28 Financial instruments
Cash and cash equivalents
Cash and cash equivalents comprise cash in hand, demand deposits and other short-term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value. The carrying amount of these assets approximates to their fair value.
General risk management principles
The Board has overall responsibility for the establishment and oversight of the Group’s risk management framework. A formal risk assessment and management framework for assessing, monitoring and managing the strategic operational and financial risks of the Group is in place to ensure appropriate risk management of its operations. Internal control and risk management systems are embedded in the operations of the divisions.
The key business risks identified are discussed in detail in the business review and the corporate governance statement.
Financial risks and management
The Group has exposure to a variety of financial risks through the conduct of its operations. Risk management is governed by the Group’s operational policies, which are subject to periodic review by the Group’s internal audit team and twice yearly review by the Board. The policies include written principles for the Group’s risk management as well as specific policies, guidelines and authorisation procedures in respect of specific risk mitigation techniques such as the use of derivative financial instruments. The Group does not enter into derivative financial instruments for speculative purposes.
The following represent the key financial risks resulting from the Group’s use of financial instruments:
- credit risk
- liquidity risk
- market risk.
(a) Credit risk
Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations and results primarily from the Group’s trade receivables and amounts recoverable on construction contracts.
Amounts due from construction contract customers and trade receivables
The Group’s primary exposure to credit risk arises from the potential for non-payment or default from construction contract debtors and trade receivables. The degree to which the Group is exposed to this credit risk depends on the individual characteristics of the contract counterparty and the nature of the project. The Group’s credit risk is also influenced by general macroeconomic conditions. The Group primarily operates in one geographical segment, being the United Kingdom. The Group does not have any significant concentration risk in respect of amounts due from construction contract customers or trade receivables balances at the reporting date with receivables spread across a wide range of customers. Due to the nature of the Group’s operations, it is normal practice for customers to hold retentions in respect of contracts completed. Retentions held by customers at 31 December 2008 were £59.6m (2007: £66.2m).
The Group manages its exposure to credit risk through the application of its credit risk management policies which specify the minimum requirements in respect of the credit worthiness of potential customers, assessed through reports from credit agencies, and the timing and extent of progress payments in respect of contracts.
The risk management policies of the Group also specify procedures in respect of obtaining parent company guarantees or, in certain circumstances, use of escrow accounts, which in the event of default means that the Group may have a secure claim. The Group does not require collateral in respect of amounts due from construction contract customers or trade receivables.
The Group manages the collection of retentions through its post-completion project monitoring procedures and ongoing contact with customers to ensure that potential issues that could lead to the non-payment of retentions are identified and addressed promptly. The Group assesses amounts due from construction contract customers and trade receivables balances for impairment and establishes a provision for impairment losses that represents its estimate of incurred losses.
The ageing of trade receivables at the reporting date was as follows:
| Gross trade receivables 2008 £m |
Provision for impairment losses 2008 £m |
Gross trade receivables 2007 £m |
Provision for impairment losses 2007 £m |
|
|---|---|---|---|---|
| Not past due | 143.6 | 0.6 | 144.7 | – |
| Past due 1 to 30 days | 24.7 | 0.1 | 34.3 | – |
| Past due 31 to 120 days | 12.2 | – | 6.2 | – |
| Past due 121 to 365 days | 14.5 | 0.3 | 12.3 | 1.8 |
| Greater than one year | 1.9 | 1.7 | 9.4 | 3.1 |
| 196.9 | 2.7 | 206.9 | 4.9 |
The movement in the provision for impairment losses on trade receivables during the year was as follows:
| 2008 £m |
2007 £m |
|
|---|---|---|
| Balance at beginning of the year | 4.9 | 1.5 |
| Amounts written off during the year | (1.9) | (0.1) |
| Amounts recovered during the year | (0.3) | (0.1) |
| Increase in provision recognised in the income statement | – | 3.6 |
| Balance at 31 December | 2.7 | 4.9 |
(b) Liquidity risk
Liquidity risk is the risk that the Group will not be able to meet its financial obligations as and when they fall due. The ultimate responsibility for liquidity risk rests with the Board.
The Group aims to manage liquidity by ensuring that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stress conditions, without incurring unacceptable losses or risking damage to the Group’s reputation.
The Group actively manages its liquidity profile while ensuring that the return achieved on cash and investments is maximised. The Group had not drawn down any current debt facilities as at the reporting date (2007: £nil).
As discussed below under capital management, the Group does not have any derivative or non-derivative financial liabilities with the exception of finance lease liabilities, trade and other payables, current tax liabilities and retirement benefit obligations. Current tax liabilities and trade and other payables are non-interest bearing and therefore have no weighted average effective interest rates. Retirement benefit obligations are measured at the net of the present value of retirement benefit obligations and the fair value of the Plan assets. Finance lease liabilities are carried at the present value of the minimum lease payments with the future value of finance charges. An analysis of the maturity profile for finance lease liabilities is contained in note 16.
The Group reports cash balances daily, and invests surplus cash to maximise income whilst preserving credit quality. The Group prepares weekly short-term and monthly long-term cash forecasts, which are used to assess the Group’s expected cash performance, and compare with the facilities available to the Group and the Group’s covenants.
In addition to its cash balances, the Group has a £25m loan facility available until November 2009, a £25m loan facility available until June 2010, and a further £25m loan facility available until June 2009 which can be extended to June 2010 at the Group’s option.
Key risks to liquidity and cash balances are a downturn in contracting volumes, a decrease in the value of open market sales, deterioration in credit terms obtainable in the market from suppliers and subcontractors, a downturn in the profitability of work, delayed receipt of cash from customers and the risk that major clients or suppliers suffer financial distress leading to non-payment of debts or costly and time consuming reallocation and rescheduling of work. Certain measures and KPIs are continually monitored throughout the Group and used to quickly identify issues as they arise, enabling the Group to address them promptly. Key amongst these are continual monitoring of the forward order book, including the status of orders and likely timescales for realisation so that contracting volumes are well understood, monitoring of overhead levels to ensure they remain appropriate to contracting volumes, weekly monitoring of open market house sales volumes and prices, continual monitoring of working capital exceptions (overdue debts and conversion of work performed into certificates and invoices), continual review of levels of current and forecast profitability on contracts, review of client and supplier credit references, approval of credit terms with clients and suppliers to ensure they are appropriate.
The ageing of trade payables at the reporting date was as follows:
| 2008 £m |
2007 £m |
|
|---|---|---|
| Not past due | 109.9 | 137.0 |
| Past due 1 to 30 days | 32.8 | 34.9 |
| Past due 31 to 120 days | 17.9 | 23.8 |
| Past due 121 to 365 days | 12.8 | 9.2 |
| Greater than one year | 0.1 | 4.2 |
| 173.5 | 209.1 |
(c) Market risk
Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates or equity prices, will affect the Group’s income or the carrying amount of its holdings of financial instruments. The objective of market risk management is to achieve a level of market risk that is within acceptable parameters as set out in the Group risk management framework.
Interest rate risk
The Group is not exposed to significant interest rate risk as it does not have significant interest bearing liabilities and its only interest bearing asset is cash invested on a short-term basis.
Certain of the Group’s equity accounted joint ventures enter into interest rate swaps to manage their exposure to interest rate risk arising on floating rate bank borrowings.
The Group’s share of joint ventures’ interest rate and Retail Prices Index swap contracts with nominal values of £75.6m (2007: £29.4m) have fixed interest payments at an average rate of 5.11% (2007: 4.98%) for periods up until 2035.
The Group’s share of the fair value of swaps entered into at 31 December 2008 by joint ventures is estimated at a £2.3m liability (2007: £2.2m liability). These amounts are based on market values of equivalent instruments at the balance sheet date. All interest rate swaps are designated as hedging instruments and are effective as cash flow hedges. The fair value thereof has been taken to the hedging reserve (note 23).
Currency risk
The majority of the Group’s operations are carried out in the United Kingdom and the Group has an insignificant level of exposure to currency risk on sales and purchases. Given the insignificant exposure to foreign currency movements, the Group’s policy is not to hedge foreign currency transactions unless they are material, at which point derivative financial instruments are entered into so as to hedge forecast or actual foreign currency exposures.
Capital management
The Board aims to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain the future development of the business.
The capital structure of the Group consists of cash and cash equivalents and equity attributable to equity holders of the Company, comprising issued capital, reserves and retained earnings as disclosed in notes 22 and 23. From time to time certain companies within the Group use short-term debt in the form of bank overdrafts. The Group overall has no debt.
The Group dividend policy is stated in the business review.
The Board aims to achieve a suitable balance between higher returns that may be possible through borrowing and the stability afforded by a sound capital position.
There were no changes in the Group’s approach to capital management during the year and the Group is not subject to any capital requirements imposed by regulatory authorities.