Protecting your profit margins through the use of forward contracts

Given the continued volatility in the currency markets, foreign exchange risk management should be a key focus of any finance director but particularly those working within a small-to-medium sized enterprise (SME).

 

For those who don’t have an effective foreign exchange strategy in place, there are tools available to help manage and ‘hedge’ any currency risk exposure.

 

What is a forward contract?

Forward contracts can be an effective way to minimise or eliminate FX risk. A forward contract allows you to fix the current exchange rate for a settlement at an agreed date in the future, making your FX a fixed cost.  This can help provide certainty over the costs of your international payments enabling you stabilise your cash flow, protect your profit margins and reliably forecast.

 

If you can accurately forecast your quarterly/annual revenues and expenditures that will then allow you to lock in a percentage of that exposure for settlement at a future date, negating a large part of your risk to currency fluctuations.

 

An Example

Company ABC Ltd is a Manufacturing business based in Cardiff, Wales. They source their raw materials from various suppliers in Asia and have to pay them in US Dollars. Having seen the GBP/USD exchange rate as low as 1.3400 at the beginning of January, a jump into the 1.4000’s prompted ABC Ltd to get in touch. They knew they would have to spend a minimum of $50,000.00 per month on raw materials during the next 6 months of 2018.

 

With Sterling rates having been so volatile ever since the UK’s EU Referendum, and having seen the rate improve drastically in January the client decided they wanted to hedge against future fluctuations and lock in an exchange rate for their known exposure over the coming 6 month period.

 

The key advantages for them to locking in a forward contract included:

  • Protection of profits –  they had peace of mind that they couldn’t get hurt by future adverse currency movements and were able to focus on what they do best, which is running their business.
  • Cost certainty and reliable forecasting – they were able to effectively budget for the coming 6 month period.
  • Tangible savings – they realised savings of £8,141.15 over a 6 month period  (see workings on the following page).
  • Simplicity – when they needed to pay their suppliers they simply sent Godi the Sterling funds based on the forward rate fixed at the outset, and Godi then paid the corresponding Euro figure to their supplier on that very same day.

 

How were the savings achieved?

The table below illustrates the savings ABC Ltd made over the first half of 2018 by deciding to lock a forward contract in at the start of the year.

 

They locked in an exchange rate of 1.4190 on the 26th January 2018 for the $300,000.00 they required over the 6 month period.

 

Comparing the fixed forward rate against the prevailing spot rate on each one of their monthly draw downs/payments of $50,000.00 during 2018, we can see the client saved a total of £8,141.15*.

*Workings

 

Where next?

Protect your business against the risk of currency volatility. 

At Godi we specialise in helping SMEs put in place the right currency hedging strategies while also reducing the costs and fees of FX transactions

Request a free review of your currency exposure

To help protect your business against the risk of currency volatility and take control of the costs of your international payments, take advantage of our complimentary foreign exchange review.

This review can help you better understand the effects of exchange rate fluctuations on your specific business operations.

The no-obligation currency strategy review includes:

  • An assessment of your foreign exchange risk and cash flow.
  • A price comparison versus your bank or current foreign exchange provider – this is a useful way to uncover the true cost of FX transactions and any additional & unnecessary fees charged.
  • Recommendations and strategies to help to reduce your currency exposure.

For a complimentary, no-obligation review of your FX risk and to explore your options, phone 0203 326 9082, email info@godi.io or contact us here

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