risk at its source, not its symptom.
