Forward contracts can be a very useful tool for business planning and budgeting. It is basically fixing a rate for a fixed amount of currency over a fixed date. Usually, currency companies will require a deposit of 5%, this covers them if a client doesn’t follow through with the contract, the deposit is then returned as part of the last payment. These contracts can be set up from 2 weeks up to 3 years in advance.
Below are examples of how a forward contract could be used.
A client in the UK needs to buy goods from a European supplier, they normally buy 500,000 Euros in each financial year, the payments are spread throughout the year, in 2016 they would have seen the rate slip from 1.42 to 1.15 meaning a more expensive purchase as the year progressed. When the rate is favourable it is worth fixing part of the expected spend, it helps with budgeting and helps improve the bottom line.
In this case we would have recommended fixing half of the expected purchase, around 250,000 Euros, the rate for fixing for 1 year would have been around 1.395, the company now know that the first 250,000 euros is going to cost them £179,211, the remaining amount can be bought at spot depending on what the rate was doing, if it was higher than 1.395 they would use spot to buy, another reason for recommending half is that if something changes in the ordering pattern and the company needed to buy less they would still be contracted to buy the Euros, fixing half offers flexibility and if need be another forward contract could be set up with a different amount and time length.
Exporters are always fighting against competition and the currency markets, but a forward contract could help. Quoting in a potential client’s own currency could help win the business, taking away the risk of currency exposure for them and putting on to you as the supplier. Working directly with a currency company can help reduce the risk, firstly they can help with quoting exchange rates to enable a quote to be made and if the business is won a forward contract can be put in place to protect the order, the added advantage being that because the quote is in the client’s own currency a little extra can be added hopefully increasing the profit margins.
We are happy to talk to you if you feel your business could benefit from Forward Contracts.