From the Multinational Operations (Reading #19), I’m having a hard time figuring out the appreciation vs depreciation effects on Financial Ratios when dealing with Current Rate Method and Temporal Rate method.
I understand on which type of rate to use (e.g., historical, average, or current rates), but I always get hung up on the FX change when the foreign currency is appreciating or depreciating.
At the moment, I’m finding it difficult to organize the thought process in my mind when the FX changes when trying to figure out how it affects the financial ratio. When trying to figure out whether the ratio will increase or decrease, is there a ‘simple rule of thumb’ to help remember this?
For Example:
The Fixed Asset Turnover ratio = (Revenues)/(Fixed Assets)
Under the Temporal method vs Current Rate here are the effects:
*Assuming the foreign currency is depreciating*
-Revenues is converted at the average rate under both methods (so lets set that aside since it doesn’t matter, both Temporal or Current Method will result in the same amount when converted to USD from the foreign currency, lets call it FX for now).
-Fixed Assets will be higher under Temporal Method (why?), therefore the FA Turnover ratio will be lower due to higher denominator.
**Here is the confusion: If the FX currency is DEPRECIATING, would that mean the FX currency is converting to LESS us dollars? so wouldn’t fixed assets be lower, and resulting in the ratio to become higher? Based on the reasoning in the schweser notes, this is not the case. Is the FX rate shown as FX/USD or USD/FX when converting from FX to USD? is FX always the base currency (USD/FX) when dealing with FX conversions?
Please help!