What is gain or loss on foreign exchange?

Dealing with foreign currency is a part of the normal course of business. The exchange rate of currencies is always fluctuating and as a result, the exact amount you pay or receive might be different from the original amount of an invoice.

To better illustrate this difference, let's assume that your company uses Euros as the main currency and you are sending an invoice to one of your clients in the US. You might send the invoice using the currency of your client to facilitate their timely payment which in this case, you send the invoice in USD rather than EUR.

The invoice has a total value of $10,000 and is issued on the 1st of March. Even though the invoice is sent using USD, we have to record the sales in our books using EUR. Based on the exchange rate of USD to EUR on March 1st, we recorded a sale of €9,300 in our books.

Your client has 30 days to clear the invoice and on the 28th of March, they wire the $10,000 to your bank account. However, since the date you issued the invoice, Euros have lost its value against USD and the amount you received is now €9,150.

You initially expected to receive 9,300 but due to the fluctuations in currency exchange rates, you have now received 9,150 which is 150 lower than the original sales. At this time, your total actual sales are 9,150 and to balance the books, the missing 150 is registered as a “Loss on foreign exchange”. This way the loss on foreign exchange balances the higher expected sales in your books.

In the opposite scenario, you may receive a higher amount than expected. So instead of receiving €9,300 as expected while issuing the invoice, you have received €9,400. In this case, you are making €100 more than the recorded sales value. To balance the books, the extra 100 is registered as “Gain on foreign exchange”.

These gains or losses are not accounting records and reflect the actual gain or loss you have incurred during the transaction and have a real impact on your cash flow. However, the value of the product or service you have sold has not changed. Using the previous example, you have sold EUR 9,300 worth of products/services and have received a lower or higher amount due to the fluctuations in currency exchange rates.

Recording the difference of currency exchange as gain or loss on foreign exchange is necessary as making a clear distinction between your sales performance and currency fluctuation is quite important.

If you incur a loss due to currency fluctuation, your product/service has not become less profitable or desirable, and if, on the other hand, you incur a gain, your product/service has not become more profitable or desirable. Your business fundamentals are unchanged. Your product/service is as profitable and desirable as before and the difference in your cash flow is solely based on factors outside your control.

More importantly, if you are dealing with a currency that is continuously losing its value such as the Turkish Lira, the foreign exchange records help you, to some degree, anticipate the changes in the exchange rate.

While preparing the income statement, the gain/loss on foreign exchange is registered as an operating profit/expense as they occur as the result of core operations.

How our Archive module manages the gain/loss on foreign exchange for you

While using the Archive module of Vieolo, we automatically manage the calculation and the record of the discrepancies of currency exchanges.

If you are issuing an invoice or have received an invoice in another currency, all you need to do is select the currency of the invoice while saving the Archive entry. Vieolo will automatically convert the total amount of the invoice to the currency of your workspace and record the corresponding journal entries.

After the invoice is paid, you can record the payment on the entry page. When recording the payment of the invoice, the exchange rate used by Vieolo is displayed and you can edit it to match the actual exchange rate used for the payment.

If the final payment, after the exchange, is different than the initial invoice amount, the difference is automatically recorded as gain/loss on foreign exchange. The foreign exchange entry is then automatically reflected in your income statement.