Covestro’s management system is oriented toward long-term, profitable growth, continuous value creation, and sustainability. The Board of Management is the chief operating decision maker responsible for our global business and approving the planning derived from our Group strategy. In order to plan, manage, and monitor the development of our business, we use key management indicators, which enable the Group’s business performance to be evaluated in a comprehensive and holistic manner, while driving its sustainable orientation. The Board of Management manages this orientation on the basis of defined sustainability goals and selected nonfinancial performance indicators.
Key Management Indicators
The Covestro Group assesses its performance using the following four elements: Profitable growth measured in terms of EBITDA (earnings before interest, taxes, depreciation and amortization), liquidity measured in terms of free operating cash flow (FOCF), profitability measured in terms of return on capital employed (ROCE) above the weighted average cost of capital (WACC), and sustainability measured in terms of selected environmental, social, and governance (ESG) criteria.
These key management indicators are incorporated into Covestro’s Group-wide bonus system (Covestro Profit Sharing Plan), which applies to almost all Covestro employees worldwide, including the Board of Management; any exceptions are essentially due to collective bargaining arrangements. The four areas of profitability, liquidity, profitable growth, and sustainability, each account for one quarter of the calculation formula used to measure target attainment. As a result, all employees can share in the company’s success.
EBITDA is used to assess profitable growth of Covestro and its reportable segments. EBITDA replaced core volume growth as a key management indicator in the reporting year. It represents EBIT plus amortization and impairment losses on intangible assets, and depreciation and impairment losses on property, plant and equipment, less impairment loss reversals.
The ability to generate a cash surplus is measured by FOCF. FOCF is an indicator of the company’s liquidity and ability to finance its activities. It corresponds to cash flows from operating activities less cash outflows for additions to property, plant and equipment and intangible assets. A positive FOCF allows dividends and interest to be paid and debt to be repaid.
ROCE above WACC
The ROCE above WACC key management indicator, which is used to assess profitability, measures the amount by which the return on the company’s capital employed exceeds the weighted average cost of capital. If ROCE exceeds WACC, i.e., the minimum return expected by equity and debt capital providers, the company has created value. ROCE above WACC is calculated annually at the end of each fiscal year.
ROCE is calculated as the ratio of net operating profit after taxes* (NOPAT) to average capital employed. ROCE is also used as a standalone variable, in addition to ROCE above WACC, to measure Covestro’s profitability.
*Since the year 2022, the imputed income taxes have been determined by multiplying the imputed tax rate of 25% (previously: effective tax rate) by the operating result (earnings before interest and taxes, EBIT).
The weighted average cost of capital (WACC) is relevant to the calculation of ROCE above WACC and reflects the expected return on the entire company’s capital comprising both equity and debt. The cost of equity factors used in WACC is calculated by adding the risk-free interest rate to 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 adding the risk-free interest rate to a risk premium on debt capital that Covestro calculates using the financing costs of comparable companies, and subtracting the tax benefit arising from the legal deductibility of interest on borrowed capital. Calculation of the cost of capital generally has a long-term perspective; short-term fluctuations are evened out. WACC is calculated at the end of the fiscal year for the subsequent fiscal year on the basis of historical capital market data.
Since the year 2022, a sustainability component, measured against selected ESG criteria, has been laid down in the management system. The sustainability component in relation to the environment is determined on the basis of direct and indirect GHG emissions (Scope 1 and Scope 2) of the main sites. Other criteria relating to social and corporate governance are also to be incorporated in the future.
Other Relevant Financial Performance Measures
Throughout its financial reporting, Covestro uses further indicators in addition to the key management indicators to assess the business performance of the Group; details are provided below.
EBIT, which corresponds to income after income taxes plus financial result and income taxes, allows us to assess income without the influence of the income-dependent tax liability and/or various financing activities.
Capital employed, which is relevant to the calculation of ROCE, 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.
Net Financial Debt
Net financial debt is used to assess the financial position and financing requirements. It equals the sum of all financial liabilities less cash and cash equivalents, current financial assets, and receivables from financial derivatives.