Financial assets and financial liabilities
Financial risk management and fair value disclosures
The Groupís overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on its financial performance. Risk management is carried out centrally and management identifies, evaluates and analyses financial risks where necessary in close co-operation with the Groupís operating business units. The governance and risk committee oversees how management monitors compliance with the Group risk management policies and procedures and reviews the adequacy of the risk management framework in relation to the risks faced by the Group.
The Groupís normal operations expose it to the following financial risks from its use of financial instruments:
The following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy at 31 July 2019:
The following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy at 31 July 2018:
The Group does not have any financial instruments that are subject to offsetting.
All cash and cash equivalents, short-term receivables and short-term payables carrying amounts approximate their fair values due to their short-term nature. There have been no transfers between levels of the fair value hierarchy.
Financial assets at fair value through profit or loss
Financial assets measured at fair value through profit or loss, in terms of the hierarchy, are classified as level 3 where the valuation technique used is based on unobservable inputs for the asset.
Other financial assets (level 3) relate to non-controlling interests in unlisted businesses The valuation of the unlisted business is based on a discounted cash flow model which has been adjusted for risk inherent in the investees’ nature of operations At 31 July 2019 the carrying value of the level 3 financial assets, based on the directors’ evaluation, is R28,3 million (31 July 2018: R49,8 million).
The fair value of the investment is sensitive to changes in expected dividends from the entities. Discounting is not material and therefore the fair value is not sensitive to changes in discount rates.
Other financial assets reconciliation of movement of level 3 items
Financial liabilities at fair value through profit or loss
Financial liabilities measured at fair value through profit or loss, in terms of the hierarchy, are classified as level 3 as the valuation techniques used are based on unobservable inputs for the liability.
Vendors for acquisition
The balance in respect of vendors for acquisition relates to the contingent consideration where business combinations are subject to profit warranties. The profit warranties allow for a defined adjusted value to the consideration payable in the event that the warranted profit after tax is not achieved, or in the event that it is exceeded, an agreed sharing in the surplus. The fair value of the contingent arrangement is initially estimated by applying the income approach assuming that the relevant profit warrant will be achieved. Subsequent measurement uses the income approach to calculate the present value of the expected settlement payment using the latest approved budgeted results and reasonable growth rates for the remainder of the relevant warranty periods taking into account any specific circumstances.
Profit warrant periods normally extend over a 24-month period.
Upwardly revised performance expectations would result in an increase in the related liability, limited to the terms of the applicable purchase agreement.
Unobservable inputs include budgeted results based on margins and revenue growth rates historically achieved by the various segments. The fair value of the contingent consideration is dependent on the expected profit and is therefore sensitive to changes in such expected profit. Discounting is not material and therefore the fair value is not sensitive to changes in discount rates.
The EOH Group has an established control framework with respect to the measurement of fair values. This includes a valuation team that reports directly to the Group Chief Financial Officer who oversees all significant fair value measurements.
Vendors for acquisition reconciliation of movement
Non-recurring fair value measurements
Disposal groups classified as held for sale are measured at the lower of their carrying amount and fair value less costs to sell. The fair values are determined based on sales agreements that are in place for each of the disposal groups that are held for sale. The total of such fair values is R856 million. The discounted cash flow method (DCF) is used to determine their values, when the sales amount from the sale agreements was discounted using the adjusted weighted average cost of capital specific to that cash-generating unit (CGU). These fair values are categorised as level 3, based on inputs used.
Gains and losses from continuing operations
Capital risk management
The Group’s objective is to safeguard its ability to continue as a going concern and to maintain an appropriate capital structure while growing the business. This is consistent with previous years.
In order to maintain or adjust the capital structure of the Group, the Board of directors may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt.
The debt to equity ratios were as follows:
Liquidity risk is the risk that the Group will not be able to meet its financial obligations as they fall due. The Group manages liquidity risk by reviewing future commitments and credit facilities to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation.
The table below analyses the Group’s financial liabilities into relevant maturity groupings based on the remaining period from the date of the statement of financial position to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows.
The expected maturity of financial liabilities is not expected to differ from the contractual maturities as disclosed above. Subsequent to the reporting date, payment terms were renegotiated with the lenders which has resulted in R750 million being due to be settled within less than one year.
The cash flow interest rate risk is the risk that the future cash flows of a financial instrument will fluctuate owing to changes in the market interest rate. The fair value interest rate risk is the risk that the value of the financial instrument will fluctuate because of changes in the market interest rates. The Group assumes exposure to the effects of the fluctuations in the prevailing levels if the market interest rates on both the fair value and cash flow risks fluctuate.
Interest rate risk arises from long-term borrowings. Borrowings issued at variable rates expose the group to cash flow interest rate risk. Borrowings issued at fixed rates expose the group to fair value interest rate risk. The Group policy is to maintain most of its borrowings in variable rate instruments. The variable rates are influenced by movements in the prime borrowing rates. During the reporting period, the Group’s borrowings at variable rates were denominated in Rand.
The Group analyses its interest rate exposure on an ongoing basis. The Group does not hedge against fluctuations in interest rates.
At 31 July 2019, if the interest rate on Rand-denominated borrowings had been 1% higher with all other variables held constant, pre-tax profit for the year would have been R30 million (2018: R35 million) lower, mainly as a result of higher interest expense on floating rate borrowings.
Credit risk and expected credit losses
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 arises principally from the Group’s other financial assets, finance lease receivables, trade and other receivables and cash and cash equivalents.
Trade receivables, contract assets and finance lease receivables comprise a widespread customer base, spread across diverse industries and geographical areas. The Group has a general policy of only dealing with creditworthy counterparties as a means of mitigating the risk of financial loss from defaults. Management evaluates credit risk relating to customers on an ongoing basis, taking into account its financial position, past experience and other relevant factors. If customers are independently rated, these ratings are also considered.
The carrying amounts of financial assets represent the maximum credit exposure. The Group does not hold any collateral or other credit enhancements to cover its credit risks associated with its financial assets. Financial assets exposed to credit risk at year-end were as follows:
At the reporting date, the Group did not consider there to be any significant concentration of credit risk which has not been adequately provided for.
Trade receivables and contract assets
The Group’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. However, management also considers the factors that may influence the credit risk of its customer base, including the default risk associated with the industry in which customers operate. Before accepting any new customer, the Group uses an external credit scoring system to assess the potential customer’s credit quality and defines credit limits by customer. The Group’s exposure and the credit scores of its counterparties are continuously monitored and the aggregate value of transactions concluded is spread amongst approved counterparties. Credit exposure is controlled by counterparty credit limits that are reviewed and approved by the risk management committee/credit control department annually.
The average credit period on sales of goods and services range from 30 days to 120 days. In determining the recoverability of a trade receivable, the Group considers any change in the credit quality of the trade receivable from the date credit was initially granted up to the end of the reporting period. The concentration of credit risk is limited due to the fact that the customer base is large and unrelated.
Customers are grouped according to their credit characteristics. The customers grouped in a particular segment, which is industry segments, share similar credit risk characteristics. Trade receivables are assessed for impairment on a collective basis. The contract assets relate to unbilled work in progress and have substantially the same risk characteristics as the trade receivables for the same types of contracts. The Group has therefore concluded that the expected loss rates for trade receivables are a reasonable approximation of the loss rates for the contract assets.
The Group does not have trade receivable and contract assets for which no loss allowance is recognised because of collateral.
During the first half of the year, a target was set to significantly reduce the debtors’ balance. By 31 July 2019, the trades receivables balance decreased from R4,1 billion to R3,4 billion (before adjusting for assets held for sale) with over R400 million cash realised from debtors’ balances greater than 90 days at 31 January 2019.
Comparative information under IAS 39
An analysis of the credit quality of trade receivables that were neither past due nor impaired and the ageing of trade receivables that were past due but not impaired as at 31 July 2018 is as follows:
Age of receivables that are past due but not impaired:
Trade and other receivables that are neither past due nor impaired are considered to be of good credit quality.
Past due but not impaired
Expected credit loss assessment for trade receivables and contract assets
The allowance for impairment of trade receivables and contract assets is created to the extent and as and when required, based upon the expected collectability of accounts receivables. The Group uses a provision matrix to measure the ECLs of trade receivables and contract assets.
Loss rates are calculated using a ‘roll rate’/‘flow rate’ method based on the probability of a receivable progressing through successive stages of delinquency to write-off. Roll rates/flow rates are calculated separately for exposures in different industry segments based on the common credit risk characteristics.
The calculation reflects the probability-weighted outcome, the time value of money and reasonable and supportable information that is available at the reporting date about past events, current conditions and forecasts of future economic conditions.
A default event is considered to have occurred when aged 90 days. Trade receivables and contract assets are written off when there is no reasonable expectation of recovery. Indicators that there is no reasonable expectation of recovery include, among others, the failure of a debtor to engage in a repayment plan with the entity, and a failure to make contractual payments for a period of greater than 90 days past due.
The following table provides information about the exposure to credit risk and ECLs for trade receivables and contract assets as at 31 July 2019:
Loss rates are based on actual credit loss experience over the past 23 months. These rates are multiplied by scalar factors to reflect differences between current and historical economic conditions and the Groupís view of economic conditions over the expected lives of the receivables. Scalar factors are based on actual and forecast inflation, interest rates, industrial production and gasoline prices. The historical loss experience was also adjusted for the projected cash flows based on the risk grading of the receivables between receiving, recoverable, generic, legal, business rescue and write-off. Each of these risk gradings has a weighted average loss rate percentage of 3,2%, 7,7%, 17,9%, 45,7%, 64,1% and 100% respectively.
Movements in the allowance for impairment in respect of trade receivables and contract assets:
Trade receivables with a contractual amount of R52 million were written off during 2019.
The Group maintains its cash and cash equivalents with banks and financial institutions having good reputation, good past track record and high
quality credit rating and also reviews their credit-worthiness on an ongoing basis.
Finance lease receivables
The policy choice is to measure the loss allowance at an amount equal to lifetime expected credit losses.
Other financial assets
Other financial assets are very specific assets and were assessed individually for impairment, using the general approach under IFRS 9. Specific assessments were over GCT, TTCS and ED loans, which make up the other financial assets.
The Group operates internationally but has limited exposure to foreign exchange risk arising from various currency exposures, primarily with respect to the US Dollar, the Euro and the British Pound, as well as other currencies.
Foreign exchange risk arises from future commercial transactions, recognised assets or liabilities that are denominated in a currency that is not the entity’s functional currency and net investments in foreign operations. The Group has limited investments in foreign operations, where the assets are exposed to foreign currency translation risk. Currency exposure arising from net assets of the group’s foreign operations will have no effect on the post-tax profit as the effect of the translation is recognised directly in the foreign currency translation reserve. As at 31 July 2019, if the foreign entities local currencies had weakened or strengthened by 5% against the Rand, with all other variables held constant, the impact on equity for the Group would have amounted to R16 million (2018: R26 million).
Financial assets and financial liabilities are analysed by currency as follows: