Like all currencies, the US dollar fluctuates in value and if you operate your business with tight cash flow or a strict budget, you might be concerned about the impact of currency fluctuations. A forward contract might be the solution but it’s worth taking time to understand how they work and what the pros and cons of this currency tool are to decide whether it’s right for your business.
What is a forward contract?
A forward contract allows you to fix a prevailing rate of exchange for up to two years. (A forward contract may require a deposit.) Exchange rates can fluctuate by as much as 10% or more over periods of extreme volatility, so the cost in dollars can be significantly impacted. If you don’t want to end up paying more than you bargained for. Fixing the rate means that you can develop a clear budget and guarantee costs and, with protected margins you can also fix prices.
Forward contract: Pros
If you like certainty, then the forward contract offers this as a clear benefit. The dollar fluctuates according to a wide variety of factors – the trade war with China has had an effect, the actions and policies of the Federal Reserve and even volatile domestic politics can all put pressure on the dollar and other currencies and cause fluctuations. Just a fraction of a percentage point changing on the exchange rate can make a big difference on larger sums. If you’re placing a major order from an overseas supplier or have long term contracts abroad then a forward contract allows you to manage those costs within a definite budget.
Forward Contract: Cons
Currency fluctuates in both directions; a forward contract protects your business if the value of the dollar goes down, but there is the possibility that it could also go up. If the dollar rises, you may be locked into a lower rate than the market rate. A lot depends on your attitude to risk and what the business can withstand – if you are risk-averse or operate within tight budgets, then a forward contract offers reassurance. If you can withstand a little risk and your business can weather any drops in currency or wait for the rates to improve, then other currency tools for tracking and targeting rates may be an effective way to manage your international payments.