Rohit Jain Simple Finance : Constant Currency Mechanism

One of the most widely used tool in financial analysis of a company and what is its significance in current economic scenario?

Problem: If a company has significant share of its revenue and expenses from foreign currency, how to determine its actual % change YoY or any period?

Solution: Use constant currency mechanism

What is constant currency?

A method where conversion rate of a foreign currency is made constant.

Let us understand this by an example!

Year 1: S company earned €10,000 revenue. The average conversion rate for the year was ₹/€ 80.

Now,

Year 2: S company earned the same €10,000 revenue, but the conversion rate for year was ₹/€ 84.

Now, Revenue (in INR) = 840,000 [ €10000*₹84].

If we compare Year 1 vs Year 2 in absolute terms;

Revenue growth= +5% YoY. (10000*(84-80)*100//800000)

But, the revenue growth achieved is the function of entity's operational efficiency? Definitely not!
It is because of currency fluctuations!

To resolve this problem, most of the analysts and company executives use constant currency approach.

Considering the above example, if we use constant currency approach, the result will be as under:

Year 1- Revenue= ₹8,00,000.
Year 2- Revenue= ₹8,00,000. [ €10,000* ₹80]

Wonder how? In year 2 we use year 1 conversion rate to determine the actual growth of revenue over year 1.

If we notice, using constant currency approach mitigates the effect of forex fluctuations, thereby facilitating effective comparison period over period.

Usually, constant currency approach figures are not available in the financial statements of the entity!

They are usually available in:
1. Management commentary
2. Concalls
3. Investor presentations
4. Press releases etc.