Best practices for managing currency exchange in global payroll

Different currencies and fluctuating exchange rates add an additional layer of complexity to global payroll. Businesses that operate with a globally distributed team need to understand the risks and challenges that are linked to foreign exchange (forex for short) and the impact it can have on payroll.

Mismanaging currency exchange at a multinational organization can have severe repercussions on payroll accuracy, compliance, and the company’s overall financial health. That’s why internal organizations need to make sure to adopt suitable strategies for managing currency exchange in global payroll.

Read on as we dive deep into the risks and challenges forex poses for international payroll and the strategies organizations can adopt to stay profitable despite currency fluctuations and ever-increasing FX fees. But first of all, let’s take a closer look at the mechanisms that govern the foreign exchange market.

Whenever businesses engage in international trade and buy or sell products to or from companies that are based in different countries using different currencies, they need foreign exchange.

Foreign exchange basically describes the conversion of one country’s currency into a different country’s currency. In order to determine how much a certain currency is worth compared to another, each currency has a calculated value which is based on the laws of supply and demand.

There are different factors that influence the value of a currency. They include several market-driving factors, such as trade, investment, and tourism. Geopolitical factors, such as disputed elections, polarization, and conflicts, can also impact currency value.

Since factors like investment and tourism can change depending on economic climate and geopolitical risks, the value of a currency is subject to fluctuation. Another factor that impacts currency value is inflation.

Fluctuating currency values further have an impact on exchange rates between different currencies. This is why the foreign exchange market (FX or forex market for short) plays a very important role in international business.

Foreign exchange rates are not only important for banks and international funds, but also for multinational businesses that hire and pay employees in different countries. That’s because exchange rate fluctuations have a direct impact on payroll processing and salary payments.

Fluctuating currency exchange rates pose different risks for businesses that run a multi-country payroll. Since international payroll processing involves paying wages and salaries in different countries, it often requires cross-border payments which are not only slow and expensive but also impacted by currency fluctuations in international markets.

Exchange rate fluctuations need to be managed carefully in global payroll. There are several reasons for this.

1. Risk of inaccurate employee compensation

Managing salary payments in different currencies requires special attention. Mismanaging foreign exchange in global payroll can lead to inconsistencies in employee compensation.

For instance, if the payroll amounts that need to be paid out to are defined in the currency of the country where the organization is headquartered, this could lead to an employee based in a different country receiving a slightly different salary each month due to exchange rate fluctuations.

2. Negative repercussions on compliance and employee morale

Inconsistencies in salary payments not only look bad on paper, but they can also weigh down on employee morale and engagement. If an employee receives less money from one month to the next without apparent reason, this can lead to frustration and ultimately contributes to employee turnover.

What’s more, inconsistent salary payments pose compliance risks. Employers who fail to pay their employees their salary in full are at risk of a severe breach of contract since they then fail to deliver on one of the fundamental agreements of the employer-employee relationship.

3. Retrospective manual adjustments

Another problem linked to inconsistent salary payments resulting from mismanaged currency exchange in global payroll is that it leads to time-consuming manual processes which are needed to correct inconsistencies retrospectively. This involves issuing off-cycle payments to compensate for previous underpayment, correcting the payroll reports for the respective pay period, and more.

4. Additional global payroll expenses

Payroll is a major expense for businesses which is why it is typically one of the fundamental cost centers that are considered in financial planning and budgeting. Currency exchange fluctuations can lead to additional payroll spendings the business didn’t budget for.

While the additional cost with a small globally distributed team is usually hardly noticeable, organizations with large employee populations in countries with highly volatile currencies might experience overblown financial budgets that put a strain on their overall financial situation. If worst comes to worst, exchange rate volatility might nullify profits in the respective market.

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5. Inconsistencies in global payroll reporting

Paying employees in different currencies ultimately also makes it hard to achieve consolidated global payroll reporting. If payments to employees in different countries are issued in different currencies, it becomes increasingly hard to reconcile payroll data and compare payroll expenses for different geographies.

Without the help of automation and technology, the finance team needs to go through the tedious manual process of converting all payroll sums to a single currency to gain clear insights into their global payroll costs.

Managing currency exchange in global payroll can be a challenge. But with the right tools and tips, it doesn’t have to be. Here are some best practices that businesses should follow in order to master currency management in international payroll.

Leveraging automation and technology

Technology can help businesses simplify and streamline processes in many different ways, including in currency management for global payroll processing. With the right tools, businesses can track foreign exchange rates and automate currency conversion in their payroll data for accurate global reporting. Tracking exchange rates in real time can also help prevent underpayments and keep employees happy.

Paying employees through a local payroll infrastructure

Another way of preventing problems with currency exchange in global payroll is to establish local payment infrastructures in geographies with large employee populations. One possible way of doing this is setting up a local bank account through which wages and salaries are paid directly (in local currency).

Sufficient funds can be transferred to the account at times when exchange rates are favorable to the business. Alternatively, businesses can also drive a strategy of diversification which means that they manage their revenue in different currencies depending on the region where revenue is generated. Spreading global revenue across different currencies offers protection from exchange rate volatility and offers greater flexibility.

Working with a global EOR

Not every business that works with a globally distributed team has a sufficiently strong employee headcount in each geography that would justify a local payroll infrastructure with a dedicated local bank account that holds funds in local currency. In long-tail payroll countries that have only small employee populations, employing workers through a local Employer of Record (EOR) might be a better and more cost-effective option.

An Employer of Record acts as an employee’s official employer in the eyes of the law and handles all the administrative aspects of the employment relationship, including payroll. Given that EORs are typically based in the same jurisdiction as the employee, it’s easy for them to pay the employee in local currency. Foreign exchange risks can then be mitigated via additional clauses and provisions in the services agreement that is concluded between the Employer of Record and the company that contracts the EOR services.

Exchange rate clauses in employment contracts

Another way of preventing compliance issues and unhappy employees is to use international employment contracts with built-in provisions that regulate foreign exchange in salary payments and define rules for mitigating foreign exchange risks.

For instance, businesses can add a dedicated currency clause in their employment agreement template that clearly determines which currency is used for salary payments, how exchange rates are determined, and how currency volatility is handled in employee compensation.

Foreign exchange risk management strategies

With the right strategy in place, foreign exchange risks can be minimized. Successful risk management for foreign exchange transactions requires an in-depth risk assessment to identify key risk factors and define appropriate means of lowering the financial impact on the business.

In a next step, businesses need to set up continuous foreign exchange rate monitoring and develop clear internal procedures on how to deal with currency exchange across all departments and geographies. Businesses that are always up to date regarding current exchange rates for their key currencies can make informed decisions about when to best convert larger sums from one currency to another to save costs.

Last but not least, successful foreign exchange risk management also requires constant training and education of employees in HR, payroll, accounting, and finance departments so that everyone knows what the risks are and how to prevent them.

Currency hedging strategies

Hedging is a strategy businesses can employ to protect themselves against financial losses that result from currency volatility. The process consists of stabilizing a current position in a currency pair. Another option is to protect an upcoming currency exchange or transaction from spiking exchange rates that would lead to increased costs.

Having a strong FX risk management strategy in place is essential for managing currency exchange in global payroll and avoiding unforeseen financial losses that might decrease operational profitability. However, to really minimize the potential impact of exchange rate fluctuations, risk management strategies should be paired with software tools that simplify multi-currency management in payroll.

Lano’s global payroll consolidation platform comes with an integrated global payments solution that allows businesses to effortlessly pay global teams in 28 local currencies and issue one-click mass payments to more than 170 countries. Thanks to low currency exchange fees, it’s easy to transfer money between different legal entities and save costs. Book a demo with one of our global payments experts to learn more.