Forward Contracts Explained: How Importers Fix Their Rate and Protect Their Margin
Most businesses don’t lose money on foreign exchange because they paid a fraction of a percent too much on a single transfer.
They lose money because there was a gap between the moment they agreed a price and the moment they paid it — and nobody managed what happened in between.
That gap is where forward contracts do their work.
The problem in one example
A UK distributor agrees to buy €500,000 of stock from an Italian supplier. Payment terms are 90 days.
The moment that contract is signed, the business has quoted its own customers, built its margin, and priced its stock — all based on the exchange rate it saw on the day of the deal.
But it doesn’t buy the euros for another three months.
If sterling weakens by 4% over that period, the stock costs roughly £17,000 more than the figure the business planned around. On a product line running a 12% gross margin, a large slice of the profit on that shipment has gone — not because of anything the sales team, the buyer or the supplier did, but because of a currency market the business never intended to participate in.
That’s the point most finance teams miss. You are exposed to the FX market whether you meant to be or not. The only decision available is whether you manage the exposure or accept whatever happens.
What a forward contract actually is
A forward contract is an agreement to buy or sell a fixed amount of currency, at a rate agreed today, for settlement on a date in the future.
That’s it. Three components:
The amount — how much currency you need
The rate — agreed now, not later
The date — when the currency is delivered
You typically place a small deposit (a margin) at the outset, then pay the balance on or before the settlement date. Many providers, Orbis included, offer flexible or “window” forwards that allow you to draw down the currency in stages as invoices fall due, rather than in one lump at maturity.
What a forward contract is not
Three misconceptions come up in almost every first conversation we have:
It’s not a prediction. A forward rate isn’t anyone’s forecast of where the currency is going. It’s derived from today’s spot rate adjusted for the interest rate differential between the two currencies. Nobody at the other end of the trade is guessing.
It’s not a bet. Gambling creates risk that didn’t previously exist. Hedging removes risk that already does. A business with €2m of euro invoices due next year is already carrying a currency position. A forward closes it.
It’s not about beating the market. Businesses that hedge properly aren’t trying to win. They’re trying to know. The value of a forward isn’t the rate you get — it’s the certainty you buy.
When a forward is the right tool
Forwards suit exposures that are known and committed. The clearest cases:
A signed supply contract with fixed pricing in a foreign currency
A confirmed purchase order with payment terms of 30, 60, 90 days or longer
Recurring overseas payroll where the monthly cost is predictable
An agreed acquisition or property purchase with a completion date
Tendering for work where you’ve quoted a fixed price and can’t reprice later
That last one deserves attention. If you’ve submitted a fixed-price tender in a foreign currency and won it, your margin was fixed on the day you quoted. Every day after that, the currency market gets a vote on your profitability.
When a forward isn’t the right tool
Forwards create an obligation. You will buy that currency on that date at that rate. That’s the trade-off for certainty, and it’s the reason forwards don’t suit every situation.
If the underlying transaction might not happen — a bid you haven’t won, a deal that could fall through, a project that may be delayed — a forward can leave you holding currency you no longer need. In those cases a vanilla option is often the better structure: you pay a premium for the right, but not the obligation, to exchange at a set rate. You keep full downside protection and still benefit if the market moves your way.
Similarly, if the rate you want is meaningfully better than the market and your timeline is flexible, a limit order sits in the market waiting for your target level without committing you to anything.
The right instrument depends on how certain the underlying cash flow is. That’s the question to answer first — not “what rate can you get me?”
What does a forward cost?
There are no premiums or upfront fees on a forward. The cost sits in two places:
The forward points. The difference between the spot rate and the forward rate, driven by the interest rate gap between the two currencies. Depending on the pair and direction, this can work for you or against you. Buying euros forward with sterling has, in recent years, often been marginally favourable — a detail plenty of businesses never realise.
The spread. The margin your provider builds into the rate. This is where most FX firms make their money, and it varies enormously.
The second one is worth pressing on. Ask any provider — including us — to show you the spread as a number, not a rate. A provider who won’t quantify their margin is telling you something.
How much of your exposure should you hedge?
There’s no universal answer, but there is a sensible framework:
Rule-based hedging — hedge a fixed percentage of forecast exposure on a set schedule (say, 100% of committed orders and 50% of the forecast pipeline). Predictable, defensible, easy to explain to a board.
Layered hedging — hedge more of the near-term exposure and progressively less of the further-out exposure, adding cover as forecasts firm up.
Opportunistic hedging — hedge partially and leave some exposure open. This requires genuine market monitoring and a clear tolerance for the outcome if it goes against you.
Most SMEs are best served by the first two. The third quietly turns a finance function into a trading desk, usually without anyone deciding that’s what they wanted.
The question to start with
Before you look at a rate, answer these:
What currency payments or receipts are committed over the next 12 months?
What exchange rate is baked into your pricing and budget?
How far could the rate move before your margin becomes uncomfortable?
What proportion of that exposure are you willing to leave unmanaged?
If you can answer those four, you have the beginnings of a currency strategy. If you can’t, you don’t have a rate problem — you have a visibility problem, and no exchange rate will fix it.
William Fuller is Co-Founder and Sales Director at Orbis Exchange Group. Orbis works with businesses across the UK and UAE on international payments, currency risk management and trade finance.