Financing and treasury
Smiths Group operates a centralised treasury system to manage the financial risks of the group. The objectives of our treasury function are to manage the liquidity needs of the businesses cost-effectively, to provide appropriate funding for supporting capital expenditure (including business acquisitions) and to protect the group from the effect of foreign currency and interest rate fluctuations.

These objectives are achieved through detailed treasury policies approved by the Board, and compliance with these is reported annually to the Audit Committee. The strong financial disciplines and lower than average business risks in the Smiths Group were recognised by both Standard & Poors and Moody's credit ratings agencies when – following the merger – they aligned the credit rating for the group at A- and A3 respectively.

The treasury function provides services to the group within a strong control environment. Derivative financial instruments are used in specific hedging circumstances and any trading or speculating is strictly prohibited.

Borrowings: Our funding requirements are largely driven by acquisition activity and met by centrally arranged debt finance. This is lent through to the relevant subsidiary on inter-company loans at commercial arm's length terms. Our strong cash generation in the businesses is tax-efficiently remitted to the UK to repay central borrowings. Local working capital needs and capital expenditure requirements are typically funded by local bank facilities, which are not guaranteed by the parent company.

The borrowings in the former TI Group increased rapidly in recent years through extensive acquisitions. Since the merger, debt has been greatly reduced from £1.76bn at the time of merger to £1.12bn at the year-end.

Shortly after the year-end, the two TI Group syndicated loans were integrated into a single Smiths Group facility of £500m, with all major bank borrowings now drawn by Smiths Group plc.

The current net debt level of £1.12bn represents four times free cash-flow, and 'ongoing' EBITDA interest cover is more than eight times – comfortably within credit rating parameters. Our average interest cost in the year was nearly 7%, due to a large proportion of the TI Group debt being fixed. We have taken action to ensure that, going forward, we will benefit from the current low level of global interest rates. We seek to keep our debt broadly evenly split between fixed and floating rate funds, as demonstrated in note 22 to the Accounts.

Liquidity: Cash in hand at year-end was £117m and is available for redeployment within the group. Borrowings are evenly balanced between listed debt and bank facilities.

Our new Smiths Group syndicated bank facility of £500m runs until 2004. US private placements provide $160m of finance, with $100m repayable in 2002 and $60m by 2003. In addition to these facilities, we have £236m committed but undrawn credit lines. The maturity profile of our bonds is well spread, maturing in 2005, 2010 and 2016.

Currency: All material cross-border trading contracts or forecast commitments are hedged at inception by appropriate derivative financial instruments, with our core banks as counterparties. We take competitive quotes on all major foreign exchange contracts through our central foreign exchange programme. For smaller deals, we have centralised the entire group's foreign exchange dealings through a foreign exchange trading system based on the internet and operated by a major bank.

We protect our reserves from foreign currency fluctuation by ensuring that at least 75% of the total net overseas operational assets are offset, either by borrowings in the respective currency or by currency swaps. We do not hedge the translation of our overseas profits, although we mitigate currency effects through our foreign interest costs and by applying average exchange rates for the year.

Pensions
The company's principal pension schemes are in the UK and the US. The most recent actuarial valuations for the principal schemes were April 1999 and March 1998 in the UK and July 2000 and December 2000 in the US. In aggregate at these dates, assets exceeded liabilities by 19%.

The company calculates pension expense under SSAP24. The surplus is amortised over the members' estimated remaining working lives, reducing the company's pension cost.

All pension and post-retirement healthcare plans have additionally been actuarially reviewed at July 2001 under the new FRS17 methodology. Note 12 fully discloses the funding position, with an overall surplus of £319m. In 2002 the full effect of FRS17 will be shown as a note, and this accounting treatment will replace SSAP24 in 2003. The greatest effect is presentational, with operating profit bearing the full cost of pensions as if there were no surplus. The benefit of the surplus will be shown as a financing gain adjacent to interest in the Profit and Loss Account.

The main pension schemes have matched their liabilities with substantial bond holdings. As a consequence, the schemes are less affected by falls in the equity market and/or interest rates than is generally the case, which gives the Profit and Loss charge some protection against volatility.

Accounting Standards
During the year FRS18 (Accounting Policies) came into force. The Group's accounting policies complied with FRS18 without change. The Group has made the new disclosures required by FRS17 (Retirement Benefits). Next year FRS19 (Deferred Taxation) will be in force. As already explained we have made steps towards the required disclosures.

Alan Thomson
Financial Director