Note 5. Financial risk management

5.1 Financial risk factors

In its business activities the Group is exposed to different financial risks: market risk (including currency risk, price risk, cash flow interest rate risk and fair value interest rate risk), credit risk and liquidity risk. The Group’s financial risk management focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group’s financial performance. The Group uses derivative financial instruments to hedge certain risk exposures.

The Group’s financial risks are managed under the control and supervision of the Management Board by the financial department. Financial department identifies, evaluates and manages financial risks in co-operation with the Group’s operating units.

Market risk

Foreign exchange risk

Foreign exchange risk arises when future commercial transactions or recognised assets or liabilities are denominated in a currency that is not the entity’s functional currency. The Group’s foreign exchange risk is related to purchases done and amounts owed in foreign currencies.

Majority of Group’s purchases are made in euros. The proportion of purchases in other currencies in 2015 was 2.7% (2014: 2.0%). Because of the small proportion of transactions in foreign currencies the Group has not taken any special activities to reduce this risk.

On 31 December 2015 the Group’s bank accounts balances (including deposits) totalled EUR 37,819 thousand (31 December 2014: EUR 38,560 thousand) from which no sums were in foreign currencies (31 December 2014: no foreign currencies). There were no other significant exposures to foreign currencies arising from Group’s other financial assets and financial liabilities.

Due to the above the Group considers its currency risk level to be low.

Price risk

The Group has no price risk regarding financial instruments because it has no investments into equity instruments.

Cash flow interest rate risk and fair value interest rate risk

Fair value interest rate risk is the risk that the fair value of financial instruments will fluctuate in the future due to changes in market interest rates. Cash flows interest rate risk is the risk that financial expenses arising from financial liabilities with floating interest rate will increase when interest rates on the market increase.

The Group’s interest rate risk arises mostly from long-term borrowings. Borrowings issued at variable interest rates (Note 10) expose the Group to cash flow interest rate risk. The Group’s policy is to maintain approximately 80% of its borrowings at fixed rate. In order to mitigate the cash flow interest rate risk, the Group has concluded 6 (2014: 6) floating-to-fixed interest rate swap contracts (Note 8). As of 31 December 2015 the interest rate swap contracts have the notional amount of EUR 75 million (31 December 2014: EUR 90 million with one contract in amount of EUR 15 million becoming effective in November 2015), therefore only borrowings in the amount of EUR 19.9 million from total of EUR 94.9 million (31 December 2014: EUR 19.9 million from total of EUR 94.9 million) remain exposed to the cash flow interest rate risk.

As of 31 December 2015, if the interest rates of the Group’s borrowings, that are exposed to the cash flow interest rate risk, had been 50 basis points (31 December 2014: 50 basis points) higher with all other variables held constant, profit for the year would have been EUR 102 thousand (2014: EUR 97 thousand) lower.

Overnight and fixed term deposits have fixed interest rate and therefore expose the Group to fair value interest rate risk. As all these instruments are carried at amortised cost, the change in market interest rates would not have an effect on the financial statements of the Group.

Credit risk

Credit risk expresses potential loss that can arise if counterparty fails to fulfil its contractual obligations. Cash in bank accounts and deposits, financial assets at fair value through profit and loss, trade and other receivables are exposed to credit risk.

According to the Group’s risk management policies the Group’s short term resources can be deposited only in accounts, overnight deposits and fixed term deposits opened in credit institutions. For fixed term depositing counterparties with at least a long term Baa1 rating (by Moody’s) is used. As of 31 December 2015 100% of Group’s fixed term deposits were deposited with counterparty with higher rating than A3 (31 December 2014: 100% higher than A3). The Group is also monitoring European Banking Authority’s recommendations regarding banks’ recapitalization needs and fixed term deposits are opened only in banks with no capitalization shortfall.

Sales of Group’s products and services is done in compliance with internal procedures. To reduce credit risk related to accounts receivable the customers’ payment discipline is consistently observed. In the case of overdue debt the clients are contacted by billing group. As of the end of December 2015 there were no clients (31 December 2014: one client) with receivables (Note 23) exceeding 5% of total trade receivables.

The Group’s maximum credit risk is equal to the carrying amount of the financial assets and is considered to be low.

Liquidity risk

Liquidity risk is the risk that the Group is unable to fulfil its financial obligations due to insufficient cash funds or inflows. This risk realizes when the Group does not have enough funds to serve its loans, to fulfil its working capital needs, to invest and/or to make declared dividend payments.

In liquidity risk management the Group has taken a prudent view, maintaining sufficient cash balance and short term deposits to be able to fulfil its financial liabilities at every moment of time. Continuous cash flow forecasting and control are essential tools in the day-to-day liquidity risk management of the Group.

5.2 Capital management

The Group’s objectives when managing capital is to safeguard the Group’s ability to continue as a going concern, to be in accordance with Business Plan’s capital structure approved by Supervisory Board and the long-term borrowing contracts that limit the Group’s equity ratio to a minimum of 35% of the total assets.

The Group monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (Note 10; including ‘current and non-current borrowings’ as shown in the consolidated Statement of financial position) less cash and cash equivalents (Note 6). Total capital is calculated as ‘equity’ as shown in the consolidated Statement of financial position plus net debt.

5.3 Fair value estimation

Fair values of cash and cash equivalents, trade receivable, other long-term receivables, short-term borrowings and trade payable do not vary significantly from their carrying amount because their realization will take place within 12 months or these were recognised close to the balance sheet date. The fair values of the government grant receivables have been measured using unobservable inputs (level 3) (Note 4).

At the end of 2015 all Group’s long-term borrowings had floating interest rates. The fair values of long-term borrowings are based on discounted cash flows using the borrowing rate of 0.95% (2014: 0.97% - 1.12%) and are within level 3 of the fair value hierarchy. As of 31 December 2015, the fair value of the Group’s long-term borrowings was EUR 150 thousand higher than their carrying amount (31 December 2014: EUR 68 thousand higher).

The fair value of financial instruments carried at fair value (interest rate swap contracts, Note 8) has been determined by using valuation techniques. These valuation techniques maximise the use of observable market data where it is available and rely as little as possible on entity specific estimates. If all significant inputs required to fair value an instrument are observable, the instrument is included in level 2. The fair value of interest rate swap contracts is calculated as the present value of estimated future cash flows based on observable yield curves.