Exchange rate

What it means

An exchange rate is the price of one currency expressed in another, such as how many dollars, crowns or zlotys one euro costs. It is set on foreign exchange markets by supply and demand and changes continuously under the influence of interest rates, inflation, the trade balance and investor expectations.

Banks quote buying and selling rates, with a spread between them from which the bank earns, and a mid rate. For accounting and tax in Slovakia, the reference exchange rate set and published by the European Central Bank or the National Bank of Slovakia is used, the ECB reference rate.

For companies trading in foreign currencies, the exchange rate directly affects margins. If a Slovak company sells in dollars and the dollar weakens, it receives fewer euros for the same invoice. This uncertainty is called currency risk and can be managed with various tools.

How it works in practice

Foreign currency transactions are translated into euros at the ECB reference rate valid on the day before the transaction, or at a fixed rate set by internal policy. The rules for foreign currency translation must be chosen and applied consistently.

When an invoice is paid at a different rate from the one at which it was booked, an FX difference arises. At the reporting date, receivables, payables and cash in foreign currency are retranslated at the closing rate and the difference is booked to income or expense.

Companies with regular foreign currency income or expenses can reduce risk through natural hedging, paying and collecting in the same currency, by keeping a foreign currency account or by entering into a forward contract that fixes the rate for a future transaction.

What to watch out for

A bank's conversion rate can be much worse than the reference rate. For larger amounts it pays to compare banks and payment services, as the difference in spread on annual volumes can amount to thousands of euros that never appear as a fee.

For VAT, the tax base in a foreign currency is translated at the rate valid on the date the tax liability arises, not the payment date. Differences between the VAT rate and the accounting rate are common and must be captured correctly so that the control statement and the accounting balances agree.