|41.||FINANCIAL ASSETS AND FINANCIAL LIABILITIES|
Financial risk management and fair value disclosures
The Group's 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 Group's 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 Group's 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 2020:
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 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 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.
Fair values have been determined using discounted cash flows. Unobservable inputs include budgeted results based on margins, discount rates and revenue growth rates historically achieved by the various segments. The applicable discount rate is 7%, discounting cash flows over a two-year period. Changing such inputs to reflect reasonably possible alternative assumptions does not significantly change the fair value of the vendors for acquisition liability.
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 R1 033 million (2019: R856 million). These fair values are categorised as level 3, based on inputs used.
Gains or losses from continuing operations
Capital risk management
The Group recognises as part of its strategic intent an appropriate capital structure is required to ensure both sustainability of the business and to leverage growth opportunities.
The Group has a historically large debt burden which is not fit for purpose in terms of its capital structure. The stated objective of the Group has been to deleverage the Group to an appropriate capital structure. The deleverage process has primarily been done by disposing of non-core assets and certain IP assets (as disclosed in note 16). The Group is targeting a 70% equity to 30% debt ratio. Significant progress has been made in this regard over the past year.
While the Group is focused on creating a fit for purpose capital structure the full focus has been on deleveraging. Appropriate funding for the business has also been a key focus.
In terms of allocating capital within the business the Group looks at Return on Invested Capital metrics (ROIC) to allocate capital. This is measured against the Group's discount rate of 12.6%, to ensure there is value creation whereby ROIC needs to exceed the discount rate.
The debt to equity ratios were as follows:
Refer to note 42 which provides further discussion surrounding the EOH Group debt reduction strategy.
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.
During the financial period PiA Solar SA Proprietary Limited had breached its debt covenant requirements. As a result, the related borrowing of R132 million has been classified as current within the Group's statement of financial position.
Subsequent to the reporting date the Group has entered into agreements with its lenders, refer to note 42 for further information thereon.
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 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 Rands.
The Group analyses its interest rate exposure on an ongoing basis. The Group does not hedge against fluctuations in interest rates.
At 31 July 2020, if the interest rate on Rand-denominated borrowings had been 1% higher/lower with all other variables held constant, pre-tax profit for the year would have been R26 million (2019: R30 million) lower/higher, 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 contract assets 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 among 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 held.
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 receivable. The Group uses a provision matrix to measure the ECLs of trade receivables and contract assets.
Loss rates as per the provision matrix 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 exposure to credit risk table presents the gross carrying amount of trade debtors and contract assets by industry together with the associated expected credit loss.
The calculation reflects the probability-weighted outcome 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 or beyond. 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 2020:
The following table provides information about the exposure to credit risk and ECLs for trade receivables and contract assets as at 31 July 2019:
The expected loss rate by industry is based on payment profiles of sales over a 11-month period respectively and the corresponding historical credit losses experienced within this period. These loss rates are adjusted to reflect a deterioration in the risk of the customer and macro-economic overlay affecting the ability of the customers to settle the receivables. The macro-economic overlay is based on the difference in default rates during 2008-2010 financial crisis versus a financial non-crisis period and applied to the portion of each industry that is expected to be affected by the COVID-19 crisis (this industry expectation is taken from Fitch).
Movements in the allowance for impairment in respect of trade receivables and contract assets:
Trade receivables with a contractual amount of R158 million (2019: R52 million) were written-off during the year.
Cash and cash equivalents
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 on-going basis.
Due to the short-term nature of these assets and historical experience, cash and cash equivalents are regarded as having a low probability of default and therefore the related expected credit loss is deemed to be insignificant. However, a cash balance held within a Zimbabwe bank account, related to Twenty Third Century Systems, which has been fully provided for during the 2019 financial year at R50 million, this was due to the risk of changes in currency within Zimbabwe of the bank balance and the difficulty in getting the funds at that time.
The risk rating grade (Moody's) of cash and cash equivalents for the current year are set out below. Given these credit ratings, management does not expect any counterparty to fail to meet its obligations.
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 specific assets and were assessed individually for expected credit losses, using the general approach under IFRS 9 raising a life-time expected credit loss. The expected credit loss model of IFRS 9 requires the classification and measurement of expected credit losses using the general model is a three-stage model. The three stages are performing (stage 1), underperforming (stage 2) and non-performing (stage 3). Management evaluates the credit worthiness of counterparties on an ongoing basis, taking into account their financial position, past experience and other relevant factors that may indicate whether there is a significant increase in credit risk.
Allowances have been raised considering the probability of default by the borrower.
Expected credit losses have been raised for a significant portion of other financial assets, as explained in note 8. The balance of other financial assets comprises amounts receivable from the sale of Construction Computer Software Proprietary Limited and Change Logic CS Proprietary Limited, both of which have settled subsequent to the reporting period. Given the credit losses of banking institutions, restricted cash balances are not exposed to a significant increase in credit risk. Specific assessments were performed on loans provided to equity-accounted entities and Enterprise Development loans.
Movements in the allowance for impairment in respect of 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.
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 Groups strategy to dispose of non-core business lines has resulted in the sale of the majority of its foreign investments. The Group has limited investments in foreign operations where the assets are exposed to foreign currency translation risk.
Financial assets and financial liabilities are analysed by currency as follows:
Foreign currency financial instruments