HSBC 2008 Annual Report Download - page 41

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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 the post-tax profit attributable
to ordinary shareholders (less goodwill previously
amortised in respect of the French regional banks
sold in 2008) represents the amount of economic
profit generated. Economic profit generated is used
by management as a means of deciding 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 ahead of absolute amounts within
business units. In order to ensure consistency and
comparability with the five-year strategic plan
completed in 2008, the cost of capital on a
consolidated basis remains at 10 per cent.
Economic profit decreased by US$14.8 billion to
a loss of US$8.2 billion. Profit attributable fell, while
average shareholders’ equity increased marginally.
The decline in profit was predominately driven by
the US$10.6 billion goodwill impairment charge
relating to the North American Personal Financial
Services business, alongside a significant increase in
loan impairment charges and write-downs in credit
trading, leveraged and acquisition finance, and
monoline exposures. The comparative period
included dilution gains of US$1.0 billion (excluding
minority interests) which were not repeated. These
effects were partially offset by fair value gains on
own debt, driven by a widening of credit spreads, of
US$6.6 billion compared with US$3.1 billion in
2007. The lower return on average invested capital
led to a decrease in economic profit and an erosion in
economic spread, which fell by 11.3 percentage
points compared with 2007. Excluding the goodwill
impairment charge, the economic profit spread
decreased by 3.6 percentage points compared with
2007.
2008 2007
US$m %1 US$m %1
Average total shareholders’ equity ......................................................... 122,292 120,346
Adjusted by:
Goodwill previously amortised or written off ................................... 8,152 8,172
Property revaluation reserves ............................................................. (828) (898)
Reserves representing unrealised losses on effective
cash flow hedges ............................................................................ 997 425
Reserves representing unrealised (gains)/losses on
available-for-sale securities ........................................................... 9,163 (1,918)
Preference shares and other equity instruments ................................. (2,685) (1,405)
Average invested capital2 ........................................................................ 137,091 124,722
Return on invested capital3 ..................................................................... 5,497 4.0 19,043 15.3
Benchmark cost of capital ...................................................................... (13,709) (10.0) (12,472) (10.0)
Economic profit/(loss) and spread .......................................................... (8,212) (6.0) 6,571 5.3
1 Expressed as a percentage of average invested capital.
2 Average invested capital is measured as average total shareholders’ equity after:
– adding back the average balance of goodwill amortised pre-transition to IFRSs or subsequently written-off, directly to reserves (less
goodwill previously amortised in respect of the French regional banks sold in 2008);
– deducting the average balance of HSBC’s revaluation surplus relating to property held for own use. This reserve was generated when
determining the deemed carrying cost of such properties on transition to IFRSs and will run down over time as the
properties are sold;
– deducting average preference shares and other equity instruments issued by HSBC Holdings, and;
– deducting average reserves for unrealised gains/(losses) on effective cash flow hedges and available-for-sale securities.
3 Return on invested capital is based on the profit attributable to ordinary shareholders of the parent company less goodwill previously
amortised in respect of the French regional banks sold in 2008.