Capital and risk management principles 

The ultimate goal of capital and risk management in the KONE Group is to contribute to the creation of shareholder value and secure the continuance of operations. In order to achieve this goal, KONE applies the following principles in managing its capital resources and position, as well as in managing its risks.

Management of capital

Capital is managed in order to maintain a strong financial position and ensure that the Group’s funding needs can be optimized at all times in a cost-efficient way. KONE wants to be able to take advantage of opportunities to create major shareholder value when they are available.

Cash inflows from operating activities are 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 approved by the Board of Directors.

The assets employed in KONE’s business consist of net working capital and fixed assets funded by equity and net debt, as shown in the following table. Thanks to KONE’s business model and processes, net working capital does not tie up capital and the level of fixed assets
is relatively low.

In order to ensure good credit quality, KONE monitors and estimates its financial position through key indicators such as the equity ratio, gearing and their components. KONE has not acquired a credit rating.

KONE’s philosophy is to take an aggregated view of share price trends and dividends as components of total shareholder return. The growth in share value can also be influenced by the purchase of own shares. Consequently, KONE does not define a separate dividend policy. Furthermore, no definite capital structure target has been defined.

This means that the level of net debt and financial gearing can be very low, even negative, over a given period of time. In the present weak economic situation, having no debt is a strength. Liquid assets are invested only in counterparties with high creditworthiness. The new limited list of counterparties is approved by the Group Treasury committee. When value-creating business opportunities result in major investments, the borrowing capacity is used and the level of financial gearing will be higher for a period of time. Long term funding is guaranteed by existing committed lines of credit.

These principles also mean that annual dividends will be determined on the basis of overall business outlook and business opportunities, as well as the present capital structure and the anticipated changes in it.*)

KONE ensures efficient allocation of its capital resources in its management system by measuring and monitoring financial results after the cost of capital tied up in assets employed by business activities. The weighted average cost of capital (WACC) is the weighted average of the cost of debt and equity. KONE estimates its WACC annually on the basis of the estimated return requirement
based on its equity capital and on the estimated cost of its debt capital and the budgeted gearing. Local interest rates are taken into account.

The cost of capital 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 and discounted cash flow.

1) Property, plant and equipment, acquired maintenance contracts and other intangible assets.
*) In 2006–2008, the dividend payout ratio has been 39.2%–90.3% for class B shares (Board’s proposal 2008).

Risk management

KONE’s business activities are exposed to risks, which may arise from changes in KONE’s business environment or events or incidents resulting from operating activities. In its business planning process, KONE continuously assesses the risks and opportunities of its business decisions in order to limit unnecessary or excessive risks. In KONE’s risk management process, the risks that can threaten the achievement of KONE’s business objectives are identified and assessed on the basis of their probability and impact.

The KONE Board of Directors reviews the KONE risk portfolio regularly on the basis of the KONE Executive Board’s assessment. The KONE Risk Management function is responsible for developing and steering the risk management process and administering the global insurance programs.

Operational risks

A global slowdown in economic growth may bring about a decrease in the number
of new equipment orders received by KONE, cancellations of agreed-on deliveries, or delays in the commencement of projects. A significant part of KONE’s sales consists of services which are less susceptible to the effects of economic downturn. Economic downturn may affect the liquidity and payment schedules of KONE’s customers and lead to credit losses. Credit risks are managed by requiring advance payments and actively monitoring the liquidity of customers.

As a global group, KONE is exposed to foreign exchange rate fluctuations. The Group Treasury function manages exchange rates and other financial risks centrally on the basis of principles
approved by the Board of Directors. KONE’s subsidiaries are assessed and managed in their local currencies. The main effect of exchange rate fluctuations is seen in the consolidated financial
statements of the KONE Group resulting from the translation of financial statements of foreign subsidiaries into euros, the reporting currency of the KONE Group.

A significant proportion of KONE’s new equipment sales take place in the context of major construction projects utilizing innovative technologies in which KONE is a subcontractor. In these projects, KONE’s project management organization cooperates with the main contractors’ project organization. Long supply chains, the high technology featured in components and technologically demanding installation and service processes may make it more difficult to achieve the quality, cost or schedule objectives set for the project. Common project management tools are used for managing project risks.

As malfunctions or other disturbances may appear in all technical equipment, any such occurrences in the case of equipment made by KONE may have an effect on the company’s reputation as a provider of high-quality elevators, escalators and automatic doors. The company’s aim is to ensure high quality products by the application of standardized and controlled manufacturing, installation and service processes.

KONE systematically analyzes risks related to products, their installation and service as part of the product development process and product change management. The quality of KONE’s own installation and service processes is actively controlled and inspected, as is that of the components and services supplied by KONE’s subcontractors. The main production, installation and maintenance processes are ISO 9001 certified. Some of the products made and installed by KONE are serviced by third parties.

KONE’s business activities are dependent on the uninterrupted operation and reliability of sourcing channels, production plants, logistics processes and the IT systems used. These risks are controlled by analyzing and improving the fault tolerance of processes and by increasing the readiness for transferring the manufacturing of critical components from one production line to another. The aim is also to secure the availability of alternative sourcing channels for critical components and services. Additionally, KONE has a global property and business interruption insurance program in place.

A significant part of KONE’s sales consist of services which are very labor-intensive. If the increases in labor costs cannot be transferred to prices or the productivity targets are not met, the profit development of the Group will be adversely affected. A failure to efficiently reallocate human resources in response to reduced business opportunities may also have a negative effect on the profit development.

Changes in raw material prices are reflected directly in the production costs of components made by KONE, such as doors and cars, and indirectly in the prices of purchased components.
The Group consumes commodity metals such as stainless steel, copper and aluminum, most of which are purchased indirectly via supplied components. Risks related to the prices
of commodities and components are minimized by 3 to 12-month fixed price supply agreements with preferred partners. Although such agreements protect KONE’s deliveries from increases
in commodity prices, they may adversely affect KONE’s profit performance
if raw material prices drop for an extended period and the decreases in prices cannot be utilized to their full extent. These agreements have been made for the above-mentioned metals and for services. The maintenance business deploys a significant fleet of service vehicles, for which reason oil price fluctuations affect the cost of maintenance.

KONE takes active steps to reduce the direct and indirect environmental impacts and risks related to its operations. The environmental risks are mainly related to the consumption of raw materials and energy, carbon dioxide emissions and waste handling. KONE’s own production does not employ environmentally hazardous manufacturing methods or chemicals to any material extent. Maintenance activity requires transport by service vehicles, which generates carbon dioxide emissions