Base Currency Defined

Companies no longer need to physically operate internationally to find themselves dealing with multiple currencies and the resulting fluctuations in value of their overseas payables, receivables, and other finances. At times when currency exchange rate volatility is on the rise, a company’s base currency provides a touchstone for quantifying and managing its foreign exchange risk.

Base currency is the primary currency in which a company conducts business operations, maintains accounting records, and prepares financial statements. Business done in any other currency must be converted back into the base currency. Therein lies a challenge: Exchange rates can change rapidly, affecting everything from profitability to the reported values of foreign assets to quarterly shareholder reports and stock prices.

What Is Base Currency?

Base currency is also known as functional currency in accounting standards and as reporting currency when the time comes to produce official financial statements. While all three may be the same currency, “base” tends to be the term favored by foreign exchange traders and in the software programs used in accounting. The very word conveys its significance: A company’s base currency is typically the official currency in its home base as well as being the basis for consolidated financial record-keeping and risk management. As such, the transaction currencies used in its various overseas subsidiaries and business transactions must continually be converted into its base currency. A key benefit of this conversion is that the base currency provides a more consistent benchmark for evaluating the performance of different international operations.

Base Currency Explained

For a US-based company with overseas business—typically using the dollar as its base currency—dollar volatility complicates accounting. Timing is tricky, since values can change between the date of a transaction and the date it’s paid, or between the transaction date and the balance sheet date at the end of an accounting period.

For instance, a European subsidiary would most likely use the euro as its base currency, recording a transaction on the day it occurs. Consolidation into the books at US headquarters could take weeks or longer after the transaction. At that time, balance sheet items related to the transaction, such as assets and liabilities, would be translated from euros into dollars at the exchange rate in effect as of the date on the balance sheet. In the interim, the dollar-to-euro exchange rate could have changed, causing a gain or a loss. Looking at other finances, the US parent’s income statement would include any European revenues converted to dollars at the average exchange rate for the fiscal period being covered, whether a month, quarter, or year. And European equity would be translated at historical rates, based on when equity was issued. Under Generally Accepted Accounting Principles (GAAP), most such differences are recorded in the company’s “cumulative translation adjustment” account on its balance sheet, so that financial statements remain balanced despite currency fluctuations and varying translation methods.

The main challenge any time a company deals in multiple currencies is to avoid losses from currency exchange rate changes. To mitigate these risks, companies use hedging strategies, such as forward contracts that lock in a fixed exchange rate for future foreign transactions. This ensures that currency fluctuations during payment delays don’t lead to losses, as the rate is secured in advance. Another challenge is the sheer complexity of accounting amid currency volatility, which ever-more-powerful accounting software helps to automate and streamline.

Managing foreign currencies has become an urgent issue in international business, as currency exchange rate volatility grows. But that volatility also makes foreign currency management more complex. At the core of this conundrum is a company’s base currency, into which all foreign activities eventually need to be translated. Handled well, base currency translations can provide much-needed clarity, alert business leaders to potential foreign exchange risk, improve financial reporting, and support decision-making.