First in an ongoing series of accounting lessons for small businesses and freelancers.
If you ever bill in a foreign currency, here are some things to look out for:
The simplest foreign currency transactions are those where you receive payment at the same time as you create an invoice -- or if you do an on-the-spot transaction where your customer pays you right when you deliver a product or service. Just accept the payment in the foreign currency, find the correct exchange rate, convert the amount, and enter the amount into your accounting application in your native currency. In Wave it's even easier: We update global exchange rates daily, so you can just enter amounts in the foreign currency you used. For instance, even if you do your accounting in U.S. dollars but you received a payment in Euro, you can just enter the Euro value and Wave will look after the conversion. (You can also override the exchange rate if you want to.) Things get trickier if your invoice and its payment happen on different days. The issue here is that the exchange rate will likely have changed over time. Let me break down the steps to reveal the problem. For the sake of the illustration, let's say you usually deal in U.S. dollars, but this invoice is in Euro; and let's pretend you send the invoice on November 1.
- On November 1, the same day you send the invoice, you enter the income into your accounting application. To do this, you convert the invoice amount from Euro to U.S. dollars. Let's pretend the the exchange rate is 1.38.
- Your client takes 30 days to pay. By the time they pay (in Euros) the exchange rate has changed. Let's say 1.32.
- You convert the payment into U.S. dollars and deposit it into your bank account. But because the exchange rate has changed, the amount you deposit on December 1 is different from the amount you entered on November 1.
- To account for the difference, you need to enter a Gain or Loss on Foreign Currency transaction. (Where you find this depends on your accounting application.) If you deposit more than you originally invoiced, it's a Gain. If you deposit less than you originally invoiced, it's a Loss.