If you run a business that pays overseas suppliers, receives foreign currency revenue, or has any regular exposure to exchange rate movements, you have almost certainly felt the pain of currency volatility. One month your costs are manageable; the next, a swing in the AUD wipes out your margin.

Forward contracts are one of the oldest and most widely used tools for dealing with this problem. They are not exotic. They are not complicated. And for many Australian businesses, they are the difference between predictable costs and financial uncertainty.

What Is a Forward Contract?

A forward contract is an agreement to buy or sell a specific amount of foreign currency at a predetermined exchange rate on a set future date. Once the contract is in place, the rate is fixed regardless of what happens in the market between now and the settlement date.

For example, an Australian importer who needs to pay a US supplier $500,000 in three months’ time could enter a forward contract today at an AUD/USD rate of 0.6500. When the contract matures, the importer delivers Australian dollars and receives US$500,000 at that agreed rate — even if the spot rate has moved to 0.6200 or 0.6800 in the meantime.

The benefit is certainty. The importer knows exactly what the payment will cost in Australian dollars and can budget, price products, and plan accordingly.

How Forward Rates Are Calculated

Forward rates are not predictions of where the exchange rate will be in the future. This is a common misconception. Instead, they are derived from the interest rate differential between the two currencies.

If Australian interest rates are higher than US rates, the forward rate for AUD/USD will typically be at a premium to the spot rate — meaning you get a slightly better rate in the forward market than the current spot rate. If Australian rates are lower, the forward rate will be at a discount.

This is a reflection of the cost of carry — the relative cost of holding one currency versus another. It is pure mathematics, not forecasting.

Who Uses Forward Contracts?

In Australia, forward contracts are used by businesses of all sizes. Large mining companies use them to hedge revenue streams denominated in US dollars. Importers use them to fix the cost of goods purchased from Asia, Europe, or the Americas. Even small businesses with regular overseas payments find them useful for smoothing out cash flow.

They are also used by individuals in certain situations. Australians purchasing property overseas, paying international school fees, or planning large transfers for emigration often use forwards to protect against adverse rate movements during the settlement period.

Forward contracts are typically arranged through banks or specialist foreign exchange brokers. In Australia, any provider offering forwards must hold an Australian Financial Services Licence, which provides a degree of regulatory oversight and client protection.

The Trade-Offs

Forward contracts provide certainty, but that certainty comes at a cost. If the exchange rate moves in your favour after you have locked in a forward, you will not benefit from the better rate. You are committed to the agreed price.

This is not a flaw — it is the nature of hedging. The purpose of a forward contract is to remove uncertainty, not to speculate on direction. Businesses that try to time the market or avoid hedging because they think the rate will improve are effectively taking a speculative position, whether they realise it or not.

There are also practical considerations. Forward contracts typically require a credit facility or margin deposit with the provider. The terms — amount, tenor, and rate — are fixed at inception, which means they work best when the underlying payment or receipt is reasonably predictable in timing and size.

Variations and Alternatives

Beyond vanilla forwards, there are several variations that offer more flexibility:

Window forwards allow settlement at any point within a defined period rather than on a single date. This is useful when the exact payment date is uncertain.

Participating forwards give partial protection at a guaranteed rate while allowing some participation in favourable rate movements. They are more complex and typically carry a wider spread.

Options give the right but not the obligation to transact at a set rate. They offer more flexibility than forwards but come at a premium — the option cost.

For most Australian SMEs, a straightforward forward contract remains the most practical and cost-effective tool. The more complex products tend to suit larger businesses with dedicated treasury functions.

Getting Started

If you have not used forward contracts before, the first step is to map out your foreign currency exposure. What currencies do you deal in? How much? How often? What is the typical lead time between committing to a purchase and making payment?

With that information, a conversation with your bank or an independent FX broker can quickly establish whether forwards make sense for your business and what rates are available.

Currency volatility is not going away. But with the right tools, its impact on your business does not have to be unpredictable. Forward contracts will not make you money, but they will let you sleep at night — and in business, that is worth a great deal.