Currency depreciation refers to the decline of the price of one currency against another. If, for example, you could buy one euro for $1.11 a week ago but must pay $1.12 today, the dollar has depreciated against the euro. Such fluctuations in exchange rates significantly affect a wide range of companies. The effects can range from mild to dramatic depending on the product or service supplied by the business and the competitive landscape.
Input costs of any business selling imported goods will increase as a result of currency depreciation. Assume you run a dealership selling European cars and must send the manufacturer a check of 20,000 euros for a particular model. When the exchange rate is $1.11 per euro, the cost of the vehicle is $22,200. When the dollar weakens to $1.12, the cost will increase to $22,400. This means you either have to raise the price of the car or cut your profit.
Video of the Day
Exporters are in the opposite situation and will benefit from a depreciation of the home currency. If you are selling software to Europe for 50 euros per download, the price paid by European consumers will increase from $55.50 when the euro is at $1.11 to $56 as the dollar depreciates to $1.12 per euro. Such a business will earn 50 cents more per unit as a result of currency depreciation. The unexpected increase in profits due to currency fluctuations is often referred to as the translation effect.
Currency fluctuations can make or break businesses holding financial instruments denominated in other currencies. If the company is keeping some of its excess cash in foreign stocks or bonds or has them invested in certificates of deposit in another nation's currency, the exchange rate will proportionally redefine the net worth of these investments. A European stock changing hands for 100 euros will suddenly be worth more in dollars when the dollar depreciates. A large appreciation in the value of the dollar against the euro, however, can result in significant losses.
The Bigger Picture
Significant changes in exchange rates are almost always the result of significant changes in economic fundamentals. A currency rarely depreciates very much without a big swing in such factors as interest rates, unemployment levels or governmental budget cuts. The impact of these factors on the bottom line of a corporation can and often do override the currency's influence. Therefore, businesses must consider the big picture when building budgets or making income projections. A weakening currency is often the result of a weaker economy at home, which tends to eventually hit all domestic corporations.