HSBC 2005 Annual Report Download - page 45

43
2005 2004
US$bn US$bn
Funds under management
At 1 January .............................. 476 386
Net new money .......................... 63 64
– Bank of Bermuda ............... –22
– Other .................................. 63 42
Value change ............................. 45 19
Exchange and other ................... (23) 7
At 31 December ........................ 561 476
Economic profit
HSBC’s internal performance measures include
economic profit, a calculation which compares the
return on financial capital invested in HSBC by its
shareholders with the cost of that capital. HSBC
prices its cost of capital internally and the difference
between that cost and post-tax profit attributable to
ordinary shareholders represents the amount of
economic profit generated. Economic profit is used
by management as a means to decide where to
allocate resources so that they will be most
productive. In order to concentrate on external
factors rather than measurement bases, HSBC
emphasises the trend in economic profit within
business units rather than absolute amounts. In light
of the current levels of world interest rates, and
taking into account its geographical and customer
group diversification, HSBC believes that its true
cost of capital on a consolidated basis is 10 per cent.
HSBC plans to continue using this rate until the end
of the current five-year strategic plan in 2008 in
order to ensure consistency and comparability.
The effect of adopting IFRSs on the Group’s
financial results has been reflected in the derivation
of economic profit shown below. Under IFRSs, there
is no periodic amortisation charge for goodwill
arising on acquisitions. This removes the need for
adjustments to post-tax profit for economic profit
purposes. In addition, the Group has modified its
calculation of economic profit for the following:
• Unrealised gains and losses on effective cash
flow hedges. Gains and losses on the effective
hedging of future cash flows essentially reflect
the opportunity profit or loss on decisions taken
to fix in monetary terms the yield on assets or
the cost of liabilities when measured against
current market rates. Given that these amounts
are ultimately reflected in profit for the period,
they are excluded from average invested capital
upon which the capital charge is based.
• Unrealised gains and losses on available-for-sale
securities. These are excluded from the measure
of average invested capital for the purpose of
computing economic profit because (i) the gains
or losses represent unrealised profit which may
be offset or reversed in the future, and (ii) there
is accounting asymmetry in that the offsetting
profit or loss on the liabilities taken out to fund
these assets is not reflected.
On this basis, economic profit increased by
US$1,318 million or 31 per cent compared with
2004, reflecting improved underlying profitability.
Economic profit
Year ended 31 December
2005 2004
US$m %1US$m %1
Average total shareholders’ equity ............................................................ 89,589 79,391
Add: Goodwill previously amortised or written off ................................... 8,172 8,172
Less: Property revaluation reserves ........................................................... (1,092) (1,092)
Reserves for unrealised gains on effective hedges ............................ (315) –
Reserves for unrealised gains on available-for-sale securities .......... (1,294) –
Preference shares............................................................................... (351) –
Average invested capital2 ........................................................................... 94,709 86,471
Return on invested capital3 ........................................................................ 15,060 15.9 12,918 15.0
Benchmark cost of capital ......................................................................... (9,471) (10.0) (8,647) (10.0)
Economic profit/spread ............................................................................. 5,589 5.9 4,271 5.0
1 Expressed as a percentage of average invested capital.
2Average invested capital is measured as average total shareholders’ equity after adding back goodwill previously written-off directly to
reserves, deducting preference shares issued by HSBC Holdings and deducting average reserves for unrealised gains/(losses) on
effective hedges and available-for-sale securities. This measure reflects capital initially invested and subsequent profit.
3Return on invested capital is based on the profit attributable to ordinary shareholders of the parent company.