Alternative Performance Measures

Throughout its financial reporting, Covestro uses alternative performance measures (APMs) to assess the business performance of the Group. These are not defined in the International Financial Reporting Standards (IFRSs). These non-IFRS indicators should be considered a supplement to, not a replacement for, the performance measures determined in accordance with IFRSs. The calculation methods and reconciliation of the non-IFRS sales and earnings APMs to the figures reported in the financial statements are presented below. The calculation methods for the APMs may vary from those of other companies, thus limiting the extent of the overall comparability. These alternative performance measures should not be viewed in isolation or employed as an alternative to the financial indicators determined in accordance with IFRSs and presented in the consolidated financial statements for purposes of assessing Covestro’s net assets, financial position and results of operations.

The following are the alternative performance measures relevant to the Covestro Group:

• EBITDA
• Return on capital employed (ROCE)
• Free operating cash flow (FOCF)
• Net financial debt

Covestro uses ROCE to assess profitability in the context of the company’s internal management system. EBITDA is also calculated as an additional indicator of profitability. FOCF is a key factor in the presentation of the liquidity position that indicates the company’s ability to generate a cash surplus and finance its activities. Net financial debt gauges the Group’s financial condition and financing requirements.

EBITDA

EBIT is a measure used in the calculation of EBITDA. EBIT represents the share of the income after income taxes plus financial result and income taxes attributable to Covestro’s core business after elimination of the influence of variable tax rates and/or various financing activities.

EBITDA is EBIT plus amortization and impairment losses on intangible assets, and depreciation and impairment losses on property, plant and equipment, less impairment loss reversals. In addition, EBITDA is adjusted for possible distortions arising from various depreciation/amortization methods and measurement options, and therefore represents earnings from operating business activities.

Return on capital employed (ROCE)

The foremost objective of the Covestro Group is to steadily increase enterprise value. Value is generated if Group earnings exceed the cost of capital. Covestro uses return on capital employed (ROCE) as the central value-based management metric. ROCE measures profitability and is calculated as the ratio of EBIT, adjusted for special items as needed, after imputed income taxes (NOPAT = net operating profit after taxes) to the average capital employed. If ROCE exceeds the weighted average cost of capital (WACC), the company is generating a premium on its cost of capital.

Calculation of the return on capital employed

Calculation of the value contribution

Calculation of average capital employed

The capital employed is the interest-bearing capital required by the company for its operations. It is calculated from operating noncurrent and current assets less non-interest-bearing liabilities. Non-interest-bearing liabilities include, for example, trade accounts payable and current provisions. The average capital employed is determined using the capital employed at the beginning and end of the relevant period.

Calculation of the net operating profit after taxes (NOPAT) and capital costs

NOPAT is the operating result (EBIT) after imputed income taxes. The imputed income taxes are determined by multiplying the effective tax rate by EBIT.

WACC reflects the expected return on the company’s capital comprising both equity and debt. The cost of equity factors used in WACC are calculated by addition of the risk-free interest rate and the risk premium for an equity investment. Covestro uses the returns on long-term German government bonds as the risk-free interest rate. We derive this risk premium from capital market information for comparable listed companies. The cost of debt factors is calculated by addition of the risk-free interest rate and a risk premium on debt capital that Covestro calculates using the financing costs of comparable companies, less the tax benefit of interest incurred on borrowed capital. Calculation of the cost of capital generally has a long-term perspective; short-term fluctuations are evened out. The capital cost factor for the Covestro Group was 6.8% in fiscal 2019 (previous year: 6.7%).

Calculation of the value contribution

The absolute value generation of the company is measured by the metric value contribution. This is the difference between NOPAT and the cost of capital. The latter is calculated by multiplying the average capital employed by WACC. A positive value contribution means that value has been generated.

Free operating cash flow (FOCF)

FOCF is the operating cash flow less cash outflows for additions to property, plant, equipment and intangible assets. Free operating cash flow serves in particular to pay dividends and interest and to repay debt.

Net financial debt

Net financial debt equals the sum of all financial liabilities less cash and cash equivalents, current financial assets and receivables from financial derivatives.

Effects of IFRS 16 (Leases)

Initial application of the IFRS 16 accounting standard in the reporting period did not result in any changes in the method for calculating the alternative performance measures relevant to Covestro.

The effects of the initial application of IFRS 16 in the reporting period on the alternative performance measures are presented in the following table: