Siemens 2007 Annual Report Download - page 138

138 Management’s discussion and analysis
EVA Performance
During fi scal 2007, Siemens continued its enterprise-wide focus on economic value
added (EVA). We tie a signifi cant portion of our executive incentive compensation
to achieving EVA targets.
EVA is a fi nancial performance measure of the value created or destroyed by
a business. In simple terms, it compares the earnings of a business (using Group
profi t for the Operations Groups and income before income taxes for the Financ-
ing and Real Estate businesses as a base) against the cost of capital employed to
run that business. A positive EVA means that a business has earned more than its
cost of capital, whereas a negative EVA means that a business has earned less than
its cost of capital. Depending on the change of EVA between comparable fi scal
periods, a business is defi ned as value-creating or value-destroying. Conse-
quently, the increase or decrease in EVA is an important measure of fi nancial
performance.
We use this measure of performance in addition to Group profi t and income
before income taxes because those measures focus on results without taking into
consideration the cost of capital employed in the business. In this manner, EVA
complements Group profi t and income before income taxes. For EVA calculation
purposes, data from the consolidated fi nancial statements is used and to a limited
extent adjusted. The most important fi nancial adjustment representing the major
part of the total EVA adjustment amount within our Operations component,
results from operating lease commitments. We believe that including such fi nan-
cial adjustment in the EVA measure enhances our business decision-making pro-
cesses.
As the two major business components of Siemens – Operations compared to
Financing and Real Estate – are fundamentally different from each other, we use
two types of EVA calculations: the industry concept in the case of Operations
Groups and the fi nancial concept in the case of Financing and Real Estate.
In the case of Operations Groups, we use Group profi t as the base measure and
apply a fl at tax rate for calculating the operating profi t after taxes. The cost of cap-
ital for each Group is determined by taking the weighted average of the after-tax
cost of debt and equity of Siemens and applying a risk-based factor which takes
into account the specifi c risk associated with the particular business.
In the case of Financing and Real Estate, we use the fi nancial concept to calcu-
late the EVA. As the base measure we use income before income taxes and apply
a fl at tax rate to arrive at the net operating profi t after taxes. From this result, we
deduct the capital charge, which is calculated by multiplying the cost of capital
expressed as a percentage by the risk-adjusted equity allocated to this component.
Since the cost of debt is already considered within the income before income
taxes, the cost of capital is only based on equity components. The EVA for Corpo-
rate Treasury is calculated similarly to Financing and Real Estate.
Other organizations that use EVA as a measure of fi nancial performance may
defi ne and calculate EVA differently.