Best Practice for Converting Currency for Historical Financial Statements?
Let's say I want to value a company, whose financial statements are reported in Brazilian Reals. I want to convert the numbers into $USD. When I go back to historical financial statements and do the conversion, should I be using the current exchange rate for all the historicals, or use a different exchange rate each year (such as the year end exchange rate)? Which one is better for the purpose of valuation?
Depends on how you are valuing the company. Low inflation and medium inflation uses the year end rate only.
High inflation? This is an extremely general overview but US GAAP is similar to number 1, IFRS is similar to 2. I'm sure you can see why. The McKinsey valuation guide has an example of this.
1)
-Look at a company's filings and their annual report will list the currency rate for the last year in most instances if they actively trade in the U.S. Places to find it include text about dividends, derivatives, options, etc... If they supply another currency quote then use the dollar rate which coincides with the date in the currency they use.
-If they make an assumption about currency rates in the 10-k just copy it, don't try to work it out on your own. They might be using a rate from the middle of the year due to their fiscal calendar for example.
2)
-For simple comparisons on a superficial level just do everything in the home currency and then convert that to today's figures. The only caveat is here you can use the year end rate.
Use the average rate across the year in question. The cash flows didn't all come in at year end, and they definitely didn't come in today. These are historic snapshots of a company, not "well if this happened today at today's rates this is what it would look like...."
Why wouldn't you just value it in BRL and then apply today's rate to the valuation? I haven't read the McKinsey valuation book so I could be off here, but the only reason I can think of to use historical rates is to look at historical relative valuation against US comps or something. But if you just want valuation today shouldn't it just be the BRL valuation times the current spot rate?
You need the historical rates so that you have a proper starting point. Your Jan 2015 starting numbers depend on the December 2014 numbers being correct. You're 2014 statements depend on that rate to be correct. If you just take today's rate, you'll be inserting a number that has nothing to do with what they could have converted everything at. (Unless it happens to equal the average of 2014) for value of assets today you could use today's rate, but for year over year ratios you'll need the historical rate.
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