What Is Transaction Currency?

In international business, transaction currency is the original currency in which a transaction takes place. While that sale or expense may have to be converted into dollars, euros, or yen for the books back at company headquarters in the United States, Europe, or Japan, recording the initial value is a critical enabler of foreign exchange risk management.

What Is Transaction Currency?

Transaction currency captures the value of an overseas transaction at the very moment it happens. Yet, payment may not be due for another 30 days or more, and the transaction may not hit a company’s accounting books for weeks. In the meantime, the value of the currency used in the transaction may fluctuate relative to the company’s main currency (variously known as functional currency, base currency, or reporting currency). So, that sale or expense may gain or lose value in the timing gaps between transaction, payment, and financial reporting.

This is why transaction currency is important to financial reporting, managing foreign exchange exposures, and compliance with Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards. It’s the starting point for calculating foreign exchange gains or losses and, therefore, for accurate cash flow forecasting, especially when currency exchange markets become volatile.

Transaction Currency Explained

To manage foreign exchange risk, companies seek to minimize potential losses due to exchange rate fluctuations from the time of a sale to the time of payment using hedging strategies, such as currency futures or forward contracts. Either of these would aim to cover any potential loss by enabling the purchase of the transaction currency at a predetermined exchange rate, for settlement when payment for the goods sold comes due. Other hedging strategies include simply using the same overseas currency for both receivables and payables in a particular country, negotiating earlier payment or currency adjustment clauses in sales contracts, and creating overseas bank accounts in the local currency to avoid immediate conversion to a company’s functional currency.

Simplify Multicurrency Management With NetSuite

Businesses can use NetSuite’s accounting software to record, convert, and analyze the transaction currency of overseas sales and expenses relative to the business’s functional currency at headquarters. Among its strengths, NetSuite software mitigates currency conversion risks by automating the entire workflow. Foreign currency transactions recorded by subsidiaries are simultaneously posted at headquarters in the appropriate currency and with the current exchange rate. The automatic recording of currency gains and losses further enhances the precision of foreign exchange risk management.

Understanding and accurately recording transaction currency is a fundamental step for any company doing business abroad. This initial recordkeeping task becomes the basis for managing subsequent fluctuations in foreign exchange rates and assessing overseas operations. With currency volatility reaching new heights, companies that become fluent in converting their subsidiaries’ transaction currencies into their headquarters’ base currency can make informed assessments, mitigate risk, and improve performance in their international business.