Group of business workers pointing to a tablet and graphs on a table.

Why do you need a Forward Contract for your business?

November 24, 2022

Why do you need a Forward Contract for your business?

Synopsis
4 Minute Read

In a volatile global market, your manufacturing business can hedge against exchange rate fluctuations and improve bottom line.

Partner and Business Advisor

A Forward Contract is a financial instrument that allows you to lock a transaction at the current exchange rate for a pre-determined period. With this agreement, you can buy or sell assets, commodities, and foreign currencies at a specific price and date in the future despite market volatilities.

Considering the uncertainties in the global market and the risks attached to fluctuating exchange rates, it is advisable that business owners deploy risk management strategies to hedge against loss and protect their profit margins. A Forward Contract is a currency tool that forms a part of your strategy.

How does a Forward Contract work?

This type of agreement can be maximized by small and mid-size businesses as well as large corporations who make international transactions and understand the impact of market conditions on foreign exchange and subsequently, business cost.

For example, your manufacturing business plans to order raw materials estimated at five million Euros from France over the next six months and has a budgeted an exchange rate of 1 CAD to 0.70 Euros for this transaction. With the persistent hike in interest rates in Canada and its effects on foreign exchange, you may consult your financial institution for a Forward Contract that allows you to purchase and lock down five million Euros at the current exchange rate. Over the next six months, you would not have to worry about the market rate at which the Euro trades.

If you trade on the commodities market, you could enter a Forward Contract with a supplier to buy raw materials at a certain price.

A Forward Contract should clearly state the following:

Price

It is important for the Contract to be clear on the price that will be paid for the transaction and the currency in which it will be paid.

Expiration Date

Every Forward Contract is set for a specific period, usually one year or less. You and your supplier must agree on a delivery date for the commodities ordered and an end date for the contract.

Quantity

It should state the number of units of commodities being sold or purchased, in terms of volume.

Why you should use a Forward Contract

When deciding if a Forward Contract is right for your business, here are some benefits to consider:

  • Certainty: The effects of trade war, global inflation, and economic politics have put pressure on currencies across the world, including the dollar. A Forward Contract helps you hedge against currency fluctuations as changes in exchange rates can have huge effects on your budget.
  • Risk reduction: Locking in a specific price for a specific period helps you to significantly minimize the risk of losing cash.
  • Profit margin: A Forward Contract can protect your profit margin and help you to accurately predict your cash flow and revenue over a course of time.
  • Peace of mind: Entering a Forward Contract helps you to control the future of your business and prevents unpleasant surprises that may affect your bottom line.

Next steps for your business

Setting up a Forward Contract is simple and seamless, with support and guidance from a professional who understands the terms and can help you take full advantage of it. Because a Forward Contract comes with pitfalls that can work against you, it is crucial to get professional advice before negotiating one.

Contact us

To learn more about how MNP can help your organization, contact Yuriy Tyshchuk, CPA, CA, HBA.

Insights

  • Performance

    November 28, 2022

    Managing your farm’s living and dynamic budget

    Consider your farm’s budget as more than just a limit on your spending. When done properly, budgeting on your farm can be liberating, not limiting.

  • Confidence

    November 28, 2022

    What you need to know about the CRA’s self-assessment tax audit process

    How do you prepare when the CRA requests an audit of specific expenses or deductions you’ve made?

  • Performance

    November 25, 2022

    Managing your farm in an era of rising interest rates

    Rising interest rates present new challenges to farmers, but using the right strategies allows you to stay in control and navigate this period of change.