“We add value as one company” is one of the four principles of our “We create chemistry” strategy. To create value in the long term, a company’s earnings must exceed the cost of stockholders’ equity and borrowing costs. This is why we strive to earn a significant premium on our cost of capital. To ensure BASF’s long-term success, we encourage and support all employees in thinking and acting entrepreneurially in line with our value-based management concept. Our goal: to create awareness as to how each and every employee can find value-oriented solutions in the company’s day-to-day operations and implement these in an effective and efficient manner.
EBIT after cost of capital
- Performance and management indicator
Income from operations (EBIT) after cost of capital is a key performance and management indicator for the BASF Group, its operating divisions and business units. This ﬁgure combines the company’s economic situation as summarized in EBIT with the costs for the capital made available to us by shareholders and creditors. When EBIT exceeds cost of capital, we earn a premium on our cost of capital and exceed the return expected by our shareholders.
Calculating EBIT after cost of capital
- Cost of capital determined using cost of capital percentage and cost of capital basis
To calculate EBIT after cost of capital, we take the BASF Group’s EBIT and deduct the EBIT of activities recognized under Other – not allocated to the segments – and subtract the cost of capital of the BASF Group from the resulting figure. Cost of capital is determined by applying cost of capital before taxes to the value of the cost of capital basis at each month end. Monthly cost of capital is then added up over the course of the year.
The cost of capital percentage (weighted average cost of capital, WACC) is determined using the weighted cost of capital from equity and borrowing costs. The cost of equity is ascertained using the Capital Asset Pricing Model. Borrowing costs are determined based on the ﬁnancing costs of the BASF Group. EBIT after cost of capital, which we use as a steering parameter, is a pretax ﬁgure. Therefore, we use the current average tax rate to derive the pretax cost of capital percentage from the WACC. The projected net expense of Other is already provided for by an adjustment in the cost of capital percentage.
The cost of capital basis consists of a segment’s operating assets plus the customer and supplier financing not included there. Operating assets comprise the current and noncurrent asset items1 used by the operating divisions.
Value-based management throughout the company
- Exercising a value-oriented mindset in day-to-day business by every employee
For us, value-based management means the daily focus placed on value by all of our employees. To this end, we have identified value drivers that show how each and every unit in the company can create value. We develop performance indicators for the individual value drivers that help us to plan and pursue changes.
An important factor in ensuring the successful implementation of value-based management is linking the goals of BASF to the individual target agreements of employees. In the operating units, the most important performance indicator is EBIT after cost of capital. By contrast, the functional units’ contribution to value is assessed on the basis of effectiveness and efficiency.
All this forms a consistent system of value drivers and key indicators for the individual levels and functions at BASF. In addition to EBIT after cost of capital, EBIT and EBIT before special items are the most signiﬁcant performance indicators for measuring economic success as well as for steering the BASF Group and its operating units.
We primarily comment on EBIT before special items on a segment and division level in our financial reporting. Special items arise from the integration of acquired businesses, restructuring measures, impairments, gains or losses resulting from divestitures and sales of shareholdings, and other expenses and income that arise outside of ordinary business activities. Adjusting for special items makes EBIT before special items an especially suitable figure for illustrating development over time. In addition to EBIT before special items, we also report on sales as a further main driver for EBIT after cost of capital. BASF’s nonfinancial targets are focused more on the long term, and are not used for short-term steering.
According to our value-based management concept, all employees can make a contribution in their business area to help ensure that we earn the targeted premium on our cost of capital. We pass this value-based management concept on to our team around the world through seminars and training events, thereby promoting entrepreneurial thinking at all levels within BASF.
1 These include fixed assets, intangible assets, investments accounted for using the equity method, inventories, trade accounts receivable, other receivables generated by core business activities, and other assets as well as any assets of disposal groups.