TI AUTOMOTIVE
Smiths continues to hold, at cost, £325m of preference shares in TI Automotive, which was demerged in July 2001. No preference dividend has been received or accrued in 2004.

GEOGRAPHICAL SPREAD AND EXCHANGE RATES
The geographical analysis of ongoing operations is largely unchanged from 2003.

	Sales	Profits
United Kingdom	26%	13%
North America	52%	61%
Continental Europe	15%	19%
Rest of World	7%	7%

The key exchange rates affecting the Group are the US dollar and the Euro. The table below shows the average and year-end rates for these currencies.

	£1 = US$	£1 = Euro
Average
2004	1.75	1.46
2003	1.59	1.51
£ (stronger)/weaker	(10%)	3%
Year–end
2004	1.82	1.51
2003	1.61	1.43
£ (stronger)/weaker	(13%)	(6%)

The effect of the decline in the average value of the US dollar outweighed the effect of the stronger Euro, as would be expected from the geographic weighting of the business. The net translation effect was to reduce sales by £137m and operating profits by £20m. A movement of 1 cent in the US dollar affects profit by approximately £1.4m. Exposure on export transactions after hedging is not material.

Information on the impact of hedging foreign exchange translation is contained in the Treasury section below.

COST OF CAPITAL AND RETURN ON INVESTMENT
The Company uses its weighted average cost of capital as one measure to appraise both internally-generated investment opportunities and acquisitions. During 2004, the Company's weighted average cost of capital for the year remained at 8%.

The after-tax return before goodwill amortisation and exceptional items on average shareholder investment, including goodwill set off against reserves was 11% compared with 12% last year and continues to exceed the weighted average cost of capital.

RETIREMENT BENEFITS
The Company applies the full accounting requirement of FRS17 to calculate its pension expense. FRS17 is a more prescriptive accounting treatment than SSAP24, and we consider that the greater transparency and consistency offered are significant benefits.

Under FRS17, the Group's accounts reflect the net surplus/deficit in retirement benefit plans, taking assets at their market values at 31 July and evaluating liabilities by discounting at year-end AA corporate bond interest rates.

The table below gives an analysis of the Company's year-end net liabilities.

	2004 £m	2003 £m
Funded plans
Assets	2,558	2,468
Liabilities	(2,686)	(2,776)
Deficit	(128)	(308)
Average funding level	95%	89%
Unfunded liabilities	(119)	(145)
	(247)	(453)
Deferred tax	85	145
Net liability	(162)	(308)

The Profit and Loss Account bears the cost of providing retirement benefits in two places. The actuarially calculated cost of the current year's benefits earned is charged against operating profit (the 'service cost') – in 2004 this was £47m (2003 £48m). The interest section of the profit and loss account is charged with the interest on retirement liabilities and credited with the expected return on pension scheme assets – in 2004 this was a net credit of £3m (2003 net charge £2m) reflecting the improved asset mix at the beginning of the year.

Pension funding (company cash contribution) decisions are based on the advice of independent actuaries, which takes account of the long-term nature of the liabilities. For funding purposes, the most recent actuarial valuations of the two principal schemes were performed as at March and April 2003 in the United Kingdom, and January 2004 in the United States. Contributions to the funded plans were increased to £64m in 2004 (2003 £46m), as funding deficit payments were made. Slightly lower contributions are expected in 2005.

TREASURY
Smiths continues to apply centralised treasury management over its financial risks operating within a strong control environment. The Company uses financial instruments to raise finance for its operations and to manage the related financial risks. There is neither speculation nor trading in financial instruments and all funding is properly recognised on the balance sheet. The Board has approved the treasury policy, which governs the financial risk profile, and a treasury compliance report is presented annually to the Audit Committee.

The objectives of the treasury function remain the same as in previous years and are explained in further detail below in the context of current developments.

To deliver the liquidity requirements of the businesses cost effectively – As referred to earlier, liquidity was strong during the year. The Company aims to minimise the level of surplus cash balances but where these arise, such as with the Polymer disposal proceeds, tight controls apply to ensure that they are securely placed with highly rated counterparties and are available for redeployment around the Group at short notice. Local working capital needs and capital expenditure requirements are typically funded by local bank facilities. In addition, Smiths has extensive local and cross-border cash-pooling arrangements, and arm's length intercompany lending through financial centres, to optimise the global deployment of funds across its businesses in a tax efficient manner.

To manage the central funding demands and provide a low cost of debt – The Company funding requirements are largely driven by acquisition activity and met by centrally arranged debt finance. The Company holds term debt, largely in the bond markets, of £692m with average maturity of six years and at an average cost of debt of 4.7%. Through the use of interest rate swaps, the Company maintains a broadly even mix of fixed and floating rate debt. The Company seeks to maintain a spread of maturity profiles on its debt and no more than 30% of the Company's net debt will be held on borrowings due within one year, without firm plans for refinancing or repayment. The €1300m Eurobond matures in July 2005 and currently Smiths could retire this debt out of surplus cash resources. The credit ratings of the Group remain at A–/A3 with Standard & Poor's and Moody's, respectively, reflecting the Group's strong financial profile and stable business outlook. Smiths believes that it has access to further financial resources to cater for all envisaged business requirements and opportunities.

To develop and maintain strong and stable banking relationships and services – Smiths has a core and stable group of ten leading global banks and financial institutions who competitively tender for treasury business. Credit exposures to any one bank are carefully controlled. All business is transacted with banks on consistent terms and is fairly allocated.

To provide the Group with reasonable protection from the effect of foreign currency volatility – Material cross-border trading contracts or forecast commitments are hedged at inception by appropriate derivative financial instruments, with the Company's core banks as counterparties. Whilst the trends of foreign currency movements cannot be eliminated, this hedging programme reduces the volatility on the results and protects the cash-flow and margins. Moreover, Smiths largely manufactures in countries whose currency is linked to the currency of its sales revenue, and hence gross transactional exposures are around £300m annually, before hedging.

The Company protects its reserves from foreign currency fluctuations 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.

Smiths' overseas earnings are translated at average currency rates for the year which smooths the effect of currency volatility. However, Smiths is increasingly exposed to the US dollar due to its significant North American presence. Following the Interim results, a short-term hedging contract was entered into to protect against further dollar exchange rate volatility on the translation of US earnings for the remaining part of the year. This contract produced a £1.4m profit and cash inflow.