Notes to the financial statements

for the year ended 31 March 2012

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28 Financial instruments and risk management

The Group’s principal financial instruments during the year comprised bank loans, cash on short-term deposits, interest rate swaps and forward foreign exchange contracts. The main purpose of these financial instruments is to finance the Group’s operations, to manage the interest rate risk arising from its sources of finance and to minimise the impact of fluctuations in exchange rates on future cash flows. The Group has various other financial instruments such as short-term receivables and payables which arise directly from its operations.

The Group regularly reviews its exposure to interest, liquidity and foreign currency risk. Where appropriate the Group will take action, in accordance with a Board approved Treasury Policy, to minimise the impact on the business of movements in interest rates and currency rates.

The Group only enters into derivative instruments with members of the banking group to ensure appropriate counterparty credit quality.

Liquidity risk

The Group keeps its short, medium and long-term funding requirements under constant review. Its policy is to have sufficient committed funds available to meet medium-term requirements, with flexibility and headroom to make minor acquisitions for cash if the opportunity should arise.

The Group’s bank facilities comprise a multi-currency revolving credit facility of £200.0 million, provided by a group of six core relationship banks. The facility matures in July 2015. The Group considers that this facility will provide sufficient funding to meet the organic investment needs of the business. In addition, short-term flexibility of funding is available under the £10.0 million overdraft facility provided by the Group’s clearing bankers.

The net debt position of £82.0 million at the beginning of the financial year has decreased during the year to net debt of £75.3 million. The Group generated positive cash flow from its operating activities after capital expenditure of £34.8 million for the year (2011: £54.1 million).

The table below analyses the Group’s financial liabilities which will be settled on a net basis into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. Notional interest is included for the period from the year end up to the contractual maturity date of the debt, calculated on the amount of debt drawn down at the year end.

Less than
one year
£’000
One to
three years
£’000
Over
three years
£’000
At 31 March 2011
Borrowings 6,090 7,519 95,013
Finance leases 392 135
Trade and other payables 142,636
Cash flow hedges 3,703
Total 152,821 7,654 95,013
At 31 March 2012
Borrowings 3,075 6,150 86,025
Finance leases 136
Trade and other payables 143,998 388
Cash flow hedges 17 12 3,736
Total 147,226 6,550 89,761

The table below sets out the year-end fair value of derivative financial instruments by category:

2012 2011
Assets
£’000
Liabilities
£’000
Assets
£’000
Liabilities
£’000
Interest rate swaps – cash flow hedges 3,736 3,638
Forward foreign exchange contracts – cash flow hedges 29 65
Total 3,765 3,703
Less non-current portion:
Interest rate swaps – cash flow hedges 3,719
Forward foreign exchange contracts – cash flow hedges 29
3,748
Current portion 17 3,703

Interest rate risks

Sterling interest rate swaps were held during the year that fixed approximately 80% (2011: 98%) of the year-end net debt. The weighted average fixed interest rate payable was 4.90% (2011: 5.5%). The weighted average rate of current interest rate swaps in place at the year end was 2.71%, based on new interest rate hedging arrangements from 5 January 2012, on £60.0 million of debt. Maturity dates of the current interest rate swaps are all July 2015 and reflect the forecast profile of net debt over the period. The weighted average period over which the interest rates are fixed is 3.3 years (2011: 0.8 years). Interest rate exposures will continue to be hedged in accordance with the Treasury Policy.

The impact of an increase in interest rates of 100 basis points is shown in the following table:

2012
£’000
2011
£’000
Reduction in profit before tax (154) (9)
Increase in fair value of derivatives taken to equity (2) (9)

The sensitivity of profit before tax is calculated based on floating rate borrowings at the balance sheet date, after deducting floating rate financial assets and amounts hedged into fixed rates by interest rate swaps.

Foreign currency risk
Cash flow exposure

The Group’s only major foreign currency risk arises due to the purchase of equipment invoiced in US Dollars. Whenever possible the Group resells this equipment in US Dollars. The remaining exposure is managed principally through the use of forward foreign exchange contracts in order to minimise the impact of fluctuations in exchange rates on future cash flows and gross margin.

The Group has also some Euro cash flows but these are not material on a net basis and are not hedged.

Net asset exposure

The Dollar denominated trading described above results in a balance sheet exposure since debtor days are longer than creditor days. It is the Group’s policy not to hedge this exposure. If Sterling strengthened by 5% against both the US Dollar and the Euro this would reduce net assets at the balance sheet date by £134,179 (2011: reduced by £Nil).

Credit risk

Credit risk arises from cash and cash equivalents and derivative financial instruments, as well as credit exposures to business and retail customers.

Credit ratings of institutions which hold the Group’s financial assets are regularly monitored to ensure they meet the minimum credit criteria set by the Board through the Group Treasury Policy. At the year end all the institutions holding the Group’s financial assets were rated A-/A- or higher by Standard and Poor’s.

The credit quality of customers is assessed by taking into account their financial position, past experience and other factors. Individual risk limits are set and the utilisation of credit limits monitored regularly.

Currency and interest rate risk profile of financial assets and financial liabilities
Financial assets

The Group had financial assets of £8.3 million at the year end (2011: £6.5 million), comprising cash on overnight money market deposits and cash at bank. This attracts floating rates of interest.

The currency profile of the Group’s financial assets at 31 March 2012 and 31 March 2011 was:

2012
£’000
2011
£’000
Currency
Sterling 6,706 5,660
US Dollar 1,357 660
Euro 270 215
Total 8,333 6,535

Foreign currency cash balances are held on a short-term basis to fund cash flow requirements in these currencies.

At the year end £1.3 million (2011: £1.3 million) of cash collateral was held by Barclays in respect of a bank guarantee given under OFCOM’s ‘Funds for Liabilities’ regulations.

Financial liabilities

The currency and interest rate risk profile of the Group’s financial borrowings at 31 March 2012 and 31 March 2011 was:

2012 2011
Floating
£’000
Fixed
£’000
Total
£’000
Floating
£’000
Fixed
£’000
Total
£’000
Sterling 23,464 60,136 83,600 8,004 80,527 88,531

Undrawn committed borrowing facilities at the year end were £115.0 million (2011: £110.0 million).

Interest on amounts drawn under the committed borrowing facility is based on the relevant LIBOR plus margin.

Fair values of financial assets and financial liabilities

The mark to market value of the interest rate swaps and forward contracts at 31 March 2012 was a liability of £3.8 million (2011: liability of £3.7 million). Interest rate swaps are accounted for by adjusting the interest cost on the floating debt return. The fair value of financial assets and financial liabilities is obtained from third party sources. The movement in mark to market value is reflected in reserves and is shown below:

£’000
Hedging reserve
31 March 2011 (2,883)
Movement in the year (62)
31 March 2012 (2,945)

The effectiveness of the interest rate swaps was tested quarterly throughout the period, and at the year end, and all are considered to be effective cash flow hedges. There are no other significant differences between the fair value of the Group’s financial assets and liabilities and their book value.

IFRS 7 requires disclosure of fair value measurements by level of the following fair value measurement hierarchy:

All of the Group’s financial instruments fall into hierarchy level 2.

Capital risk management

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern, support the growth of the business and to maintain an optimal capital structure to reduce the cost of capital.

Consistent with others in the industry, the Group monitors capital on the basis of its gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (including ‘current and non-current borrowings’ as shown in the Consolidated balance sheet) less cash and cash equivalents.

Total capital is shown in the table below and is calculated as ‘equity’ as shown in the Consolidated balance sheet plus net debt.

2012
£’000
2011
£’000
Net debt 75,267 81,996
Total equity 73,457 73,194
Total capital 148,724 155,190

Under the Group’s £200 million revolving credit facility the Group is required to comply annually with certain financial and non-financial covenants. The Group is required to maintain a minimum interest cover ratio and a maximum net debt: EBITDA ratio. Both financial covenants were tested and complied with throughout the year and at the year end. The Board monitors both covenant compliance and net debt performance on a regular basis.

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