30 Financial risk management objectives and policies
The Group is exposed to a variety of financial risks: market risk (including foreign currency risk, interest rate risk and fuel price 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 enters into derivative transactions in order to manage certain market risks. All such transactions are carried out within guidelines approved by the Board.
Group treasury carries out financial risk management under governance approved by the Board. Group treasury identifies, evaluates and hedges financial risks. The Board provides written principles for overall risk management, as well as written policies covering specific areas, such as foreign exchange risk, interest rate risk, credit risk, use of derivative financial instruments and investment of excess liquidity.
a Fuel price risk
The Group is exposed to fuel price risk. The Group’s fuel price risk management strategy aims to provide the airline with protection against sudden and significant increases in oil prices while ensuring that the airline is not competitively disadvantaged in a serious way in the event of a substantial fall in the price of fuel.
In meeting these objectives, the fuel risk management programme allows for the judicious use of a number of derivatives available on the Over The Counter (OTC) markets with approved counterparties and within approved limits.
The following table demonstrates the sensitivity of financial instruments to a reasonably possible change in fuel prices, with all other variables held constant, on profit before tax and equity:
| Group | Company | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2008 | 2007 | |||||||
| Increase/decrease in fuel price per cent |
Effect on profit before tax £ million |
Effect on equity £ million |
Effect on profit before tax £ million |
Effect on equity £ million |
Increase/decrease in fuel price per cent |
Effect on profit before tax £ million |
Effect on equity £ million |
Effect on profit before tax £ million |
Effect on equity £ million |
|
| 10 | 14 | 166 | 6 | 70 | 10 | 14 | 166 | 6 | 70 | |
| (10) | (11) | (163) | (11) | (59) | (10) | (11) | (163) | (11) | (59) | |
b Foreign currency risk
The Group is exposed to currency risk on revenue, purchases and borrowings that are denominated in a currency other than sterling. The currencies in which these transactions are primarily denominated are euro, US dollar and Japanese yen. The Group generates a surplus in most currencies in which it does business. The US dollar can be an exception as capital expenditure, debt repayments and fuel payments denominated in US dollars can create a deficit.
The Group can experience adverse or beneficial effects arising from foreign exchange rate movements. The Group seeks to reduce foreign exchange exposures arising from transactions in various currencies through a policy of matching, as far as possible, receipts and payments in each individual currency. Surpluses of convertible currencies are sold, either spot or forward, for US dollars or sterling.
The Group has substantial liabilities denominated in yen and US dollars.
The Group utilises its yen debt repayments as a hedge of future US dollar and yen revenues.
Forward foreign exchange contracts and currency options are used to cover near-term future revenues and operating payments in a variety of currencies.
The following table demonstrates the sensitivity of financial instruments to a reasonably possible change in the US dollar, Japanese yen and euro exchange rates, with all other variables held constant, on profit before tax and equity.
| Strengthening/ (weakening) in US dollar rate per cent |
Effect on profit before tax £ million |
Effect on equity £ million |
Strengthening/ (weakening) in Japanese yen rate per cent |
Effect on profit before tax £ million |
Effect on equity £ million |
Strengthening/ (weakening) in euro rate per cent |
Effect on profit before tax £ million |
Effect on equity £ million |
|
|---|---|---|---|---|---|---|---|---|---|
| Group | |||||||||
| 2008 | 10 | (4) | (42) | 10 | (7) | (57) | 10 | (2) | (26) |
| (10) | 3 | 32 | (10) | 5 | 47 | (10) | 2 | 22 | |
| 2007 | 10 | (8) | (49) | 10 | (8) | (49) | 10 | (11) | |
| (10) | 7 | 36 | (10) | 6 | 40 | (10) | 10 | ||
| Company | |||||||||
| 2008 | 10 | (6) | (42) | 10 | (7) | (57) | 10 | (2) | (26) |
| (10) | 5 | 32 | (10) | 5 | 47 | (10) | 2 | 22 | |
| 2007 | 10 | (10) | (49) | 10 | (8) | (48) | 10 | (11) | |
| (10) | 8 | 36 | (10) | 6 | 40 | (10) | 10 |
c Interest rate risk
The Group is exposed to changes in interest rates on floating debt and cash deposits.
The following table illustrates the sensitivity of financial instruments on profit before tax for the year to a reasonably possible change in interest rates, with effect from the beginning of the year. There was no impact on shareholders’ equity. These changes are considered to be reasonably possible based on observation of current market conditions. The calculations are based on financial instruments held at each balance sheet date. All other variables were held constant.
March 31, 2008
| Effect on profit before tax | ||
|---|---|---|
| £ million | 100 basis points increase | 100 basis points decrease |
| Group | ||
| Variable rate instruments | 3 | (3) |
| Company | ||
| Variable rate instruments | (3) | 3 |
March 31, 2007
| Effect on profit before tax | ||
|---|---|---|
| £ million | 100 basis points increase | 100 basis points decrease |
| Group | ||
| Variable rate instruments | 4 | (4) |
| Interest rate swap | 1 | (1) |
| Company | ||
| Variable rate instruments | 4 | (4) |
| Interest rate swap | 1 | (1) |
d Credit risk
The Group is exposed to credit risk to the extent of non-performance by its counterparties in respect of financial assets receivable. However, the Group has policies and procedures in place to ensure credit risk is limited by placing credit limits on each counterparty. The Group continuously monitors counterparty credit limits and defaults of counterparties, incorporating this information into credit risk controls. It is the Group’s policy that all counterparties who wish to trade on credit terms are subject to credit verification procedures.
The maximum exposure to credit risk is limited to the carrying value of each class of asset as summarised in note 31.
The Group does not hold any collateral to mitigate this exposure. Credit risks arising from acting as guarantor are disclosed in note 36.
e Liquidity risk
Prudent liquidity risk management includes maintaining sufficient cash and interest-bearing deposits, the availability of funding from an adequate amount of credit facilities and the ability to close out market positions. Due to the dynamic nature of the underlying business, Group treasury maintains flexibility in funding by maintaining availability under committed credit lines.
The table below analyses the Group’s financial assets and 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 and include interest.
| Group | ||||||
|---|---|---|---|---|---|---|
| £ million | Within 6 months | 6-12 months | 1-2 years | 2-5 years | More than 5 years | Total 2008 |
| Cash and cash equivalents | 683 | 683 | ||||
| Other current interest-bearing deposits | 861 | 360 | 1,221 | |||
| Trade receivables | 586 | 586 | ||||
| Interest-bearing loans and borrowings: | ||||||
| Finance lease and hire purchase obligations | (169) | (220) | (523) | (695) | (1,268) | (2,875) |
| Fixed rate borrowings | (98) | (21) | (51) | (150) | (468) | (788) |
| Floating rate borrowings | (20) | (37) | (56) | (143) | (211) | (467) |
| Trade and other payables | (1,163) | (1,163) | ||||
| Derivative financial instruments: | ||||||
| Cross currency swaps | (1) | (1) | (2) | |||
| Forward currency contracts | (15) | (4) | (1) | (20) | ||
| Fuel derivatives | (20) | (18) | (18) | (12) | (68) | |
| Forward currency contracts | 5 | 3 | 8 | |||
| Fuel derivatives | 170 | 100 | 68 | 12 | 350 | |
| 820 | 163 | (581) | (989) | (1,948) | (2,535) | |
Group |
||||||
| £ million | Within 6 months | 6-12 months | 1-2 years | 2-5 years | More than 5 years | Total 2007 |
| Cash and cash equivalents | 713 | 713 | ||||
| Other current interest-bearing deposits | 1,016 | 707 | 1,723 | |||
| Trade receivables | 654 | 654 | ||||
| Interest-bearing loans and borrowings: | ||||||
| Finance lease and hire purchase obligations | (252) | (188) | (373) | (925) | (1,306) | (3,044) |
| Fixed rate borrowings | (37) | (42) | (119) | (155) | (513) | (866) |
| Floating rate borrowings | (22) | (34) | (59) | (159) | (261) | (535) |
| Trade and other payables | (1,230) | (1,230) | ||||
| Derivative financial instruments: | ||||||
| Forward currency contracts | (2) | (1) | (3) | |||
| Fuel derivatives | (1) | (14) | (6) | (21) | ||
| Interest rate swaps | 2 | 2 | ||||
| Forward currency contracts | 1 | 1 | ||||
| Fuel derivatives | 19 | 56 | 8 | 83 | ||
| 859 | 486 | (549) | (1,239) | (2,080) | (2,523) | |
Company |
||||||
| £ million | Within 6 months | 6-12 months | 1-2 years | 2-5 years | More than 5 years | Total 2008 |
| Cash and cash equivalents | 433 | 433 | ||||
| Other current interest-bearing deposits | 414 | 414 | ||||
| Trade receivables | 574 | 574 | ||||
| Interest-bearing loans and borrowings: | ||||||
| Finance lease and hire purchase obligations | (182) | (225) | (543) | (760) | (1,431) | (3,141) |
| Fixed rate borrowings | (92) | (24) | (47) | (138) | (986) | (1,287) |
| Floating rate borrowings | (18) | (33) | (51) | (126) | (172) | (400) |
| Trade and other payables | (2,679) | (2,679) | ||||
| Derivative financial instruments: | ||||||
| Cross currency swaps | (1) | (1) | (2) | |||
| Forward currency contracts | (15) | (4) | (1) | (20) | ||
| Fuel derivatives | (20) | (18) | (18) | (12) | (68) | |
| Forward currency contracts | 5 | 3 | 8 | |||
| Fuel derivatives | 170 | 100 | 68 | 12 | 350 | |
| (1,410) | (201) | (592) | (1,025) | (2,590) | (5,818) | |
Company |
||||||
| £ million | Within 6 months | 6-12 months | 1-2 years | 2-5 years | More than 5 years | Total 2007 |
| Cash and cash equivalents | 662 | 662 | ||||
| Other current interest-bearing deposits | 1,016 | 704 | 1,720 | |||
| Trade receivables | 635 | 635 | ||||
| Interest-bearing loans and borrowings: | ||||||
| Finance lease and hire purchase obligations | (265) | (193) | (392) | (988) | (1,500) | (3,338) |
| Fixed rate borrowings | (29) | (44) | (113) | (136) | (930) | (1,252) |
| Floating rate borrowings | (21) | (30) | (54) | (143) | (214) | (462) |
| Trade and other payables | (2,719) | (2,719) | ||||
| Derivative financial instruments: | ||||||
| Forward currency contracts | (2) | (1) | (3) | |||
| Fuel derivatives | (1) | (14) | (6) | (21) | ||
| Interest rate swaps | 2 | 2 | ||||
| Forward currency contracts | 1 | 1 | ||||
| Fuel derivatives | 19 | 56 | 8 | 83 | ||
| (704) | 480 | (557) | (1,267) | (2,644) | (4,692) | |
f 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.
Consistent with others in the industry, the Group monitors capital on the basis of the gearing ratio, net debt as a percentage of total capital. Net debt is defined as the total borrowings, finance leases and hire purchase liabilities, net interest-bearing deposits and cash and cash equivalents less overdrafts. See note 24 for details of the calculation of net debt. Total capital is defined as the total of capital, reserves, minority interests and net debt.
The gearing ratios at March 31, 2008 and 2007 were as follows:
| £ million (except ratios) | 2008 | 2007 |
|---|---|---|
| Capital reserves | 3,033 | 2,211 |
| Add minority interests | 200 | 200 |
| Total equity | 3,233 | 2,411 |
| Net debt (a) | 1,310 | 991 |
| Total capital (b) | 4,543 | 3,402 |
| Gearing ratio (a)/(b) | 28.8 | 29.1 |
The decrease in the gearing ratio during 2008 resulted primarily from increased equity due to higher operating profit. The impact of this on the gearing ratio was partially offset by the increased borrowings relating to the purchase of three Airbus 320s, and lower cash balances as a result of the £610 million cash injection into NAPS together with the $300 million (£149 million) payment made to the US Department of Justice in respect of anti-competitive activity.