“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 high 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.
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.
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 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.
The cost of capital basis consists of the operating assets of the segments plus the customer and supplier financing not included there. Operating assets comprise the current and noncurrent asset items used by the operating divisions. 1
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 units and levels 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 and other assets generated by core business activities as well as any assets of disposal groups.