Less fun: dealing with the books once foreign currencies are involved. In this guide, we’ll walk you through the basics.
Why bother with foreign currencies?
Dealing with foreign currencies makes your accounting a bit more complicated. It also opens you up to certain risks: if an exchange rate spikes or drops unexpectedly, you might find yourself with less money than you’d expected.
So why not just back away from the entire situation?
First off, most people prefer to pay in their own currency. Accepting different currencies can help you attract new customers from other countries.
Second, some suppliers only accept their local currency or charge a fee for conversion. For a long-term relationship, it might make sense to pay them using the currency they prefer.
The practical stuff: how to pay, and get paid
When dealing with customers/vendors in other countries, you need to decide on the best way to get money from A to B—and state those terms clearly in any contracts or online policies. This is a good moment to consider what you can do to keep transfer fees low and manage the risks of fluctuating exchange rates.
Choose a method of payment
How will the money actually get from your customers to you, or from you to your suppliers? You have a few options:
- Stripe, Square, and other ecommerce payment providers: Check whether your current solution allows you to list prices and accept payments in different currencies—and decide if you’re comfortable with the fees involved. Read this if you don’t have a payment processor yet.
- PayPal: PayPal lets you make and accept payments in more than 20 different currencies, as well as hold foreign currency balances. It does charge extra for currency exchange, though.
- International wire transfer: Banks often charge steep fees—$50 or more—for international money transfers. Newer, web-based services like TransferWise and OFX could be a better solution if you’re looking to keep costs low.
- A foreign bank account: If you’re doing significant business in one country, it might be worth the trouble of going there to set up a bank account. Depending on the bank, there may be a monthly charge or a minimum deposit required.
Set a payment schedule
You’ll also want to get crystal clear on the timing of any big transactions.
It’s always nice to know when you’ll have money coming in, but it’s even more important when invoices are in foreign currencies. Why? Exchange rates fluctuate, and the value of your invoice could change dramatically in a matter of weeks.
Getting paid faster helps lower the risk that the invoice will suddenly be worth a lot less, or you’ll suddenly be paying a lot more. Every once in a while it may work out in your favour, but for accurate planning purposes, the shorter the time between delivery and payment, the better.
The basic rules of foreign currency bookkeeping
Once your international operation is up and running, it’s time to think about how to deal with foreign currencies in your financial books.
- Translate any foreign currency transactions, assets, or liabilities into your home currency.
- Make sure to record the gains and losses that result from changes in the exchange rate over time.
How do you know what exchange rate to use?
Exchange rates change all the time. You’ll need to know which rate to use when you’re translating amounts into your home currency—otherwise your totals may be hundreds or even thousands of dollars off the mark.
- For revenues and expenses, use the rate that was in effect on the date the transaction occurred. If the currency is relatively stable, it’s okay to use a weekly or monthly average, but if the exchange rate is fluctuating wildly, you’ll have to track down the rate for each specific transaction date.
- For monetary assets and liabilities, use the exchange rate in effect on the date you create your balance sheet. Monetary assets and liabilities are things with a clear, fixed value—think cash, overseas bank accounts, accounts payable, and accounts receivable.
- For non-monetary assets and liabilities that were purchased in a foreign currency, use the exchange rate in effect on the original purchase date. Non-monetary assets and liabilities are things that aren’t easily to converted into cash—think property and equipment.
How to record a foreign currency transaction
An example will help show how these principles might play out in real life.
Step 1: Record the value of the transaction on the purchase or sale date
Let’s say you own a US-based company selling marble sculptures. A German hotelier buys a bust of Beethoven for 2,500 euros. That day, the euro is trading at 1.2 US dollars.
To translate 2,500 euros into US dollars, you do the following calculation:
2,500 x 1.2 = 3,000
So you would record the transaction as 3,000 US dollars in your records. Here’s how that would look:
It’s also a good idea to add a note that the original price was 2,500 euros, so you can refer back if necessary.
So far so good.
Step 2: Calculate the value of the payment when the transaction settles and record the loss or gain
Now let’s say that the hotelier pays you two weeks later. The exchange rate has changed over the past 14 days; now the euro is now worth 1.3 USD. To translate the payment, you calculate:
2,500 x 1.3 = 3,250
The payment is worth 3,250 US dollars. Thanks to exchange rate fluctuations, you just made an additional $250 (nice!). Here’s how you’d record this gain:
When it’s time for financial reporting
When you sit down to prepare your financial statements at the end of a period, use the exchange rate on your balance sheet to translate any assets and liabilities listed in a foreign currency.
That includes accounts payable and accounts receivable. If the exchange rate has changed between the transaction date and the balance sheet date, you’ll post the changes as income (if it’s a gain) or an expense (if it’s a loss).
A reminder: when you’re calculating foreign exchange gains or losses, it’s important to double-check that they are the result of a change in the value of the currency—and not discrepancies or fees that should be caught when you’re doing bank reconciliations.
Think about hiring a pro
Foreign currency accounting can be finicky. When you start to expand into other countries, it’s a good time to assess whether you want to get help with your books.
A bookkeeping service (like Bench), an experienced accountant, or a tax professional can guide you through the nitty-gritty details. They can also offer advice on how your international operations affect your tax situation—and they may even be able to find a few ways to lower your foreign exchange risk.