The Leads and Lags method consists in advancing or postponing the payment date in order to benefit from foreign currency fluctuations. This method is used when foreign exchange exposure has not been covered.
This could take the form of 4 scenarios:
Scenario 1: Let’s consider the case of an Exporter who will receive a payment in a foreign currency at a given date. If he forecasts that this foreign currency is likely to appreciate in the future, he might ask the payment to be postponed. By doing so, he expects to increase the amount translated in his domestic currency and ultimately his profit margin.
Scenario 2: Conversely, if the Exporter expects a depreciation of the foreign currency in which the payment is denominated, it is in his best interest to speed up the process by asking a payment by anticipation.
Scenario 3: An Importer who must honour a payment in a foreign currency, is exposed to the risks resulting from its appreciation. This is why if he forecasts an upward trend, it is in his best interest to process the payment in advance in order to limit potential losses.
Scenario 4: On the other hand, if the foreign currency is expected to depreciate, the Importer might want to postpone the payment. By doing so, he will be better off, since the payment denominated in his domestic currency will be lower.
It must be pointed out that the leads and lags method is particularly speculative as it is based on predicting exchange rates evolutions. In addition, postponing a payment generally imply an increase of financial cost (cash flow financing) that must be subtracted from potential gains in order to determine whether or not the whole operation is worthwhile conducting.
Furthermore, it must be stressed that asking for a payment in advance might not be possible as this might put pressure on buyer’s financial situation. Eventually, this method is hardly compatible with usual payment methods in International trade, which requires a strict compliance with payment terms (letter of credit, documentary collection, etc.…).