Financial Policy

Treasury Policy

Treasury activities are carried out in accordance with policies approved by the board and implemented by the finance director. The finance director and a treasury committee of the board receive reports and review and comment upon the treasury policies of the Group. The treasury department is not operated as a profit centre and is subject to audit.

Borrowings

We aim to manage the amount of net debt - total borrowings less cash and liquid funds - and the level of net interest cover in a manner which maintains our credit ratings at their appropriate levels. Current ratings from Standard & Poor’s and Moody’s are A and A2 respectively for long term debt and A1 and P1 respectively for short term debt.

At the year end, total borrowings were £922m, with £519m in US dollar borrowings, £318m in sterling, and the rest in a number of other currencies.

A proportion of our overseas assets is hedged through foreign currency debt to reduce the extent to which changes in foreign exchange rates affect shareholders’ funds. We may vary the level in a particular currency for operational reasons if there is some other element of risk, but normally we hedge around 20% of capital employed, inclusive of any purchased goodwill, in each principal foreign currency.

We meet our long term financing requirements through sterling and US dollar debt issues in the capital markets. At 31 December 1997, approximately 51% of core borrowings were provided by non-bank sources; our target is between 25% and 75%, with a norm of 50%.

We aim for a diversity of debt maturity dates to avoid a concentration of refinancing risk in any short period. Our target is a weighted average maturity of our core gross borrowings of between three and eight years. At the end of 1997 it was 6.1 years.

Short term funding requirements are met through committed or uncommitted bank facilities and through the USA commercial paper programme. At 31 December 1997, committed bank facilities amounted to £476m, all of which had a maturity of over four years. The general guideline is that available undrawn committed bank facilities should be at least £200m.

Cash

At 31 December 1997, we had £215m in total cash and liquid funds, with the largest currency being US dollars. We invest funds which are temporarily surplus to business requirements in a range of money market instruments, including AAA-rated asset-backed securities. We aim to maximise after-tax returns while preserving liquidity and managing counterparty risk. We ensure the portfolio is appropriately diversified by regularly reviewing limits for individual issuers and assets, taking published credit ratings, among other factors, into account. The finance director approves the limit.

Interest rate management

Interest rate exposure is mainly in relation to sterling and the US dollar. We manage exposure within parameters agreed by the board, with the interest rate on at least one-third of core sterling and US dollar borrowings fixed or capped for around the next five years. We borrow on a fixed rate basis, but we also enter into interest rate swaps and forward rate agreements to modify the interest rate reset profile of our borrowing portfolio. At the year end, 37% of US dollar borrowings were fixed at a weighted average rate of 6.2% and 38% of sterling borrowings were fixed at a weighted average rate of 9.4%. In broad terms, a 1% rise in US dollar interest rates would increase the net interest charge by £4m, while a 1% rise in sterling interest rates would increase the net interest charge by £2m.

Foreign exchange

Foreign currency transactional cash flows were normally hedged on the basis of rolling forecasts for periods of up to twelve months. In January 1998, we began to convert these cash flows at the relevant spot exchange rate, and we expect this new policy to be fully effective by the middle of 1998. Unremitted profits are not hedged under either policy. Cross-border trading flows and other recurring items, such as dividends, which give rise to transactional foreign exchange exposure in the UK amounted to the equivalent of approximately £95m in 1997.

Accounting policies

The accounting policies of the Group are shown on pages 51 and 52. These policies have not changed and have been consistently applied during 1997. In 1998, we will adopt two new UK Accounting Standards - FRS 9 ‘Associates and Joint Ventures’ and FRS 10 ‘Goodwill and Intangible Assets’. FRS 9, like its predecessor, requires the equity method to be used to account for associates but also requires additional disclosures. FRS 10 will mean a significant change to our accounts, as to the accounts of many UK companies. In summary, any purchased goodwill is now required to be shown as an asset on the balance sheet and amortised over its useful economic life, presumed to be not greater than 20 years unless shown to be otherwise. The charge is to be taken through the profit and loss account. Goodwill arising on all acquisitions made from 1998 onwards will be shown as an asset in the Pearson balance sheet and will be amortised accordingly. To show results from operating activities on comparable bases, we plan o exclude amounts charged to operating profit from the calculation of adjusted earnings.

Risk management

In 1997 we combined our internal audit and risk management functions into a single Group control department, which has an independent reporting line to the Audit Committee and checks our effectiveness at managing risk. Through regular audits and reviews, it seeks to identify under-managed risks, and then works with the responsible line management to resolve any issues arising. The department also ensures that policies and procedures operating throughout the Group are suitably comprehensive and up-to-date. We will complete a comprehensive revision of central policies and procedures during 1998.

Following the major fraud at Penguin USA reported in last year’s accounts, we undertook an extensive review of our operations to be sure that no other material unidentified exposure exists. We found no surprises.

Our most significant risks arise from our normal course of business. Our newspapers are highly dependent on advertising revenue, and therefore on the business cycles of our markets. This risk is spread well over Europe, and the global expansion of the FT’s initiative will improve our resilience against potential future regional economic downturns.

All our major business systems are on track to be Year 2000 compliant by Christmas 1998, one year ahead of the critical date. For two years, Pearson has had a project team working with our businesses to plan their responses and audit their progress.

Our education business has to manage the US process of school book adoption whereby each state asks potential suppliers of education programmes to compete for adoption, which will secure sales for several years. AWL manages this risk by competing over all states, with a broad range of programmes, as well as by ensuring focused management support to each AWL programme seeking adoption.