SME’s secret weapon to international payments:  Forward Contracts

If your business makes or receives international payments, you should be using forward contracts.

SME’s are not aware of forward contracts and its usually because they are either afraid to commit to the rate, they don’t understand how forward contracts work or  because they may not have the cash available to put down the 10% deposit required to secure the forward contract or FEC.

We maintain FECs are one of the most useful and beneficial foreign exchange products available to SME’s and we’re continually encouraging small businesses to use them to reduce foreign exchange risk.

It’s a fact that the South African Rand is one of the most volatile and unpredictable currencies in the world. The economic and political instability in South Africa makes the Rand highly susceptible to daily fluctuations. It’s not uncommon for exchange rates to move as much as 3% in a single day. For this reason alone, small businesses cannot afford not to do this themselves.

When it comes to international business to business payments, the first step is to understand when and how you are exposed to currency markets. Once you better understand your exposure and how it can impact your business, you can take the necessary steps to manage it. Importers and exporters create market exposure whenever there is a time difference between when an order is placed, and the funds are transferred or paid. In some cases, this period can be as long as 90 – 120 days.

It’s always important for SMEs to consider the commercial implications before committing to using a forward contract. Below are some examples of where a forward contract could be useful:

• To fix an exchange rate to cover an invoice that is dated in the future.

• To fix a rate to cover a percentage of a company’s forecasted currency requirements for future supplier payments.

• To hedge a rate for project work that is paid in stages for up to 24 months.

• To protect forecasted export proceeds from currency volatility

• When profit margins are tight and the ability to adjust the product and pricing is not an option.

Benefits of forward contracts

• A rate can be fixed upfront, providing SME’s with certainty over their profit margins or future payment costs.

• The exchange rate is locked in for the entire length of the forward contract, providing the buyer with a guaranteed rate of exchange.

• If the live market rate moves against the SME’s favour they will not be negatively impacted.

Things to consider with forward contracts

• Forward contracts are designed to reduce or remove currency risk on future payments.

• If a currency moves in your favour, you won’t be able to capitalise on that opportunity.

• You will be required to put down a 10% deposit to fix the exchange rate on a future dated payment.

• It is important to take a view on the exchange rate when evaluating your decision and risk appetite. If you are unsure, you can call our dealing desk to see what our view is.

Let FX Paymaster help you navigate this space and secure a forward contract that will benefit your business.