Capital and risk management 

Operational risks
KONE is exposed to risks, which may arise from its operations or changes in the business environment. The risk factors described below can potentially have an adverse effect on KONE’s business operations and financial position and hence the value of the company. Other risks, which are currently either unknown or considered immaterial to KONE may, however, become material in the future.

A disruption in the growth of the new equipment markets in Asia-Pacific, in China in particular, or a significant weakening of the new equipment markets in Europe or in North America could result in a decrease in orders received, cancellations of agreed deliveries, delays in the commencement of projects, further intensified price competition and as a result negatively affect KONE’s profitability.

The continued uncertain global economic environment also exposes KONE to counterparty risks in respect of financial institutions and customers. The exposure to the counterparty risks related to financial institutions arises through the significant amounts of liquid funds deposited into financial institutions in Europe and in China. In order to diversify the financial credit risk KONE deposits its funds into several banks and invests a part of its liquidity into highly liquid money market funds. KONE also manages its counterparty risk by accepting only counterparties with high creditworthiness. The size of each counterparty limit reflects the creditworthiness of the counterparty and KONE constantly evaluates such limits.

KONE is also exposed to risks related to the liquidity and payment schedules of its customers, which may lead to credit losses. To mitigate this risk, defined rules for tendering, levels of approval authority and credit control have been established. The risks related to accounts receivable are minimized also through the use of advance payments, documentary credits and guarantees in KONE’s payment terms. KONE’s customer base consists of a large number of customers in several market areas and no individual customer represents a material share of KONE’s sales.

KONE operates internationally and is thus exposed to risks arising from foreign exchange rate fluctuations related to currency flows from revenues and expenses and from the translation of income statement and statement of financial position items of foreign subsidiaries into euros. The KONE Treasury is responsible for the centralized management of financial risks in accordance with the KONE Treasury Policy approved by the Board of Directors. For further information regarding financial risks, read more here.

KONE’s business activities are dependent on the uninterrupted operation, quality and reliability of sourcing channels, production plants, logistics processes and the IT systems used. A significant part of KONE’s component suppliers and supply capacity is located in China. These risks are controlled by analyzing and improving the fault tolerance of processes, accurate forecasting, close cooperation with KONE’s suppliers and by increasing the readiness for transferring the manufacturing of critical components from one production line or supplier to another. KONE actively monitors the operations and financial strength of its key suppliers. The aim is also to secure the availability of alternative sourcing channels for critical components and services. Additionally, KONE has a global property damage and business interruption insurance program in place.

Changes in raw material and component prices are reflected directly in the production costs of elevators, escalators and automatic doors. The increases in raw material and component prices have had and may continue to have a negative impact on KONE’s profitability. In order to reduce material and sourcing price fluctuation KONE aims to enter into fixed price contracts with its major suppliers for a part of its raw material and component purchases. The maintenance business deploys a significant fleet of service vehicles, and fuel price fluctuations therefore have an effect on the cost of maintenance.

KONE operates in certain markets with high growth rates, where there are challenges in the availability of skilled technicians. This can lead to delays in deliveries and increases in costs, which can have an adverse impact on the profitability of the company. KONE manages this risk by proactive project and resource planning in order to ensure that required resources are available.

A significant part of KONE’s sales consists of services which are less susceptible to the effects of economic cycles, but which are very labor-intensive. The profit development of KONE could be adversely affected if its productivity improvement targets were not met, in particular if salaries and costs increased more than KONE would be able to increase its prices or if it were not possible to adapt its resources in response to changing business opportunities and environments. These risks are managed by proactive planning and forecasting processes, by the constant development of pricing processes and productivity as well as by the outsourcing of certain activities.

Risk management
The objective of risk management at KONE is to coordinate and develop a systematic assessment of risks and opportunities within core business planning and decision making processes.

KONE continuously assesses the risks and opportunities of its business decisions in order to limit unnecessary or excessive risks. In addition, KONE’s units and functions systematically identify and assess as part of the strategic planning and budgeting processes the risks that can threaten the achievement of their business objectives. Key risks are reported to the KONE risk management function, which facilitates the risk management process and consolidates the risk information to the KONE Executive Board. The Executive Board assigns the ownership of globally identified risk exposures to specific functions or units. The KONE Board of Directors reviews the KONE risk portfolio regularly on the basis of the Executive Board’s assessment.

The KONE Risk Management function is also responsible for administering the global insurance programs. The KONE Treasury function manages financial risks centrally according to the KONE Treasury Policy.

Capital management
KONE aims to manage its capital in a way that supports the profitable growth of operations by securing an adequate liquidity and capitalization of the group at all times. The target is to maintain a capital structure that contributes to the creation of shareholder value.

The assets employed in KONE’s business consist principally of net working capital, fixed assets and investments which are funded by equity and net debt, as shown in the table below. Due to the business model and the business processes of KONE, the level of total assets employed is relatively low. KONE aims to maintain a negative net working capital to ensure a healthy cash flow even when the business is growing and to maintain a high return on assets employed.Cash flow from operations is the principal source of KONE’s financing. External funding, as well as cash and cash equivalents, are managed centrally by the Group Treasury according to the Group Treasury Policy. Liquid assets are invested only in counterparties with high creditworthiness and deposits to ensure the availability of the excess liquidity.

KONE has not defined a specific target for its capital structure, but the aim is to ensure a strong credit quality to provide for ample access to external funding sources and to support the growth ambitions of the business. The level of net debt and financial gearing can be very low over a given period of time, even negative, as was the case at the end of 2011. KONE considers that its capital structure is a strength in a continued uncertain environment and allows for capturing potential value-creating business opportunities, should they emerge. In the event that significant attractive investment or acquisition opportunities were available, KONE could also utilize its borrowing capacity. In such cases the level of debt and financial gearing could be higher for a period of time. At the end of 2011, the funding of KONE was guaranteed by existing committed credit lines and an excess liquidity.

KONE has not defined a specific target for dividends or share buy-backs. The dividend proposal by the Board of Directors is determined on the basis of the overall business outlook, business opportunities, as well as the present capital structure and the anticipated changes in it.*) At the end of December 2011, KONE had 4,962,176 class B shares in its possession.

To ensure an efficient internal allocation and utilization of its capital resources, KONE measures the financial results of its business activities after a capital allocation charge. The capital allocation charge is based on the assets employed in the business activity and the weighted average cost of capital (WACC).

The WACC is also used as a hurdle rate when evaluating the shareholder value creation potential of new acquisitions, major capital expenditure and other investments. The valuation methods used are payback time, discounted cash flow and profitability and cash flow multiples.

 1) Property, plant and equipment, acquired maintenance contracts and other intangible assets.
*) In 2007–2011, the dividend payout ratio has been 39.2%–90.3% for class B shares (Board's proposal 2011).

(Updated on 1.2.2012)