Notes to the financial statements
For the 52 weeks ended 1 March 2008
4. Financial risk management
Financial risk factors
There are a number of financial risks and uncertainties which could impact the performance of the Group: market risk (foreign exchange and interest rate risk), credit risk and liquidity risk. The Group operates a structured risk management process which identifies, evaluates and prioritises risks and uncertainties.
The Group’s treasury function seeks to reduce exposures to foreign exchange, interest rate and other financial risks, and to ensure sufficient liquidity is available to meet foreseeable needs and to invest cash assets safely and profitably. Policies and procedures are subject to review and approval by the Board of Directors as well as subject to audit review.
Market risk – foreign exchange risk
The Group operates internationally and is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the US dollar and the euro. Foreign exchange risk arises from future commercial transactions, recognised assets and liabilities and net investments in foreign operations.
To manage the foreign exchange risk arising from future commercial transactions and recognised assets and liabilities, entities in the Group use forward contracts, transacted with external banks. Foreign exchange risk arises when future commercial transactions or recognised assets or liabilities are denominated in a currency that is not the entity’s functional currency.
Group Treasury is responsible for managing the net position in each foreign currency by using external forward currency contracts. The key objective of the Group’s foreign exchange transaction exposure management is to minimise potential volatility in profits which could arise as a result of exchange rate fluctuations whilst maintaining an appropriate competitive stance.
To achieve the above objectives, the Group will initially seek to hedge up to 90% of any foreign exchange transaction risks expected to arise as a result of uncertain, but probable, foreign currency cash flows up to one year forward. This subsequently increases to 100% as cash flows become certain. Probable cash flows for this purpose will be considered for hedging once included within rolling 12 month forecasts.
For segment reporting purposes, each subsidiary designates contracts with Group Treasury as fair value hedges or cash flow hedges, as appropriate. External foreign exchange contracts are designated at Group level as hedges of foreign exchange risk on specific assets, liabilities or future transactions on a gross basis.
The cash flow hedges are intended to hedge the foreign currency exposure of future purchases of inventory. Weekly reports are made to management to demonstrate that this objective is being reached. The hedged cash flows are expected to occur up to one year into the future and will be transferred to the consolidated income statement or inventory carrying value as applicable. The Group has foreign operations whose net assets are exposed to foreign currency translation risk. Currency exposure arising from the net assets of the Group’s foreign operations is not hedged.
If the UK pound had weakened/strengthened by 5 cents (approximately 2.5%) against the US dollar as at 1 March 2008, with all other variables held constant, post-tax profit would have been unchanged (2007: unchanged). Equity would have been £5.3m (2007: £5.0m) higher/lower, arising mainly from the revaluation of US dollar forward currency contracts.
If the UK pound had weakened/strengthened by 5 cents (approximately 3.8%) against the euro as at 1 March 2008, with all other variables held constant, post-tax profit would have been £2.6m (2007: £0.8m) lower/higher, mainly as a result of foreign exchange losses/gains on translation of sterling-denominated cash balances in subsidiary companies with euro functional currency. Equity would have been £0.3m higher/lower (2007: £3.0m), arising mainly from foreign exchange gains/losses on translation of euro-denominated net assets held by subsidiary companies with euro functional currency.
Market risk – cash flow and fair value interest rate risk
Whilst the Group’s Financial Services business has gross instalment receivable balances on fixed interest rates and floating rates, the Group’s income and operating cash flows are still considered to be substantially independent of changes in market interest rates.
The Group maintains a portfolio of cash and borrowings which can result in either a net cash position or a net debt position.The Group currently holds a net cash position with no borrowings.
The Group’s interest rate risk arises from any future long-term borrowings that it may incur. Borrowings issued at fixed rates expose the Group to fair value interest rate risk. The principal objective of the Group’s interest rate risk management is to manage the trade-off between obtaining the most beneficial effective rates of interest whilst minimising the impact of interest rate volatility on profits before tax. The aim will normally be to manage interest rate risks by achieving a ratio of between 30% and 70% of net debt fixed rate.
If the Group were to incur long-term borrowings it would manage its cash flow interest rate risk by using fixed-to-floating interest rate swaps. Such interest rate swaps would have the economic effect of converting borrowings from fixed rates to floating rates. Under the interest rate swaps, the Group would agree with other parties to exchange, at specified intervals (mainly quarterly), the difference between fixed contract rates and floating-rate interest amounts calculated by reference to the agreed notional principal amounts.
At 1 March 2008 the Group had no borrowings. At 3 March 2007 if interest rates on pound-denominated borrowings had been 10 basis points higher/lower with all other variables held constant, post-tax profit for the period would have been £0.2m lower/higher, mainly as a result of higher/lower interest expense on floating rate borrowings; other components of equity would not be affected by such a change in interest rates because gains and losses are not recognised directly in equity, but released directly to the income statement.
Credit risk
The Group has no significant concentrations of credit risk. It has policies in place to ensure that sales of financial services products are made to customers with an appropriate credit history. Sales to retail customers are made in cash, via major credit cards or via in-house operated financial products.
The Group’s exposure to credit risk with regard to treasury transactions is managed by dealing only with banks and major financial institutions with credit ratings of at least AA-(Standard & Poor’s) or Aa1 (Moody’s) and within a limit of £100m set for each organisation. Foreign exchange counterparty limits are set at £20m for each organisation. Dealing activity is closely controlled and counterparty positions are monitored daily.
Liquidity risk
Home Retail Group manages its cash and committed bank borrowing facilities to maintain liquidity and funding flexibility. Liquidity is achieved through arranging funding ahead of requirements and maintaining sufficient undrawn committed facilities to meet short-term needs. At 1 March 2008, the Group had undrawn committed borrowing facilities available of £700m which expire in 2012. This facility attracts fixed charges and includes a covenant that borrowing cannot exceed 1.5 times earnings before interest, tax, dividends, amortisation and rent. These facilities are in place to enable the Group to finance its working capital requirements and for general corporate purposes.
Group policy is that all other cash is invested either in AAA overnight funds or fixed term deposits with banks rated AA-or higher. Unlimited amounts with a maturity of up to one year may be invested with sign off from the finance director but the Board may approve an investment with an unlimited duration.
The table below analyses the Group’s financial liabilities and derivative financial liabilities into relevant maturity groupings based on the remaining period at the balance sheet to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows. Balances due within 12 months equal their carrying balances, as the impact of discounting is not significant.
| At 1 March 2008 | Less than 3 months £m |
3-6 months £m |
6-9 months £m |
9-12 months £m |
Total £m |
|---|---|---|---|---|---|
| Unsecured bank loan | – | – | – | – | – |
| Other borrowings | – | – | – | – | – |
| Fair value hedge | – | – | – | – | – |
| Trade and other payables | (596.6) | – | – | – | (596.6) |
| At 3 March 2007 | Less than 3 months £m |
3-6 months £m |
6-9 months £m |
9-12 months £m |
Total £m |
|---|---|---|---|---|---|
| Unsecured bank loan | – | (222.6) | – | – | (222.6) |
| Other borrowings | – | (0.9) | – | – | (0.9) |
| Fair value hedge | – | (0.5) | – | – | (0.5) |
| Trade and other payables | (530.5) | – | – | – | (530.5) |
When a forward foreign exchange contract matures, this requires an outflow of the currency being sold and an inflow of the currency being bought. The table below analyses the Group’s outflow and inflow from derivative financial instruments into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows. Balances due within 12 months equal their carrying balances, as the impact of discounting is not significant.
| At 1 March 2008 | Less than 3 months £m |
3-6 months £m |
6-9 months £m |
9-12 months £m |
Total £m |
|---|---|---|---|---|---|
| Forward foreign exchange contracts – cash flow hedges | |||||
| – outflow | (256.6) | (200.9) | (86.1) | – | (543.6) |
| – inflow | 256.7 | 201.1 | 83.9 | – | 541.7 |
| At 3 March 2007 | Less than 3 months £m |
3-6 months £m |
6-9 months £m |
9-12 months £m |
Total £m |
|---|---|---|---|---|---|
| Forward foreign exchange contracts – cash flow hedges | |||||
| – outflow | (294.0) | (143.4) | (118.8) | (22.8) | (579.0) |
| – inflow | 291.0 | 142.9 | 120.3 | 22.9 | 577.1 |
Capital risk management
The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders or issue new shares. The Group finances its operations through a combination of retained profits, bank borrowings and property leases. The Group has significant liabilities through its obligations to pay rents under property leases. The Group, in common with the credit rating agencies, treats its lease liabilities as debt when evaluating financial risk and investment returns. The Group’s net debt varies significantly throughout the year due to trading seasonality.
Foreign currency
The principal exchange rates used were as follows:
| Average | Closing | |||
|---|---|---|---|---|
| 52 weeks ended 1 March 2008 |
Short period ended 3 March 2007 |
52 weeks ended 1 March 2008 |
Short period ended 3 March 2007 |
|
| US dollar | 2.00 | 1.90 | 1.99 | 1.94 |
| Euro | 1.43 | 1.48 | 1.31 | 1.48 |
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