Long-term currency planning is an essential aspect of financial strategy for businesses that operate internationally, whether they’re exporting goods, paying overseas suppliers, or managing international payments. Exchange rate fluctuations can pose significant financial risks, impacting profit margins, costs, and overall financial stability. Forward contracts offer a way to reduce this risk, allowing businesses to lock in exchange rates for future transactions.
In this post, we discuss what forward contracts are, what they can be used for, and why they’re essential for long-term currency planning.
What is a Forward Contract?
A forward contract is a risk management solution that allows businesses to secure an exchange rate for a future currency transaction in advance. This means that no matter how the market moves or exchange rates change, the agreed rate will apply on the specified date of the transfer.
Exchange rates can change very quickly and often fluctuate significantly, influenced by a variety of factors, from interest rate decisions and economic data to global news. This is why forward contracts are commonly used by businesses dealing with foreign currencies to manage risk, as they provide an exact cost for the future money transfer, helping to protect against unexpected changes.
What Can Forward Contracts Be Used For?
Forward contracts can be utilised for a wide range of international transactions that a business makes to protect themselves against potential future exchange rate fluctuations. Some common uses include paying foreign staff or contractors, receiving payments from international clients, paying overseas suppliers for goods or services, and budgeting for future currency-related costs in long-term contracts.
Different Types of Forward Contracts
There are a range of different types of forward contracts available, which are ideal for use in different situations, including; fixed forward contracts, open, flexible, or variable forward contracts, and non-deliverable, time options & window forward contracts. Below we explain more about each type:
- Fixed Forward Contracts: A fixed forward contract allows businesses to exchange one currency for another at a locked-in exchange rate for a fixed future date. This means they secure the exchange rate today and transfer their money on the specific date they’ve set in the future, making them ideal for businesses that know exactly when a payment needs to be made and for how much.
- Open, Flexible, or Variable Forward Contracts: These forward contracts also allow you to secure an exchange rate for a future date but offer flexibility around the date and amount, so businesses can draw down funds over a period. Businesses can use some or all of the contract before the original settlement date, making them best suited for those with ongoing foreign currency needs but uncertain payment timings.
- Non-Deliverable, Time Options and Window Contracts: These are more specialised forward contracts that offer additional flexibility, for example, allowing transactions within a set time window or settling without physical delivery. They’re less common but can be beneficial when payment dates or exact amounts are not confirmed, and are often used in more complex or volatile markets.
Why Forward Contracts are Essential for Long-Term Currency Planning
For businesses operating internationally or with ongoing foreign currency exposure, utilising forward contracts is a vital part of long-term currency planning. Below, we share five key reasons why forward contracts are an essential tool for businesses to use:
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Protects Against Exchange Rate Volatility
Foreign exchange markets are constantly fluctuating, and even the smallest changes can have a significant impact on a business’s finances. Forward contracts play a key role in protecting against this exchange rate volatility. By locking in a fixed rate in advance, businesses can shield themselves from adverse currency movements.
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Improves Budgeting and Cash Flow Forecasting
Forward contracts help businesses to improve their budgeting and cash flow forecasting, which is a big advantage for long-term currency planning. Forward contracts remove the uncertainty around future exchange rates, giving businesses clarity on their future costs or their income in foreign currencies. This eliminates any uncertainties and allows for more accurate financial planning.
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Helps Maintain Competitive Pricing
By giving businesses the ability to lock in exchange rates for future transactions, forward contracts help them avoid passing currency fluctuations onto their customers or incurring unexpected costs. This is crucial for businesses that sell services or products abroad, as it helps them maintain stable and competitive pricing.
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Supports Long-Term Contracts and Global Expansion
Forward contracts also support businesses involved in long-term contracts and global expansion, as by locking in rates in advance, they can confidently enter new agreements or expand into markets without the worry of future currency fluctuations. This financial certainty enables businesses to plan, negotiate, and grow over time.
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Enhances Financial Certainty for Strategic Decision-Making
They also provide clarity around future currency costs, which is essential when making long-term strategic decisions. Whether it’s investing in new markets, negotiating supplier agreements, or planning capital expenditure, having a fixed exchange rate removes uncertainty and allows businesses to make long-term decisions with confidence.
Reduce Exchange Rate Volatility with Forward Contracts
Here at NewbridgeFX, we are foreign exchange and international payment specialists, offering both businesses and individuals a wide range of FX services to facilitate their global currency payments. Forward contracts are a risk management solution that allows businesses to secure an exchange rate for future dates, locking in a rate to provide certainty against currency price fluctuations. We also offer spot contracts, market orders, stop loss & limit orders, as well as currency exchange rate alerts, to further support long-term currency planning and protect against unfavourable market movements. For further information on how NewbridgeFX can assist with a range of FX services, get in touch with today, or register in minutes to get started.