What are Constant Currencies?

Constant currencies are exchange rates used to eliminate the effect of fluctuations when calculating 澳洲幸运5官方开奖结果体彩网:financial performance numbers for publication in 澳洲幸运5官方开奖结果体彩网:financial statements. Companies wit⛄h overseas operations often supplement mandatory, reported figures with optional, constant currency numbers. Basically, it enables them to show investors how they performed, independently of foreign currency movements.

How Constant Currencies Work

Companies that sell products overseas will often see their reported revenue and profit become distorted by factors they have little control over. For example, when the 澳洲幸运5官方开奖结果体彩网:greenback sಞtrengthens against other currencies it subsequently weighs on interna♕tional financial figures once they are converted back into U.S. dollars.

Business executives believe these currency fluctuations mask the true financial perfor☂mance of a company and, as a result, often choose 💧to also disclose figures that assume that exchange rates during the period did not move.

Constant currencies can be ♛calculated in numerous ways. One ap๊proach is to convert current numbers using the prior period’s average exchange rate. Another is to adjust previous numbers to reflect the current year’s exchange rate.

In both cases, the set of figures that investors look at to see how trading has improved relative to the comparative period will no longer be distorted by foreign currency swings. And a strong U.S. dollar will suddenly not appear so bad for firms whose functional currency is the greenback.

Example of Constant Currencies

Here is a simple example showing the effects of using constant cur﷽rencies, versus not🔜 using them.

ꦰCompany X is based in Australia and does business in the United States, earning revenue in U.S. dollars. In year one, the company earns $500,000 and has a net profit of 10%. At the end of year one, the AUD/USD exchange rate is 0.8. In the second year, the company earns $600,000 and has a net profit of 10%. The AUD/USD exchange rate is 1.1 at the end of the second year. Based on this, the financial results, translated to AUD, would be:

These results do 🦹not use constant currency. They show that USD revenue and net profit both increased by 20% year over year and that the exchange rate increased by 37.5%. Due to the exchange rate ꦚfluctuation, the AUD revenue and net profit numbers actually decreased by 12.7% each.

Management could argue that this is not a fair number to report because the declines were sol🃏ely due to currency exchange rates. To eliminate this problem, the company can use constant currency methodology. Here’s how that could look:

Eliminating the currency fluctuation's effects, AUD revenue and net profit numbers now show growth of 20%.

Real World Example of Constant Currencies

Let’s now take a look at a real-life example. A strong U.S. dollar weighed on McDonald’s Corp. (MCD) foreign gains once th𓆏ey were converted back into the fast-food giant’s local currency in the first quarter ending March 31, 2019

As you can see in the image above, revenues, 澳洲幸运5官方开奖结果体彩网:operating income and 澳洲幸运5官方开奖结果体彩网:net income (NI) all declined in the first quar💞ter of 2019. However, if exchange rates had not changed, the result looks much more promising, indicating that progress had in fact been made over the past 12 months. McDonald’s translates current year results using the prior year’s average exchange rate.

Disadvantages of Constant Currencies

Like other adjusted figures, constant currency measures can be better or worse than reported GAAP numbers. However, that does not mean that investors should not completely disregard the potential to use these non-compulsory measur𓆉es to paint the company in a better light.

Management teams, including McDonald’s executives, maintain 𒀰that constant currencies give a clearer idea of underlying performance. Unfortunately, that is not always the case.

The general consensus is that currency impacts generally even out over time. However, there are some exceptions. For example, in some countries, especially 澳洲幸运5官方开奖结果体彩网:emerging markets, 澳洲幸运5官方开奖结果体彩网:inflation is high and currencies depreciate consistently.

Likewise, if the U.S. dollar continues to appreciate for some time yet, perhaps investors should just accept the reality of lower profits. Chances are that companies will be converting their offshore earnings back into local dollars to fund dividend payments and so forth, and not nece𒅌ssarily at the exchange rates that they choose to report with.