Value-Based Management

The BASF Group’s steering concept

We follow a value-oriented steering concept with our financial targets. We previously used income from operations (EBIT) after cost of capital for operational steering as a key target and management indicator for the BASF Group, its operating divisions and business units. This figure combines the company’s economic performance 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.

From the 2019 business year onward, EBIT after cost of capital will be replaced by the return on capital employed (ROCE). This is calculated as the EBIT generated by the segments as a percentage of the average cost of capital basis. As stated in our strategic goals, we aim to achieve a ROCE considerably above the cost of capital percentage every year.

The change to ROCE means that the same logic and data will be used for internal management, external communication with the capital markets and variable compensation. This improves the consistency of the indicators used for BASF’s value-based management with variable compensation and pension systems, and our shareholders’ objectives.

Calculating EBIT after cost of capital and ROCE

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 divisions – and subtract the cost of capital of the BASF Group from the resulting figure. Cost of capital is determined by applying the cost of capital percentage 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 is determined using the weighted cost of capital from equity and borrowing costs (weighted average cost of capital, WACC). To calculate a pre-tax figure similar to EBIT, it is adjusted using the projected tax rate for the BASF Group for the business year. In addition, the projected net expense of Other is already provided for by an adjustment to the cost of capital percentage. 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. As in 2017 and 2018, we anticipate a cost of capital percentage of 10% in 2019.

The cost of capital basis consists of the operating assets of the segments and is calculated using the month-end figures. Operating assets comprise the current and noncurrent asset items of the segments. These include tangible and intangible fixed assets, investments accounted for using the equity method, inventories, trade accounts receivable, other receivables and other assets generated by core business activities and, where appropriate, the assets of disposal groups. The cost of capital basis also includes customer and supplier financing.

ROCE is calculated as the EBIT of the segments as a percentage of the average cost of capital basis at each month-end.

Value-based management throughout the company

An important part of our value management is the target agreement process, which aligns individual employee targets with BASF’s targets. Until the end of the 2018 business year, the most important financial performance indicator in the operating units was EBIT after cost of capital. This will be replaced by ROCE from 2019 onward. By contrast, the functional units’ contribution to value is assessed according to effectiveness and efficiency on the basis of quality and cost targets.

Until the end of the 2018 business year, the most important key performance indicators for measuring economic success as well as for steering the BASF Group and its operating units were EBIT after cost of capital, EBIT and EBIT before special items.

From 2019 onward, we will use ROCE as the most important key performance indicator for steering the BASF Group. EBIT before special items and capex (capital expenditure) are key performance indicators for BASF that have a direct impact on ROCE and as such, support its management.

• EBIT before special items is used to steer profitability at Group and segment level. As in the past, this is calculated by adjusting the EBIT reported in the Consolidated Financial Statements for special items, making it especially suitable for assessing economic development over time. Special items arise from the integration of acquired businesses, restructuring measures, certain impairments, gains or losses resulting from divestitures and sales of shareholdings, and other expenses and income that arise outside of ordinary business activities.
• Capital expenditures (capex) comprises additions to property, plant and equipment excluding additions from acquisitions, IT investments, capitalized exploration, restoration obligations and right-of-use assets arising from leases. It is used to manage capital employed in the BASF Group. Capex is not just relevant to ROCE management, but also supports our long-term goal to increase our dividend each year based on a strong free cash flow.

Furthermore, we will continue to comment on and forecast sales at Group and segment level in our financial reporting as a significant driver for EBIT before special items and thus ROCE.

BASF’s nonfinancial targets are focused more on the long term. As part of the implementation of our strategy, we are investigating the possibility of establishing short-term steering mechanisms for our nonfinancial targets as well.