Advantages and Disadvantages of Forward Contracts

Forward contracts are used heavily in business that involves the sale and purchase of goods. That being said, there are many nuances that come into play when companies are dealing with these types of contracts. A forward contract essentially means that two parties are agreeing to the sale and purchase of a certain product at a certain date in the future, which is agreed upon by both, and that is .

A forward contract is a business term that refers to an agreement between two parties to buy or sell a product at a certain price, but the purchase does not place until a specified date in the future. If a product is sold immediately, it is considered a spot contract. Examples of products that are often sold through forward contracts are farm crops or oil. A farmer whose wheat crop is still growing might make a forward contract to sell the wheat at a specified price upon its maturity in three months.One advantage of a forward contract is that the current or today price is what the purchaser pays regardless of whether the price increases before the product changes hands at the future date. Setting the price in stone makes the buyer immune from any fluctuations in market value that may occur before that date. Using a forward contract also guarantees the seller a certain minimum sales price.However, naming a set figure before the purchase actually takes place is also sometimes a disadvantage. If the price of the product drops between the time the agreement is made and the moment when the product changes hands, the buyer remains locked into the higher agreed-upon price. Similarly, if the value of the product rises during that period, the seller receives a lesser sum and thus loses out on a portion of the profit.In some cases, neither party particularly benefits or loses out from using a forward contract. In other instances, though, either the buyer or the seller clearly gets the better end of the deal. If an individual is especially skilled at predicting the future values of certain products, that person usually has the advantage when entering into a forward contract. One disadvantage of a forward contract is that disputes sometimes arise. If one party suffers a particular financial loss from this sort of deal, that person might feel that the terms are unfair and attempt to break the contract.