Financial Statements

33. Financial risk management

The Company and Group's activities expose it to a variety of financial risks including: market risk (including foreign currency risk, fixed interest rate risk and cash flow interest rate risk), credit risk and liquidity risk. The Group's overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group's financial performance. The Group uses derivative financial instruments to hedge certain foreign exchange exposures.

Credit risk

Credit risk is managed on a Group basis. Credit risk arises from cash and cash equivalents, as well as credit exposures to Wholesale and to a lesser extent Retail customers, including outstanding receivables and committed transactions. For Wholesale customers, management assesses the credit quality of the customer, taking into account its financial position, past experience and other factors. For those sales considered higher risk, the Group operates a policy of cash in advance of sale. Sales to Retail customers are settled in cash or by major credit cards. The Group regularly monitors its exposure to bad debts in order to minimise exposure. Credit risk from cash and cash equivalents is managed via banking with well established banks with a strong credit rating.

Foreign currency risk

The Group's foreign currency exposure arises from:

  • transactions (sales/purchases) denominated in foreign currencies;
  • monetary items (mainly cash and borrowings) denominated in foreign currencies; and
  • foreign currency net assets of overseas operations.

The Group is mainly exposed to US Dollar and Euro currency risks. The exposure to foreign exchange risk within each Company is monitored and managed at a Group level. The Group's policy is to hedge a portion of foreign exchange risk associated with forecast overseas transactions, and transactions and monetary items denominated in foreign currencies. The Group's policy is to hedge the risk of changes in the relevant spot exchange rate. The Group uses forward contracts to hedge foreign exchange risk. As at 1 May 2011 and 2 May 2010, the Group had entered into a number of foreign exchange forward contracts to hedge part of the aforementioned translation risk. Any remaining amount remains unhedged.

Forward exchange contracts have not been formally designated as hedges and consequently no hedge accounting has been applied. Forward exchange contracts are valued at fair value.

At 1 May 2011 if the currency had weakened/strengthened by 10% against both the US Dollar and Euro with all other variables held constant, profit for the period would have been £0.7m (2010: £0.1m) higher/lower, mainly as a result of foreign exchange gains/losses on translation of US Dollar/Euro trade receivables, cash and cash equivalents, and trade payables.

In the prior year the Group entered into a currency agreement with a supplier to guarantee the supplier a minimum exchange rate on the Group purchases. This derivative was valued at fair value through the Group statement of comprehensive income.

The Group's foreign currency exposure is as follows:

1 May 2011 2 May 2010
US Dollar Euro US Dollar Euros
£m £m £m £m
Financial assets
Trade receivables 3.3 2.0
Cash and cash equivalents 5.1 0.6 1.5 0.2
Assets 5.1 3.9 1.5 2.2
Financial liabilities
Trade payables (1.2) (0.8)
Borrowings (1.3)
Liabilities (1.2) (0.8) (1.3)
Net exposure 3.9 3.1 1.5 0.9

The US Dollar and Euro overdrafts form part of an offset arrangement and as such each currency is netted off against other cash balances in the same currency and is not recognised as an overdraft in its own right.

Cash flow interest rate risk

The Group has financial assets and liabilities which are exposed to changes in market interest rates. Changes in interest rates impact primarily on deposits, loans and borrowings by changing their future cash flows (variable rate). Management does not currently have a formal policy of determining how much of the Group's exposure should be at fixed or variable rates and the Group does not use hedging instruments to minimise its exposure. However, at the time of taking new loans or borrowings management uses its judgement to determine whether it believes that a fixed or variable rate would be more favourable for the Group over the expected period until maturity. Sensitivity analysis has not been provided due to the low level of loans and borrowings within the Group. The Group's significant interest-bearing assets and liabilities are disclosed in note 26, note 27 and note 28.

Liquidity risk

Cash flow forecasting is performed on a Group basis by the monitoring of rolling forecasts of the Group's liquidity requirements to ensure that it has sufficient cash to meet operational needs while maintaining sufficient headroom on its undrawn committed borrowing facilities.

Valuation hierarchy

The table below shows the financial instruments carried at fair value by valuation method:

1 May 2011 2 May 2010
Level 1 Level 2 Level 3 Level 1 Level 2 Level 3
£m £m £m £m £m £m
Derivative financial instruments
— forward foreign exchange contracts 0.1
Derivative financial instruments
— forward foreign exchange contracts 1.5
— foreign exchange agreement with supplier 0.3

The level 2 forward foreign exchange valuations are derived from HSBC models and are based on valuation techniques based on observable market data as at the close of business on 1 May 2011.

Fair value loss of £1.5m (2010: gain of £0.1m) relating to the forward foreign exchange contracts has been recognised in other income.

The notional principal amount of the outstanding forward foreign exchange contracts at 1 May 2011 was £37.4m (2010: £4.2m).

The level 2 valuation for the foreign exchange agreement with a supplier is derived from market exchange rate data and the loss included within cost of sales.

Derivative financial instruments

The table below analyses the Group's and Company's derivative financial instruments which will be settled on a gross basis. The amounts disclosed in the table are the contractual undiscounted cash flows.

Group Company
1 May 2011 2 May 2010 1 May 2011 2 May 2010
£m £m £m £m
Forward foreign exchange contracts
— held for trading
Outflow (21.5) (1.9)
Inflow 15.9 2.3
Net derivative exposure (5.6) 0.4

All cash flows will occur in less than one year.

All derivative financial instruments are carried at fair value as assets when the fair value is positive and as liabilities when the fair value is negative.

The table below analyses the Group's and Company's derivative financial instruments. The amounts disclosed in the table are the carrying balances of the liabilities and assets as at the balance sheet date.

Group Company
1 May 2011 2 May 2010 1 May 2011 2 May 2010
£m £m £m £m
Derivative financial assets
Forward foreign exchange contracts 0.1
Total derivative financial assets 0.1
Group Company
1 May 2011 2 May 2010 1 May 2011 2 May 2010
£m £m £m £m
Derivative financial liabilities
Forward foreign exchange contracts 1.5
Foreign exchange agreement with supplier 0.3
Total derivative financial liabilities 1.5 0.3

All financial derivative instruments are due in less than one year.

Trading derivatives are classified as a current asset or liability. The full fair value of a hedging derivative is classified as a non-current asset or liability if the remaining maturity of the hedged item is more than 12 months and as a current asset or liability, if the maturity of the hedged item is less than 12 months.

Capital risk management

The Group's objectives when managing capital are to safeguard its 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, issue new shares or sell assets to reduce debt.

Consistent with others in the industry, the Group monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital employed. 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 employed is calculated as 'equity' as shown in the consolidated balance sheet plus net debt. The Group is in a net cash position at 1 May 2011.

The Directors have concluded that the Company is best served by retaining current cash reserves to support growth. Consequentially, a recommendation will be made to the AGM that no dividend is payable for 2011 (2010: nil).