25. Risk management and financial instruments
Financial risk management policy
The Group’s activities are exposed to various financial risks: market risk (including foreign currency risk), credit risk, liquidity risk, and interest rate risk related to cash flows. The Group’s risk management policy centers on the uncertainty of financial markets and attempts to minimize the potential adverse effects on the Group’s profitability through the use of certain financial instruments as described below.
This note provides information on the Group’s exposure to each of the aforementioned risks, the Group’s objectives, policies and processes for managing risk, the methods used to measure these risks and any changes from the previous year.
Foreign currency risk
The Group operates in an international environment and, accordingly, is exposed to foreign currency risk, particularly relating to the US dollar and, to a lesser extent, the Mexican peso, the Russian ruble, the Chinese renminbi, the Japanese yen and the pound sterling. Foreign currency risk arises on future commercial transactions, recognized assets and liabilities and net investments in foreign operations.
Foreign currency risk is managed in line with Group management guidelines, which establish, mainly, the arrangement of financial or natural hedges, ongoing monitoring of fluctuations in exchange rates and other measures designed to mitigate this risk.
In 2012, had the value of the euro increased by 10% compared to the US dollar and, as a result, compared to the rest of the foreign currencies linked to the US dollar, all other things being equal, consolidated profit after income tax would have been approximately euros 84,591 thousand lower, and had the value of the euro dropped by 10%, consolidated profit after income tax would have been approximately euros 88,141 thousand higher, primarily because of the translation of subsidiaries’ annual accounts expressed in currencies other than the euro and the impact of merchandise purchases in US dollars.
Credit risk
The Group is not exposed to significant concentrations of credit risk as policies are in place to cover sales to franchises and retail sales comprise the vast majority of revenue. Collections are primarily made in cash or through credit card payments.
The Group adopts prudent criteria in its investment policy the main objectives of which are to reduce the credit risk associated with investment products and the counterparty risk associated with financial institutions by establishing highly detailed analysis criteria.
Investment vehicles are rated using a selection of criteria, including, ratings from the three main rating agencies, the size of the investment vehicle, location and returns. All the investment vehicles have the maximum credit rating.
In relation to the counterparty risk associated with financial institutions, the Group selects a minimum credit rating of A from the various rating agencies, a minimum TIER capital ratio pursuant to Basel III and also assesses other factors during the selection process.
Similarly, maximum limits are established for the various counterparties in order the meet the objective of ensuring diversification.
In relation to credit risk arising from commercial transactions, impairment losses are recognized for trade receivables when objective evidence exists that the Group will be unable to recover all the outstanding amounts in accordance with the original contractual conditions of the receivables. These impairment losses are calculated as the difference between the carrying amount and the present value of future estimated cash flows discounted at the effective interest rate and are recognized in the income statement. The net impairment losses recognized during the year in respect of value adjustments to the balances recorded under this caption amount to euros 309 thousand (net reversals of euros 19,005 thousand in 2011) and correspond to doubtful trade receivables.
At 31 January 2013 and 2012 no significant outstanding balances existed. Furthermore, based on available historical data, the Group does not consider it necessary to make valuation adjustments to receivables which are not past due. The fair value of the receivables is equal to their carrying amount.
The main financial assets of the Group are shown under Financial Instruments: other information.
Liquidity risk
The Group is not exposed to significant liquidity risk, as it maintains sufficient cash and cash equivalents to meet the outflows of normal operations. In the event the Group requires financing, either in euros or in other currencies, it reverts to loans, credit facilities or other types of financial instruments (see note 18).
Details of financial liabilities are disclosed in note 18, along with their expected maturities.
Interest rate risk
Interest rate fluctuations affect the fair value of assets and liabilities which accrue a fixed rate of interest, as well as future cash flows from assets and liabilities tied to a floating interest rate. Group exposure to this risk is not significant for the reasons mentioned above.
The Group does not have any financial assets or liabilities at fair value through profit or loss or interest rate financial derivatives. Given the Group’s investment policy, any changes in interest rates at year-end would not significantly affect consolidated profits.
Capital management
The Group’s capital management objectives are to safeguard the Group’s ability to continue operating as a going concern so that it can continue to generate returns for shareholders, benefit other stakeholders and maintain an optimum capital structure to reduce the cost of capital.
The Group manages its capital structure and makes adjustments thereto in response to changes in economic conditions. No significant changes to capital management were made during the year.
Neither the Parent nor the Inditex Group subsidiaries are subject to strict capital management criteria.
Financial instruments
Merchandise and goods for resale are partly acquired from foreign suppliers in US dollars. In accordance with prevailing foreign currency risk policies, Group management arranges derivatives, mainly forward contracts, to hedge cash flow fluctuations related with exchange rates.
Occasionally the Group instruments its hedges through financial investments owned by it.
Certain Group subsidiaries are granted internal financing denominated in currencies other than the euro. In accordance with prevailing foreign currency risk policies, derivatives are arranged, mainly forward contracts and swaps, to hedge cash flow fluctuations related with exchange rates.
Moreover, and as described in note 31.2.o, the Group applies hedge accounting to mitigate the volatility that the existence of significant foreign currency transactions would have on the consolidated income statement. Hedge accounting is used because the Group meets the requirements described in note 31.2.o on accounting policies to be able to classify financial instruments as accounting hedges. More specifically, these financial instruments have been formally designated as hedges and it has been observed that the hedges are highly effective.
The expiry dates of hedging instruments have been negotiated so that they coincide with the expiry dates of the hedged items. In 2012 there were no transactions to which hedge accounting was applied which did not occur, and no significant amounts were taken to the consolidated income statement due to the ineffectiveness of these hedges.
At 31 January 2013 and 2012, the Group had arranged derivatives, basically forward contracts on future purchases in US dollars. The fair value of these derivatives is recognized under “Other financial assets” or “Other financial liabilities” depending on the related balance.
Details of forward purchases in US dollars are as follows:
| Currency | Sale/Purchase | EUR/USD |
|---|---|---|
| Fair value (thousands of €) | 31/01/13 | (51,035) |
|
|
31/01/12 | 50,684 |
| Notional value (thousands of USD) | 31/01/13 | 1,546,688 |
|
|
31/01/12 | 1,832,556 |
| Average number of remaining months | 31/01/13 | 5.29 |
|
|
31/01/12 | 5.45 |
Also, as part of the risk management policy, the Group designates as hedged items financial assets recognized under “Current financial investments”, since the related derivatives qualify for hedge accounting.
The Group arranged hedges for the Mexican peso in 2012 (nominal value of MXP 51,797 thousand at 31 January 2012).
The fair value of forward currency contracts has been calculated using measurement techniques based on the spot exchange rate and interest rate curves (level 2).
Approximately 60% of the cash flows associated with hedges in US dollars are expected to be generated during the six months subsequent to year-end, while the remaining 40% is expected to be generated between six months to a year. It is also likely that the impact on consolidated profit and loss will arise during these periods.
Financial instruments: other information
The main financial assets held by the Group, other than cash and cash equivalents and derivative financial instruments, comprise loans and receivables related to the Group’s principal activity and guarantees in relation to the lease of commercial premises, which are shown under other non-current assets. The main financial assets of the Group are as follows:
|
|
2012 | 2011 |
|---|---|---|
| Cash and cash equivalents | 3,842,918 | 3,466,752 |
| Current financial investments | 260,632 | - |
| Trade receivables | 150,226 | 106,003 |
| Receivable due to sales to franchises | 147,116 | 110,061 |
| Other current receivables | 50,924 | 53,025 |
| Guarantees | 223,734 | 220,420 |
| Total | 4,675,551 | 3,956,262 |
The financial liabilities of the Group mainly comprise debts and payables on commercial transactions.
The fair value of financial assets and liabilities measured at amortized cost does not differ substantially from their carrying amount, taking into account that in the majority of cases collection or payment is made in the short term. In 2012, no significant financial asset impairment was recognized.
