5.2 Financial position

Principles and objectives of financial management

The objective of financial management is to ensure the availability of adequate liquidity at all times and to limit financial risk.

Ensuring that the Company has sufficient liquidity at all times includes not just its solvency in the strict sense of the term but also the availability of the necessary financial resources for its day-to-day business, the settlement of customers' orders, the supply of cash throughout the organisation, and the management of any collateral security provided. The main objective of this approach is to limit the financial risks attaching to the Company's market value and profitability. They include exchange-rate risk, interest-rate risk, price risk, credit risk and country risk.

A group of international banks and investors primarily provide the financial resources required by the KION Group for external operations. The financial resources required within the KION Group are provided through internal funding. Where possible, the KION Group covers subsidiaries' funding requirements with intercompany loans. This central source of funding enables the KION Group to present a united front in the capital markets and strengthens its hand in negotiations with banks and other market participants.

Companies in the KION Group either utilise other entities' liquidity surpluses in the form of cash pools or receive intercompany loans. Group Treasury arranges credit lines with local banks or leasing companies in some cases in order to comply with legal, tax and other regulations.

The main loan agreement includes financial covenants specifying compliance with defined ratios for financial position and financial performance. The covenants are expressed in the form of key figures relating to gearing, available liquidity, adjusted EBITDA, interest paid and capital expenditure. In 2009, the terms of the loans were adjusted in line with current market conditions with the broad consent of the lenders. In return for the adjustment of the covenants, the lenders were granted an increase in the interest premium. This premium is payable for the most part as a bullet payment on maturity, thereby ensuring that there is no adverse effect in the meantime on the KION Group's liquidity. The KION Group complied with all the financial covenants in the past financial year.

In addition, investment funds associated with Kohlberg Kravis Roberts & Co. L.P. and Goldman, Sachs & Co. have provided the KION Group with a loan of €100 million under the terms of the SFA in order to offer the Company more flexibility in its corporate strategy. The loan amount and the associated interest are repayable as a bullet payment on maturity.

The KION Group also uses factoring for financing purposes. As at 31 December 2010, the volume of non-recourse factoring was €20 million (31 December 2009: €23 million); the KION Group only uses a small amount of recourse factoring.

KION Group GmbH has sufficient cash and cash equivalents as well as unrestricted, bindingly committed credit lines at its disposal to ensure solvency at all times.

Cash flow

The key performance indicator for liquidity in the KION Group is free cash flow before tax, which does not include tax payments or interest arising from financing activities, or interest expense and similar charges from leases, or interest and similar income from leases. For more information about free cash flow before tax and other KPIs used to manage the KION Group, see section 4.4 'Financial KPIs for managing the Company's business'.

In 2010, cash flow from operating activities rose sharply by 74 per cent to €199 million (2009: €115 million). The underlying reason for this improvement was the increase in earnings before interest and tax (EBIT) to €35 million (2009: minus €182 million). The slight increase in working capital, which was related to the larger volume of business, was disproportionately low compared to revenue growth and was also reflected in the cash flow from operating activities.

Cash flow from investing activities in the Group amounted to a net outflow of €123 million in 2010 (2009: net outflow of €113 million), equating to an increase of 9 per cent. The reason for this was the higher capital expenditure on non-current assets and property, plant and equipment (capex), with total cash payments amounting to €123 million (2009: €108 million). Capital expenditure went on development projects for new products and facelifts, leaner production processes, plus the conversion and construction work required to relocate production to Germany. The KION Group acquired the remaining shares in a French dealer for €8 million.

In addition, the KION Group acquired a larger stake in Baoli in April 2010. As the KION Group assumed control of Baoli back in 2009, the additional outflow of funds amounting to some €10 million must be recognised as financing activities in accordance with IAS 7.

Cash flow from financing activities amounted to a total net cash outflow of €290 million (2009: net cash inflow of €47 million). Whereas the main activities in 2009 had been the drawdown of an existing line of credit (capex facility) and of the senior facility agreement (SFA), the net outflow of funds in 2010 was caused by the net repayment of loans (€96 million) and the repayment of other funds by individual Group companies (€42 million). Interest payments fell by €24 million to €135 million as a result of the drop in payments for interest-rate hedges.

As at 31 December 2010, the cash and cash equivalents reported on the face of the balance sheet amounted to €253 million (2009: €463 million).

For internal management purposes, free cash flow is much more narrowly defined as the total of cash flow from operating activities plus cash flow from investing activities.

In contrast to the free cash flow of €76 million, free cash flow before tax (the figure used for management purposes) does not include a number of items, including tax payments (€13 million) and lease interest payments (€10 million). In 2010, receipts from financial receivables and interest income (€2 million) and other individual items that were treated differently in accordance with IAS 7 were additionally reclassified. Taking into account these items, the free cash flow before tax was €83 million, a sharp rise of 144 per cent.