What it means
Any group that earns money abroad has to convert those earnings into its reporting currency. If the dollar strengthens, the same volume of euro or yen sales converts into fewer dollars, and reported revenue falls even though nothing went wrong in the business.
Constant currency reporting removes that noise. The current period's local currency results are recalculated using the prior period's exchange rates, so the only thing left driving the change is trading performance.
The measure is presented alongside the reported figures, never instead of them, because it is not a statutory number. Reported revenue is what actually landed in the bank; constant currency revenue is a management view of underlying performance.
Used well, it separates two very different problems. Falling reported revenue with rising constant currency revenue is a currency issue that may reverse on its own, whereas both falling together is a trading issue that will not.
The scepticism it attracts is worth understanding. Currency effects are highlighted enthusiastically when they hurt and mentioned quietly when they help, so a company that only ever quotes constant currency growth in bad years deserves a closer look.
In practice
Real-world examples.
Example
A luxury goods group reports flat revenue after a year in which its home currency strengthened sharply. On constant currencies, sales grew 9%, and the chief executive spends most of the results presentation making that distinction.
Example
A software company with 60% of sales outside its home market sets internal sales targets in constant currencies. Regional managers are measured on what they can control, and the treasury team is measured separately on how well the currency exposure was hedged.
Example
An engineering group reports 14% growth, of which 5 percentage points came from a weakening home currency. An analyst strips it out, finds underlying growth of 9%, and lowers a price target that had been set on the headline figure.
Formula
Calculation
Constant currency revenue = current period local currency revenue x prior period exchange rate
Constant currency growth % = (constant currency revenue - prior period reported revenue) / prior period reported revenue x 100
A US group has a European division. Last year it earned EUR 50,000,000 at an average rate of $1.20 per euro, which converted to $60,000,000. This year it earned EUR 55,000,000, but the average rate has fallen to $1.08, so it converts to EUR 55,000,000 x 1.08 = $59,400,000.
Reported growth is therefore ($59,400,000 - $60,000,000) / $60,000,000 x 100 = -1%, a decline. On a constant currency basis, this year's EUR 55,000,000 is translated at last year's $1.20, giving EUR 55,000,000 x 1.20 = $66,000,000, so growth is ($66,000,000 - $60,000,000) / $60,000,000 x 100 = 10%. The currency movement cost 11 percentage points of growth.
At group level the effect gets diluted. The US division grew from $140,000,000 to $154,000,000, so group revenue went from $200,000,000 to $154,000,000 + $59,400,000 = $213,400,000, reported growth of 6.7%. On constant currencies, group revenue would have been $154,000,000 + $66,000,000 = $220,000,000, or 10% growth, which is the number management will lead with.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Redhill Optics, an invented lens manufacturer based in the United States, earned roughly 30% of its revenue in euros. In one difficult year its European division grew local sales from EUR 50,000,000 to EUR 55,000,000 while the euro fell from an average of $1.20 to $1.08, turning a 10% local gain into a $600,000 reported decline.
The invented board's first instinct was to blame the European sales director, whose bonus was tied to reported dollar revenue. The finance director showed that at constant currencies the division had delivered $66,000,000 against $60,000,000, and that the entire shortfall was translation rather than trading.
Redhill made two changes as a result. Divisional bonuses moved to constant currency targets so that managers were judged on what they could influence, and the treasury function took on a rolling hedge covering roughly half of forecast euro revenue, which narrowed the gap between reported and underlying growth in later years.
Watch out
Common mistakes.
- Treating constant currency figures as the real results, when reported figures are the audited numbers and constant currency is a management adjustment.
- Only quoting constant currency growth in years when currencies moved unfavourably, which quickly costs a management team credibility.
- Confusing translation effects with transaction effects, since the first is an accounting conversion and the second is a genuine cash impact on costs and prices.
Questions
People also ask.
Is constant currency reporting audited?
The underlying figures are, but the constant currency presentation itself is a non-statutory measure, so the method and the rates used should be disclosed clearly.
Does hedging remove the need for constant currency reporting?
No, because most hedging protects cash flows and contracted transactions rather than the translation of overseas results into the reporting currency.
What rate should be used for the prior period?
The prior period's average rate for income statement items, so that both periods are translated on a consistent basis rather than at a single spot rate.
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