Annual Report 2016
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VI. ADDITIONAL DISCLOSURES ON FINANCIAL INSTRUMENTS

Financial instruments – Carrying amounts and fair values by measurement category:

ASSETS
Balance sheet item / Class (€ thousands) Measurement category Initial / subsequent measurement Carrying amount
31 Dec. 2016
Fair value
31 Dec. 2016
Carrying amount
31 Dec. 2015
Fair value
31 Dec. 2015
Non-current assets
Other investments n / a Amortised cost 5,401 5,074
Non-current financial instruments AfS Fair value 667 667 668 668
Loans LaR Fair value / Amortised cost 2,458 2,458 2,219 2,219
             
Current assets      
Trade receivables LaR Fair value / Amortised cost 504,595 504,595 524,610 524,610
Trade receivables from other investments, associates and joint ventures LaR Fair value / Amortised cost 33,576 33,576 36,193 36,193
Receivables from loans to other investments, associates and joint ventures LaR Fair value / Amortised cost 13,578 13,578 3,189 3,189
Receivables recognised by PoC, net LaR Fair value / Amortised cost 76,122 76,122 102,937 102,937
Currency forwards used as hedges n / a Fair value 2,170 2,170 1,978 1,978
Other receivables and other current assets LaR Fair value / Amortised cost 171,247 171,247 151,002 151,002
Cash and cash equivalents LaR Fair value / Amortised cost 288,883 288,883 273,136 273,136
Equity and Liabilities
Balance sheet item / Class (€ thousands) Measurement category Initial / subsequent measurement Carrying amount
31 Dec. 2016
Fair value
31 Dec. 2016
Carrying amount
31 Dec. 2015
Fair value
31 Dec. 2015
Non-current liabilities            
Financial liabilities excluding finance lease liabilities FLAC Fair value / Amortised cost 57,269 55,803 132,550 130,942
Finance lease liabilities n / a Under IAS 17 693 699 954 982
           
Current liabilities            
Financial liabilities excluding finance lease liabilities FLAC Fair value / Amortised cost 119,457 119,457 43,880 43,880
Finance lease liabilities n / a Under IAS 17 501 561 436 446
Trade payables FLAC Fair value / Amortised cost 210,813 210,813 238,848 238,848
Advances received from customers (PoC) FLAC Fair value / Amortised cost 44,046 44,046 49,418 49,418
Interest rate swaps used as hedges n / a Fair value 435 435 745 745
Currency forwards used as hedges n / a Fair value 11,203 11,203 6,843 6,843
Miscellaneous other financial liabilities
(purchase price liability)
FLAC Fair value / Amortised cost 3,506 3,506
Miscellaneous other financial liabilities FLAC Fair value / Amortised cost 33,722 33,722 25,399 25,399
Thereof aggregated by category
in accordance with IAS 39
Loans and receivables LaR Fair value / Amortised cost 1,090,459 1,090,459 1,093,286 1,093,286
Available-for-sale financial instruments AfS Fair value 667 667 668 668
Financial liabilities measured at amortised cost FLAC Fair value / Amortised cost 465,307 463,841 493,601 491,993

The carrying amount of financial assets measured at amortised cost, with the exception of non-current loans, approximates fair value. This is also the case for all financial liabilities shown on the balance sheet, with the exception of non-current financial liabilities. This is mainly due to the short maturities of these financial instruments.

The fair values of non-current financial liabilities are determined as the present value of the cash flows associated with the liabilities. We apply an appropriate yield curve to arrive at this present value.

The fair values of the current and non-current financial instruments presented in the table above are based on prices quoted in active markets (level 1). The fair values of currency forwards and interest rate swaps are determined on the basis of input factors observable indirectly (i.e. derived from prices, level 2). Level 3 includes financial instruments whose fair value is determined on the basis of inputs not based on observable market data. Foreign exchange derivatives are measured using forward exchange rates. For interest rate swaps the fair value is determined through the discount rate of future expected cash flows based on the market interest rates and yield curves that apply to the remaining term of the contracts.

The following table shows the financial assets and liabilities, as well as loans and receivables, measured at fair value on a recurring basis, broken down into measurement categories and the previously described hierarchy levels. There were no reclassifications carried out during the year under review.

PRESENTATION OF HIERARCHY LEVELS 2016
(€ thousands) Level 1 Level 2 Level 3 Total
Financial assets recognised at fair value
Current financial instruments 667 667
Currency forwards 2,170 2,170
Financial liabilities recognised at fair value
Currency forwards 11,203 11,203
Interest rate swaps 435 435
Loans and receivables measured at amortised cost
Loans 2,458 2,458
Trade receivables 504,595 504,595
Receivables from other investments, associates and joint ventures 47,154 47,154
Receivables recognised by PoC (inc. advances received from customers PoC) 76,122 76,122
Other receivables and other current assets 171,247 171,247
Cash and cash equivalents 288,883 288,883
Financial liabilities measured at amortised cost
Financial liabilities excluding finance lease ­liabilities 175,260 175,260
Trade payables 210,813 210,813
Advances received from customers (PoC) 44,046 44,046
Miscellaneous other financial liabilities 33,722 33,722
PRESENTATION OF HIERARCHY LEVELS 2015
(€ thousands) Level 1 Level 2 Level 3 Total
Financial assets recognised at fair value
Current financial instruments 668 668
Currency forwards 1,978 1,978
Financial liabilities recognised at fair value
Currency forwards 6,843 6,843
Interest rate swaps 745 745
Loans and receivables measured at amortised cost
Loans 2,219 2,219
Trade receivables 524,610 524,610
Receivables from other investments, associates and joint ventures 39,382 39,382
Receivables recognised by PoC
(inc. advances received from customers PoC)
102,937 102,937
Other receivables and other current assets 151,002 151,002
Cash and cash equivalents 273,136 273,136
Financial liabilities measured at amortised cost
Financial liabilities excluding finance lease liabilities 174,822 174,822
Trade payables 238,848 238,848
Advances received from customers (PoC) 49,418 49,418
Miscellaneous other financial liabilities 25,399 3,506 28,905

Fair values within level 1 are determined from the capital market quotations.

Fair values within level 2 are determined based on a discounted cash flow method. Future cash flows from currency forwards are estimated on the basis of forward exchange rates (observable rates on the reporting date) and the contracted forward exchange rates, and are discounted with an adequate interest rate. Future cash flows from interest rate swaps are estimated on the basis of forward interest rates (observable interest structure curves on the reporting date) and the contracted interest rates, and are discounted with an adequate interest rate. Specific contractual regulations formed the basis for calculating the Level 3 fair values of other financial liabilities measured at amortised cost.

The net gains and losses from financial instruments, after taking into account the relevant tax effect, are presented in the following table:

NET RESULTS BY MEASUREMENT CATEGORY IN 2016
From subsequent measurement
(€ thousands) From interest and dividends At fair value Currency translation Impairment losses From disposal Net results
LaR 6,357 – 1,029 – 6,815 – 1,487
AfS 161 – 87 74
FLAC – 7,607 2,636 – 4,971
– 1,089 1,607 – 6,815 – 87 – 6,384
NET RESULTS BY MEASUREMENT CATEGORY IN 2015
From subsequent measurement
(€ thousands) From interest and dividends At fair value Currency translation Impairment losses From disposal Net results
LaR 7,635 – 231 – 1,658 – 107 5,639
AfS 18 – 2 16
FLAC – 7,314 – 2,842 – 10,156
339 – 3,073 – 1,660 – 107 – 4,501

The interest shown is a component of financial income / expense. The effect from the application of the effective interest rate method is immaterial here as the interest expenses are virtually offset by the resulting interest income. The other gains and losses are partly reported in other income and other expenses.

The AfS measurement category resulted in a remeasurement value of € – 4 thousand (previous year: € 0 thousand), which was recognised directly in other comprehensive income and reported under “Change in the fair value of financial instruments” in equity. In the year under review, € 0 thousand (previous year: € 0 thousand) was withdrawn from equity or realised.

The amount of financial assets and liabilities subject to offsetting agreements is not material.

Financial risks

We are exposed to certain financial risks as a consequence of our business activities. These risks can be classified into three areas:

On the one hand, we are exposed to credit risk. We define credit risk as potential default or delays in the receipt of contractually agreed payments. We are also exposed to liquidity risk, which is the risk that an entity will be unable to meet its financial obligations, or will be unable to meet them in full. Finally, we are exposed to market risk. The risk of exchange rate or interest rate changes may adversely affect the economic position of the Group. Risks from fluctuations in the prices of financial instruments are not material for us.

We limit all of these risks through an appropriate risk management system, and define how these risks are addressed through guidelines and work instructions. In addition, we monitor the current risk characteristics continuously and regularly provide the information obtained in this way to the Board of Management and the Supervisory Board in the form of standardised reports and individual analyses.

The three risk areas are described in detail in the following. Additional information is also provided in the group management report, in particular in the Economic Review, Report on Expected Developments, Opportunities and Risks Report sections.

Credit risk

The primary credit risk is that there is a delay in settling a receivable, or that it is not settled either in full or in part. We minimise this risk using a variety of measures. As a matter of principle, we run credit checks on potential and existing counterparties. We only enter into business relationships if the results of this check are positive. Additionally, our European companies in particular take out trade credit insurance policies. As in the previous year, these policies account for around 10 % of the Group’s trade receivables in total. In exceptional cases we accept other securities (collateral) such as guarantees. The insurance policies primarily cover the risk of loss of receivables. Moreover, we also take out cover against political and commercial risks in the case of certain customers in selected countries. For both types of insurance, we have agreed deductibles, which represent significantly less than 50 % of the insured volume. As part of our receivables management system, we continuously monitor outstanding items, perform maturity analyses and establish contact with customers at an early stage if delays in payment occur. In the case of major projects, our terms and conditions provide for prepayments, guarantees and – for export transactions – letters of credit. These also mitigate risk. Impairment losses are recognised for the residual risk remaining in trade receivables. We examine regularly the extent to which individual receivables need to be written down for impairment. Indications of this are significant financial difficulties of the debtor, such as insolvency or bankruptcy. We also cover the credit risk of receivables that are past due by providing for the risk involved on the basis of historical loss experience. Receivables are derecognised if it is reasonably certain that receipt of payment cannot be expected (for example, after completion of insolvency or bankruptcy proceedings).

Impairment losses on trade receivables are the only material impairment losses in the KSB Group. They changed as follows:

(€ thousands) 2016 2015
Opening balance at 1 January 35,560 35,905
Additions 9,776 10,310
Utilised – 4,614 – 2,197
Reversals – 5,818 – 8,990
Changes in consolidated Group / CTA* / Other – 374 532
Closing balance at 31 December 34,530 35,560
* CTA = Currency translation adjustments

The maturity structure of trade receivables is as follows:

(€ thousands) 31 Dec. 2016 31 Dec. 2015
Receivables that are neither past due nor individually impaired 364,733 398,135
Receivables that are past due but not individually impaired
1 to 30 days 49,802 44,810
31 to 90 days 29,827 32,146
91 to 180 days 16,590 10,289
> 180 days 30,716 11,622
Total 126,935 98,867
Receivables individually determined to be impaired 12,927 27,608
Receivables individually determined to be impaired at their principal amount 47,457 63,168
Specific write-downs 34,530 35,560
Carrying amount (net) 504,595 524,610

With regard to the trade receivables that are neither past due nor individually impaired, there are no indications at the reporting date that our debtors will not meet their payment obligations. The same applies to all other financial instruments.

The maximum default risk, excluding collateral received, corresponds to the carrying amount of the financial assets.

There is no concentration of risk because the diversity of our business means that we supply a considerable number of customers in different sectors.

Liquidity risk

Our liquidity management ensures that we minimise this risk in the Group and that our solvency is ensured at all times. There are no concentrations of risk because we work together with a number of credit institutions, on which we impose strict creditworthiness requirements.

We generate our financial resources primarily from our operating business. We use them to finance investments in non-current assets. We also use them to cover our working capital requirements. To keep these as low as possible, we monitor changes in our receivables, inventories and liabilities regularly using a standardised Group reporting system.

The reporting system additionally ensures, with the help of monthly rolling cash flow planning, that the Group’s centralised financial management is continuously informed about liquidity surpluses and requirements. This enables us to optimally meet the needs of the Group as a whole and of the individual companies. For selected companies we use a cash pooling system to ensure that available cash is deployed optimally within the Group. We also apply a worldwide receivables netting procedure within the KSB Group so as to minimise both the volume of cash flows and the associated fees. In order to be able to provide the necessary collateral in the project business, corresponding guarantee volumes are made available. Adequate proportions are confirmed for a period of more than one year. In addition, we always ensure that credit facilities are sufficient; we identify the need for these on the basis of regular liquidity plans. In this way we can react to fluctuating liquidity requirements at all times. Our approved cash loans and credit lines total approximately € 969 million (previous year: approx. € 940 million), of which € 648.1 million has not yet been utilised (previous year: € 627.7 million).

The following tables show the contractually agreed non-discounted future cash flows of the financial liabilities (primary financial instruments) and derivative financial instruments. Interest payments on fixed-rate liabilities are determined on the basis of the fixed rate. Floating-rate interest payments are based on the last floating interest rates fixed before 31 December. Projections for future new liabilities are not included in the presentation. Based on our current state of knowledge, it is neither expected that the cash flows will take place significantly earlier, nor that the amounts will differ significantly.

CASH FLOWS OF FINANCIAL LIABILITIES 2016

(€ thousands) Total Up to 1 year 1 – 5 years > 5 years
Financial liabilities 190,914 127,826 39,477 23,611
Trade payables 210,813 210,813
Miscellaneous other financial liabilities 33,722 29,801 3,921
Derivative financial instruments
Incoming payments
– 3,094 – 2,718 – 376
Derivative financial instruments
Outgoing payments
12,562 11,000 1,493 69
444,917 376,722 44,515 23,680

CASH FLOWS OF FINANCIAL LIABILITIES 2015

(€ thousands) Total Up to 1 year 1 – 5 years > 5 years
Financial liabilities 191,227 48,386 118,138 24,703
Trade payables 238,848 238,848
Miscellaneous other financial liabilities 28,905 26,610 2,295
Derivative financial instruments
Incoming payments
– 1,877 – 1,683 – 194
Derivative financial instruments
Outgoing payments
7,487 5,542 1,881 64
464,590 317,703 122,120 24,767
Market price risk

Our global business activities expose us primarily to currency and interest rate risk. Any changes in market prices can affect fair values and future cash flows. We use sensitivity analyses to ­determine the hypothetical impact of such market price fluctuations on profit and equity. In doing so, we assume that the portfolio at the reporting date is representative for the full year.

We reduce the risks resulting from changes in prices on the procurement side for orders with extended delivery dates by agreeing cost escalation clauses or, in the case of fixed-price contracts, by including the expected rate of cost increases in our sales price.

Currency risk mainly affects our cash flows from operating activities. It arises when Group companies settle transactions in currencies that are not their functional currency. We minimise this risk using currency forwards and, on rare occasions, options. You will find further information on this in the “Derivative financial instruments” section of the Notes. We use micro hedges with regard to both transactions already recognised and cash flows that are expected in the future with a high degree of probability. The hedging instruments used share the essential terms and conditions with the underlying transactions, i.e. with regard to amount, term and quality. Internal guidelines govern the use of financial instruments. Such transactions are also subject to ongoing risk control measures. The hedging instruments used are exclusively currency forwards entered into with prime-rated banks. In order to measure the effectiveness of our hedges, the market values of the underlying and the hedge transactions are compared. Changes in the market values of the derivatives are offset by changes in the fair values of the cash flows from the underlyings (hypothetical derivative method). As a rule, we do not hedge currency risks from the translation of foreign operations into the Group currency (€).

At the reporting date, the notional volume of all currency forwards was € 269,794 thousand (previous year: € 253,980 thousand), and the notional volume of all interest rate derivatives was € 39,500 thousand (previous year: € 39,500 thousand). The contractual maturities of payments for currency forwards and interest rate derivatives are as follows:

Notional volumes 2016

(€ thousands) Total Up to 1 year 1 – 5 years > 5 years
Currency forwards 269,794 203,390 670 65,704
Interest rate derivatives 39,500 39,500
309,294 242,890 670 65,704

Notional volumes 2015

(€ thousands) Total Up to 1 year 1 – 5 years > 5 years
Currency forwards 253,980 236,311 17,448 221
Interest rate derivatives 39,500 39,500
293,480 236,311 56,948 221

Equity includes changes in the fair value of derivatives used to hedge future cash flows amounting to € – 6,644 thousand (previous year: € – 5,026 thousand). They changed as follows:

(€ thousands) 2016 2015
Opening balance at 1 January – 5,026 – 8,104
Changes in consolidated Group / CTA* / Other 8 – 32
Disposals 948 5,552
Additions – 2,574 – 2,442
Closing balance at 31 December – 6,644 – 5,026
* CTA = Currency translation adjustments

The main currencies in the KSB Group are the Chinese yuan (CNY) and US dollar (USD). For the currency sensitivity analysis, we simulate the effects based on the notional volume of our existing foreign currency derivatives and our foreign currency receivables and liabilities at the reporting date. For the analysis, we assume a 10 % increase (decrease) in the value of the euro versus the other currencies. In the reporting year, this would have amounted to approximately € 2.0 million for CNY (previous year: € 2.7 million) and € 1.2 million (previous year: € 2.2 million) for USD.

CNY 31 Dec. 2016 CNY 31 Dec. 2015 USD 31 Dec. 2016 USD 31 Dec. 2015
Trade receivables € 66.7 million € 73.4 million € 26.4 million € 36.1 million
Trade payables € 46.6 million € 46.0 million € 14.9 million € 13.8 million
Balance € 20.1 million € 27.4 million € 11.5 million € 22.3 million

Based on the measurement of derivatives, at the reporting date, equity and the fair value of the derivatives would have been € 11.3 million lower (higher), with € 8.7 million resulting from USD and € 2.6 million from the other currencies. At the previous year’s reporting date, equity and the fair value of the derivatives would have been € 8.5 million lower (higher), with € 6.4 million resulting from USD and € 2.1 million from the other currencies.

We regularly monitor the interest rate risks associated with our financing activities. To avoid the negative effects of interest rate fluctuations on the international capital markets, we conclude interest rate hedges (interest rate swaps) where necessary, generally for long-term loans. These are used exclusively to hedge floating rate loans against rising interest rates.

As part of our interest rate sensitivity analysis, we simulate a 50 basis point increase (decrease) in market interest rates and analyse the impact on the floating rate financial instruments. In 2016, the net interest balance would have been € 2.0 million (previous year: € 1.8 million) higher (lower). Changes in the fair value of interest rate derivatives used to hedge floating rate liabilities increase (decrease) equity by € 0.1 (0.1) million (previous year: € 0.3 (0.3) million).

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