A UK business agrees to pay a supplier €100,000 when a shipment arrives in three months. By the time it does, the pound has weakened and that invoice costs £85,000 instead of £80,000, eating the profit margin.
An FX forward could have prevented it.
A forward contract is a financial instrument that lets a business lock in an exchange rate today for a transaction that settles in the future. This article covers how they work, the different types available and what finance teams need to consider before using one.
FX forwards: the bottom line
A forward contract can help a business fix an exchange rate for a future payment, which may reduce uncertainty (but also removes the ability to benefit if the market moves in its favour), it trades uncertainty for certainty, at the cost of a theoretical upside.
When you sign an FX forward contract, you agree to exchange…
- a specific amount of currency
- at a set rate
- on a fixed future date (or within a defined period).
Unlike a spot transaction, which exchanges currency at today’s market rate for immediate delivery, a forward contract allows an organisation to secure its costs months in advance. By locking in an exchange rate now, the business may reduce the impact of currency movements on a future payment although the final commercial outcome will still depend on wider business factors before the invoice falls due.
Let’s look at some of the finer points of FX forwards.
What is the forward rate, why does it matter and how is it calculated?
Note: FX forwards can help to manage exchange rate risk, but they also create obligations, may involve margin requirements and remove the chance to benefit if exchange rates move favourably.
The forward rate is the rate you get when you agree a forward contract. Let’s look at how that rate is decided.
A common misconception is that a forward rate is a broker’s prediction of where the market will be in the future. In reality, the calculation is a mathematical result of interest rate parity.
The forward rate calculation is the current spot rate (the live exchange rate) plus or minus forward points. These points represent the difference in interest rates between the two countries involved. If the interest rate in the country of the currency you are buying is higher than in the UK, the forward rate will typically be lower than the spot rate. This adjustment ensures there is no free money to be made simply by switching currencies to chase higher interest rates. The final rate you receive will also include a small margin or spread applied by the provider.
Fixed-date FX forwards – Benefits and Risks
Fixed-date forwards
The most common type of forward and the one described above is a fixed-date forward (FDF); if someone refers to a forward contract without further qualification, it’s likely they mean an FDF. An FDF requires the business to complete a currency trade on a specific day at the rate agreed upon when the contract was signed. This is ideal for predictable commitments, such as a large equipment purchase or a defined quarterly royalty payment.
(Fixed-date) forward contracts: pros and cons |
|
|---|---|
| Benefits | Risks |
| May help protect profit margins | Margin requirement ties up working capital |
| May support cash flow forecasting | Variation margin can trigger a payment, impacting cash flow |
| Can be tailored to specific amounts and dates | Binding contract |
| No separate premium is usually paid | Counterparty default risk |
| Flexible variants broaden use cases | |
Window forwards
However, many UK businesses face less certain timelines due to shipping delays – a major concern in the current climate – or variable payment terms. In these scenarios, for businesses with uncertain settlement dates, a window forward may provide more flexibility because the contract can be settled within a defined period,although the pricing and operational handling may differ from a fixed-date forward. A window forward allows the finance team to settle the contract in full at any time within a specified date range, such as a thirty-day window.
While this flexibility may sometimes carry a slightly different rate than a fixed-date contract, it prevents the business from being forced into the spot market to cover early payments, or from having to settle a contract before the underlying commercial funds have actually arrived.
Think of it this way: A standard forward fixes the rate and the date. A window forward fixes the rate and lets the date move with your business.
Flexible forwards
A type of window forward, a flexible forward allows for multiple partial drawdowns within the window. For instance, if you have a €100,000 flexible forward, you could settle €20,000 on Tuesday, €50,000 the following week and the remaining €30,000 at the end of the month, all at the same agreed rate.
Window forwards vs. flexible forwards |
||
|---|---|---|
| Feature | Window forwards | Flexible forwards |
| Settlement period | A specific, pre-defined date rate (e.g., a 14-day window) | Open flexibility across the entire duration of the contract |
| Drawdown structure | Usually settled as one single, total amount | Specifically designed for multiple partial settlements (tranches) |
| Operational profile | Lower administrative load; behaves like a fixed forward with a buffer | Higher management required to track remaining balances |
| Business application | Ideal for a single large invoice where the exact shipping date is uncertain | Best for businesses with frequent, smaller invoices from multiple overseas suppliers |
| Cash flow impact | One-time impact on liquidity at the point of final settlement | Allows for pay-as-you-go cash flow management throughout the contract |
A worked example: protection vs missed upside
Consider a UK organisation that must pay a supplier €200,000 in six months. The finance director decides to secure an FX forward at a rate of 1.18. This means the business knows exactly how much it will cost in sterling: £169,491.53.
Scenario A: the pound weakens
If the market rate drops to 1.14 by the settlement date, the business is protected. Without the forward contract, the invoice would have cost £175,438.60.
By hedging, the finance director has saved the company nearly £6,000 and prevented a significant erosion of the project’s profit margin.
Note: In this scenario, the forward would have reduced the sterling cost compared with buying at the later spot rate, but a different market movement could have produced a less favourable comparison.
Scenario B: the pound strengthens
If the market rate improves to 1.22, the business still has to transact at the agreed forward rate of 1.18. That means it gives up any benefit from a stronger pound in exchange for greater certainty at the outset.
While it may feel like a loss in hindsight, the objective of the hedge was not to “beat the market” but to guarantee a price that was acceptable to the business at the time of planning.
Understanding the margin and cash flow
When entering a forward contract, the provider usually requires an initial margin. This is not a fee, but a deposit (this is a % value – set by the provider) to collateralise the position (or, simply put, secure the contract). This capital is held by the provider as security for the duration of the contract and in most cases is then deducted from the final payment.
Finance directors should also be aware of variation margin. If the market moves very significantly against the position, the provider may ask for additional funds to maintain the margin level. For this reason, many organisations choose a hedge ratio (the percentage of your total estimated foreign currency exposure that you choose to protect with a hedging instrument) of less than 100%, ensuring they have a buffer for both cash flow and potential changes in their underlying business requirements.
Operational considerations: accounting and audit readiness
For a finance director, the operational impact of a forward contract extends directly to the balance sheet. Because these instruments are classed as financial derivatives, they are typically subject to mark-to-market (MtM) valuations at each period-end. This process involves calculating the current value of the contract based on live market rates to determine its fair value for financial reporting purposes.
While this valuation was once a manual task requiring complex journal entries, modern hedging platforms now integrate directly with accounting software such as Xero. This connectivity ensures that hedging activity and settlements are reflected automatically in your books. By automating the data flow between your FX provider and your ledger, you ensure that your records remain audit-ready and that your month-end reconciliation is straightforward.
An alternative way to book an FX forward
Historically, securing a forward contract required a manual relationship with a broker or a complex bank process. For many UK finance directors, the favoured way to book an FX forward is now through a modern, self-service platform that removes the need for phone calls and manual negotiation. Alt21 allows finance teams to manage their currency risk independently. The setup process is designed to be straightforward: once an account is open, you can secure a forward rate directly through the digital dashboard.
Because the platform is built on straight-through processing, there is no requirement for dealer intervention or waiting for a callback to confirm a price. You see the exact markup in real time before you confirm the trade, providing clarity on every transaction. By connecting with your existing bank accounts and accounting software, the platform converts a complex treasury requirement into a simple, automated part of your financial workflow
