Fundamentals of International

Financial Reporting
Department for Financial Reporting and Audit
Fundamentals of International
Financial Reporting
Topic 5: KPIs and Financial
Communication
5. KPIs and Financial Communication
CONTENTS
5.1. Introduction
‒ KPIs
‒ A framework for the analysis of financial data
‒ IFRS Exposure Draft ED/2019/7 « General Presentation and Disclosures » in
financial statements

5.2. Measuring financial performance

‒ Absolute performance numbers
‒ Measuring overall performance using ratio analysis:
‒ Return on capital employed (ROCE)
‒ The Du Pont pyramid approach.

5.3. Determining value

‒ Economic value added (EVA)
‒ Free cash Flow (FCF)
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5. KPIs and Financial Communication
READINGS
▪ READINGS
▪ Elliott/Elliott: Financial Accounting and Reporting, 18th edition, Pearson 2017: ch. 28, and 29.
http://www.vlebooks.com/ (“sign in” via “Google” with your ESCP info).
*Madrid Campus (19th edition):
https://login.revproxy.escpeurope.eu/login?url=https://bc.vitalsource.com/tenants/escp_madrid_bridge/libraries?b
ookmeta_vbid=9781292256047

▪ READINGS to “dive deeper”

▪ Weygandt, J.J., Kimmel, P.D., and Kieso, D.E.: Financial & Managerial Accounting, 3rd ed.,
Wiley 2018: ch. 13.
▪ Weetman, P.: Financial & Management Accounting: An Introduction, 7th ed., Pearson 2016:
ch. 13, and 14.
▪ Marr, B.: Key Performance Indicators, Pearson 2012: ch. 1-18 (Part 1, Financial Perspective).
▪ Walsh, C., and Warner, S.: 25 need-to-know management ratios, 1st ed., Pearson 2015:
ch. 4-11.
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5. KPIs and Financial Communication
OBJECTIVES

By the end of this chapter you should be able to

▪ Carry out an initial overview of financial statements
▪ Identify and discuss the most relevant KPIs for a particular entity
▪ Discuss future implications based on KPIs
▪ Explain limitations of comparisons based on KPIs

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5.1. Introduction to KPIs
- KPIs
- A framework for the analysis of financial data
- IFRS Exposure Draft ED/2019/7 « General Presentation
and Disclosures » in financial statements
5. KPIs and Financial Communication
KPIs
– Main Financial KPIs are based on accounting numbers but they are not necessarily
defined in the standards.
– KPIs usually put the focus on the performance, solvency and liquidity of the
company and try to answer the following questions:
• Did the company make profits in absolute terms?
• How is the profit to be judged given the (financial) input necessary to generate it?
(performance ratios, margins)
• Are the profits high enough? Compared to what?
• Is the company in the medium/long term able to repay its debt? (solvency)
• Is the company in the short term able to repay its debt? (liquidity)

– Guidelines by the European Securities and Markets Authority (ESMA), have been
European enforcement priority in 2017 and 2018.
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5. KPIs and Financial Communication
EXAMPLE: ORANGE – KEY FIGURES
2020 Integrated Annual Report (p. 127)

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5. KPIs and Financial Communication
EXAMPLE: ORANGE – TOTAL SHAREHOLDER RETURN

FY2020,
Orange Presentation:
Financial Results (p. 7)

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5. KPIs and Financial Communication
EXAMPLE: ORANGE – FINANCIAL RESULTS

FY2020,
Orange Presentation:
Financial Results (p. 7)

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5. KPIs and Financial Communication
EXAMPLE: ORANGE – FINANCIAL RESULTS cont.

FY2020,
Orange Presentation:
Financial Results (p. 7)

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5. KPIs and Financial Communication
A FRAMEWORK FOR THE ANALYSIS OF FINANCIAL
DATA TO MAKE DECISIONS (1/2)
– The use of accounting/financial data (KPIs, or accounting ratios) for analysis
purposes has important benefits for investors and financial analysts:
1) It allows inter-firm comparisons for management purposes;
2) ... The comparison with peers (i.e., performance, financial position);
3) … The comparison with industry averages.

– Notes of caution!
Important to check:
• The same accounting policies have been applied
(for ex., cost vs. revaluation model; depreciation method used; etc.)
• Different investment (and related accounting) decisions have been considered
• The ratios have been defined in the same way.

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5. KPIs and Financial Communication
A FRAMEWORK FOR THE ANALYSIS OF FINANCIAL
DATA TO MAKE DECISIONS (2/2)
– Differences in estimates and/or methods between companies
Example:
During the last years, Lufthansa reported that it depreciated its aircraft over 12 yrs. on a straight-line basis,
with a residual value of 15% of the initial cost.
annual depreciation (1-0.15)/12: 7.1%

In contrast,
industry peers (Air France-KLM, British Airways) were using straight-line depreciation rates between 4-5%,
with no residual value.
• Does it mean that these 3 companies fly different routes?
No, Lufthansa overstated its annual depreciation.
• How do financial analysts adjust for the effect of different policies?
… by adjusting the asset distortion,
… and calculating the offsetting increase in “equity” and in the “deferred tax liability”.

© Palepu, Healy and Peek (2019).

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5. KPIs and Financial Communication
IFRS ED/2019/7 “GENERAL PRESENTATION AND
DISCLOSURES” IN FINANCIAL STATEMENTS (1/2)
• The IASB has published the exposure draft of a new standard “General Presentation and Disclosures” that
is intended to replace IAS 1, Presentation of Financial Statements.
It includes the proposals to improve how information is communicated in the financial statements with a
focus on performance reporting.

• The IASB decided to focus on 4 areas:

• Definition of defined subtotals and categories in the statement of profit or loss;
• Requirements to improve aggregation and disaggregation;
• Management Performance Measures (MPMs) and accompanying disclosures in financial statements;
• Improvements to the statement of cash flows.

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5. KPIs and Financial Communication
IFRS ED/2019/7 “GENERAL PRESENTATION AND
DISCLOSURES” IN FINANCIAL STATEMENTS (2/2)
• The ED (paragr. 103,104) proposes a definition of “management performance measures”:
Management performance measures (MPMs) are subtotals of income and expenses that:
(a) Are used in public communications outside financial statements.
(b) Complement totals or subtotals specified by IFRS standards
Subtotals specified by IFRS standards that are not MPMs include:
• a total or subtotal required by IFRS standards (Operating profit or loss, Operating profit or loss and income and
expenses from associates and joint ventures, Profit or loss before financing and income tax, Profit or loss);
• gross profit margin;
• operating profit or loss before depreciation and amortisation; and
• profit or loss from continuing operations.
(c) Communicate to users of financial statements management’s view of an aspect of an entity’s financial
performance.

Example: A group uses 3 MPMs, “adjusted operating profit”, “adjusted net profit”, and “adjusted equity
holders’ profit of parent”. The 3 MPMs have been calculated by adjusting for the effect of unusual expenses
(ex.: restructuring and litigation expenses).
An entity shall disclose information about any MPMs in a single note to the financial statements. It shall include a statement that the MPMs provide management’s view of an aspect of the entity’s financial
performance and are not necessarily comparable with meausures sharing similar descriptions provided by other entities.

Venter, Emanuel, and Cahan (2014) provide evidence that non-GAAP earnings under mandatory regime have higher value relevance than GAAP earnings.
[Venter, E.R., Emanuel, D., and Cahan, S.F. (2014). The Value Relevance of Mandatory Non-GAAP Earnings, Abacus, 50(1), 1-24].

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5.2. Measuring Financial
Performance
- Absolute performance numbers
- Measuring overall performance using ratio analysis:
- Return on capital employed (ROCE)
- The Du Pont pyramid approach
5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS
Net sales
- Cost of sales
= Gross margin
+/- Other operating expenses and income rent
NON- = EBITDA*
GAAP
- Depreciation, amortization, impairment
= (Recurrent) Operating profit / income
+/- Non-recurrent expenses and income
= EBIT*
- Net interest expenses
= EBT*
- Income tax
= Net income from continuing operations

GAAP +/- Net income from discontinued operations

= Net income
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5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS: EXAMPLE 1

NON-GAAP 2020 Annual Report

(p. 246)
GAAP

NON-GAAP

NON-GAAP

NON-GAAP

NON-GAAP

GAAP

GAAP
GAAP

GAAP

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5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS: EXAMPLE 2
The company evaluates the segments’ Deutsche Telekom
performance based on revenue 2020 Annual Report (p. 237-238)
and EBIT.

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5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS – EBITDA
The use of EBITDA

– It is one of the most popular and widely used performance measures.

– Although it is not mandatory, and there is no standard definition.

EBITDA: “earnings before interest, tax, depreciation and amortisation”.

• It is calculated by adding back the depreciation and amortization to the operating profit.
• As a consequence, we eliminated differences:
‒ due to different useful lifes, or
‒ arising from the use of different depreciation methods.
• It shows an approximation to the cash impact of earnings.

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5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS – EBITDA
It differs from the Operating Cash Flow…
2020 Annual Report
Inditex, S.A. and Subsidiary Companies (p. 461, 463)
Consolidated Income Statement Consolidated Cash Flow Statement

2020, Annual Report (pg. 461) 2020, Annual Report (pg. 463)

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5. KPIs and Financial Communication
ABSOLUTE PERFORMANCE NUMBERS – EBITDA
Evaluating the use of EBITDA…
✓ in company valuation;
✓ in debt contracting:
✓ in restrictive loan covenants:
– net financial debt/EBITDA
– Debt service coverage ratio: EBITDA/(annual debt
repayments+interest)
– EBITDA/interest

In some industries (i.e., aviation industry, consumer services – retailing),

there is a variant:
EBITDaL: for “EBITDA after Leases”.
(… see ORANGE example, slides 8, 10-11).

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
Return of capital employed (ROCE)
ROCE: EBIT x (1-t) / Capital Employed
• It measures the return on the capital employed.

• EBIT x (1-t): Op. Profits after tax (NOPAT)

• Capital Employed is the capital investment necessary for the company to work.

Capital Employed might be calculated as:

– Non-current asset + working capital needs; or
– Equity + net financial debt.
Denominator: usually at fiscal yr.-end, or as the average of the last two years.

Because there is no “accounting standard” that governs the definition of this ratio, care needs to be taken when making inter-firm
comparisons.
For example: The numerator could also be calculated before tax, that is using “Profit before interest and tax”.

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
Return of capital employed (ROCE) – Calculation
Balance Sheet restructured - Balance Sheet

Non-current Equity Non-current Equity

Assets Assets
Non-current Liabilities - Other non-current Net Financial Debt:
• Financial Debt liabilities + Long-term Financial Debt
• Other non-current + Short-term Financial Debt
Current Assets liabilities - Cash
• Inventories Working capital needs:
• Acc. Receivables +Inventories
• Cash Current Liabilities +Acc. Receivables
• Financial Debt - Acc. Payables
• Acc. Payables

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS Return of capital employed (ROCE) – Example
Veolia Environment

2019 Annual Report

(p. 99)

non-financial
Capital
Debt
non-financial Employed
Debt using an
« Asset »
approach.
average
Capital
Employed.

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
The Du Pont pyramid approach

ROCE
2 key
components
EBIT (1-t)/Sales x Sales/Capital Employed of ROCE
NOPAT margin Capital Employed turnover

Margin Expense Sales/Non-current assets Sales/Working capital

ratios
Analysis Analysis
that impact
on ROCE
Inventory Receivables Payables
turnover turnover turnover

At the top of the pyramid, we start with ROCE and systematically analyse those ratios that impact on the profit and those that impact on the
capital employed in the business.
ROCE= EBIT (1-t)/Capital Employed = EBIT (1-t)/Sales x Sales/Capital Employed = NOPAT margin x Capital Employed turnover

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
The Du Pont pyramid approach

2019 Annual Report (p. 99)

Income Statement (p. 110)
• Revenues (mil.€): 27,188.7
• From previous slides:
ROCE = EBIT (1-t) / av. Capital Employed: 1,502/17,924 = 8.4%

• ROCE decomposition ( multiplying by Sales/Sales):

EBIT (1-t) / Sales x Sales / av. Capital Employed: 1,502/27,188.7 x 27,188.7/17,924 = 0.0552 x 1.5169 = 8,4%

NOPAT Capital Employed

margin turnover

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
The Du Pont pyramid approach
EuroStoxx’50
50

Source: COMPUSTAT Global

ING

Fiscal yr.-end: 2019

40

BBVA
Societe Generale

Deutsche Boerse
BNP

Santander
NOPATmargin

30

Intesa

Anheuser-Busch
Nokia
ASML
Amadeus
20

Sanofi

LVMH
Kering
SAP
Unilever
Bayer
Iberdrola Loreal Inditex
Air liquide
Danone Schneider
ENEL
Vivendi Safran
10

Fresenius
Essilor OrangeDeutsche Telekom
ALLIANZPhilips Adidas
BMW CRH
Vinci
Telefonica Volkswagen Total
ENGIE Siemens
Basf
Deutsche Post
AXA Ahold

Daimler
ENI
0

0 .5 1 1.5 2 2.5
capitalemployed_turnover

Excluding outliers / n.a. [Airbus (NLD), MunichRe (DEU), Linde PLC].

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
The Du Pont pyramid approach
EuroStoxx’50: Financial Services EuroStoxx’50: non-Financial Services

25
50

Anheuser-Busch

ING Nokia

ASML
Amadeus

20
40

BBVA
Societe Generale
Sanofi

Deutsche Boerse
BNP

NOPATmargin
Santander LVMH

15
30

Kering
Intesa SAP

Unilever
Bayer Inditex
Iberdrola Loreal
Air liquide
Danone Schneider
ENEL
Vivendi Safran

10
20

Fresenius
Deutsche Telekom
Essilor Orange
Philips
Adidas
CRH
Vinci
BMW
Telefonica
Volkswagen
Total
ENGIE Siemens
10

5
Basf
ALLIANZ Deutsche Post
Ahold

AXA
Daimler
ENI

0
0

0 .2 .4 .6 .8 1 0 .5 1 1.5 2 2.5
capitalemployed_turnover capitalemployed_turnover

Excluding n.a. [MunichRe (DEU)]. Excluding outliers / n.a. [Airbus (NLD), Linde PLC].

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5. KPIs and Financial Communication
MEASURING OVERALL PERFORMANCE USING RATIO
ANALYSIS
…Some additional performance measures

Return on shareholders’ equity (RoE) = Net Income / (average) Equity Return to shareholders

Return on assets (RoA) = Operating Profit (or EBIT) / Firm’s ability to use its assets to create
(average) Assets (operating) profits.

Return on investment (RoI) = Operating Profit (or EBIT) / Similar to RoA; measure of the income
Investment (T. Assets) earned on the invested capital; used for
profit centers.

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5.3. Determining Value
- Economic value added (EVA)
- Free cash flow (FCF)
5. KPIs and Financial Communication
ECONOMIC VALUE ADDED (EVA)
– Value is created when the return on a company’s economic capital employed is
greater than the cost of that capital. This is expressed as EVA, which is the
operating profit that the company earns less the cost of capital.
– EVA is equal to operating profits after tax (NOPAT), corrected for the cost of capital
employed (weighted average cost of capital: wacc).

EVA: NOPAT – (cost of capital x Capital Employed)

= (ROCE – wacc) x Capital Employed
wacc calulation depends on the company’s capital structure
(cost of debt (after tax) and cost of equity).

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5. KPIs and Financial Communication
ECONOMIC VALUE ADDED (EVA) - EXAMPLE
2019 Annual Report
(pp. 77-78)

Group EVA2019 = (ROCE – wacc) x Capital Employed

= ( 3.8 – 6.8 ) x 84,830 = -2,544.9 mill.€

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5. KPIs and Financial Communication
ECONOMIC VALUE ADDED (EVA) - EXAMPLE
2020 Annual Report
…1 year later… (pp. 90-91)

Group EVA2020 = (ROCE – wacc) x Capital Employed

= ( -16,5 – 6.8 ) x 74,678 = -17,400 mill.€

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5. KPIs and Financial Communication
FREE CASH FLOW (FCF)
– A useful analytical derivative of the cash flow statement is the computation of the free cash
flow (FCF).
– The FCF (to the Firm) is the net cash generated by operations, which determines the ability
of the firm to pay off its debt and equity claims:
Cash Flow from operations - Net Capex required to maintain productive capacity
= Free Cash Flow (to the Firm)
An alternative definition that is widely used in valuation analysis is:
FCF (to the firm) = EBIT*(1-t) + Depreciation – Capex - Change in working capital needs

– FCF to equity (FCFE) is the net cash generated for shareholders. It is calculated as
Free Cash Flow (to the Firm)
- Change in Financial Debt
- Financial Expenses*(1-t)
= Free Cash Flow to Equity
An alternative definition that is widely used in valuation analysis is:
FCFE = NI + Depreciation – Capex - Change in working capital needs + Change in financial debt
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5. KPIs and Financial Communication
FREE CASH FLOW (FCF)
2020 Annual Report
(p.145)

(€ million) 2020

CF Op.Activities (3,296)

Adj. net interest paid (-22+548) 526ª,b

CF Investing Activities 1,562

Free Cash Flow (to the Firm) (1,208)

CF Financing Activities (3,567-978-1,536-526) 527

Free Cash Flow (to Equity) (681)

ªFor valuation purposes, “Net financial expenses” are considered CF

from financing activities.
Under IAS 7, Statement of Cash Flows, this classification is not
mandatory.
bSimplification: Not adjusted by the net effect of the income tax.

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4. Financial Instruments
QUIZ (✓ or X) 1/2
1. EBITDA is considered one of the most popular and widely used GAAP-KPIs.
It is regulated by IAS 1, Presentation of Financial Statements. X
2. EBITDA differs from the net cash flow from operations reported in the
statement of cash flows in that it is before adjustments for working capital
changes. ✓
3. EBITDA is often used when valuing a company. It helps when comparing the
performance of companies which may have different financial structures (that is,
a different Debt vs. Equity composition), different depreciation policies and tax ✓
rates.
4. ROCE measures how a company performs in using shareholders’ capital to
generate earnings. X
5. Considering the formula: ROCE = EBIT x (1-t) / Capital Employed
… We can conclude that Capital Employed is not affected by depreciation X
policies.

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4. Financial Instruments
QUIZ (✓ or X) 2/2
6. A company can improve ROCE by a deferral in profitable investments (i.e., in
PP&E). This strategy may reduce firms’ value. ✓
7. Using an “asset”-approach to calculate Capital Employed, “working capital
needs” are determined by the difference between current-assets and current- X
liabilities.

8. NOPAT margin is the main key component of ROCE.

X
9. Dividends paid to shareholders reduce the FCF to the Firm.
X
10. Debt-repayments do not reduce the FCF to the Firm, but they reduce the
FCF to Equity. ✓

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4. Financial Instruments
FURTHER READINGS
Bennett, S. (2019). EVA, not Ebitda: A new financial paradigm for private equity firms. Journal of
Applied Corporate Finance, Vol.31(3), 103-115.
Biddle, G.C., Bowen, R.M., and Wallace, J.S. (1997). Does EVA Beat Earnings? Evidence on
Associations with Stock Returns and Firm Values. Journal of Accounting and Economics,
Vol.24(3), 301-336.
Milano, G. (2019). Beyond EVA. Journal of Applied Corporate Finance, Vol.31(3), 116-125.
Penman, S. (2006). Handling valuation models. Journal of Applied Corporate Finance, Vol.18(2),
48-55.

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Thank you!

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5.4. Additional Material
Economic value added (EVA)
5. KPIs and Financial Communication
ECONOMIC VALUE ADDED (EVA)
Achieving increases in EVA
‒ EVA can be improved in three ways:
a) Increasing NOPAT: by optimising strategic choices
e.g. Bayer: by analysing cash flows arising from different strategic operating segments (Crop Science,
Pharmaceutical, and Consumer Health);
(b) Reducing wacc: by optimising the debt/equity ratio;
(c) Improving capital employed utilisation: by considering the non-current asset turnover
ratio, and the analysis of the working capital.

‒ However, maximizing EVA each year may have some limitations:

‒ Increasing NOPAT does not always imply an increase in company´s value. For example, when
depreciation is less.
‒ Wacc may decrease due to a reduction in interest rates or in market premium, which is not related
to management performance.
‒ Decrease in asset employed (such as a delay in asset replacement) or a deferral of profitable
investments.
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5. KPIs and Financial Communication
ECONOMIC VALUE ADDED (EVA)
2000 4000 6000 EuroStoxx’50: non-Financial Services

LVMH Unilever

Anheuser-Busch
ENEL
Inditex
Sanofi Loreal
SAP Safran ASML
Total Schneider
BayerTelekom
Deutsche Kering Adidas
Danone
Deutsche Post
Vinci
Fresenius Air liquide
Philips Amadeus
Siemens CRH Ahold
Vivendi
Iberdrola Nokia
EVA (million Euro)

Volkswagen
0

Orange
Basf
ENGIE
Essilor
Telefonica
BMW
-8000 -6000 -4000 -2000

ENI

Source: COMPUSTAT Global

Fiscal yr.-end: 2019
-10000

Assuming an average wacc: 5%

Daimler

-.04 -.02 0 .02 .04 .06 .08 .1 .12 .14

EVA yield ( EVA / Capital Employed)

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