Functional currency is the currency which is used in the business operations of a company. Usually, a company uses the legal tender of the country where it centers its operations as a functional currency. This is different from presentation or reporting currency, the currency used in the company's financial reports. In accounting it is not uncommon for a firm to use the same currency for functional and presentation currency.
A company which does business in Germany, generating the bulk of its income in Germany and spending most of its money there, would use the currency of Germany as its functional currency. However, the company might, for example, report its earnings in United States Dollars even though the Euro is its functional currency. In cases where companies are subsidiaries of foreign firms, sometimes the functional currency of the parent firm is considered the currency of the daughter firm.
Many international firms do business in a wide variety of currencies, but they have a currency which they prefer to use and in which most of their expenses and income are generated. Thanks to differing exchange rates and economic pressures, there may be time when a company's functional currency is weaker or stronger in contrast with other currencies. Some companies in fact make a business out of manipulating differences in exchange rates to generate income by buying and selling in various foreign currencies.
The country in which a company does most of its business is sometimes referred to as the primary environment. The legal tender of a company's primary environment is most commonly used as its functional currency. A company doing business in Australia, for example, would use Australian Dollars as its functional currency even if it also accepted and made payments in other currencies when dealing with international customers.
When a company's functional and reporting currency differ, it is important to be aware of this while examining financial reports. During the conversion from one unit of currency to another, various problems may be covered up. Although this is not intentional, it can mean that a company's public disclosures are not an entirely accurate reflection of its finances as a result of differing exchange rates. Because exchange rates also fluctuate, reports can provide an incomplete picture of what is going on inside the company, depending on when the report was generated and how the conversion was calculated by the accounting team.
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.