A recent performance indicator to measure the capital profitability and therefore measures the Value Creation, whereas
Formula
(1) Recurrent cash flow of the business if no growth and no deterioration
(2) Capital invested as a full replacement value, including Working Capital
Numerator:
(1) The "Earnings from associates and JVs" are removed from Underlying EBITDA as these are non-cash items
(2) Recurring CAPEX are normalized at 2.3% of the replacement value of assets for all GBUs, i.e.: maintenance CAPEX = 2.3% x (gross tangible + intangible assets).
The 2.3% are also a rule-of-thumb in the Industry.
Recurring CAPEX are the maintenance Capital Expenditures necessary to keep existing assets running (= the minimum to keep the level of Underlying EBITDA).
(3) Tax is normalized at 28% for all GBUs (30% until 2018), i.e. 28% x (Underlying EBIT - Equity JV earnings).
Tax rate based on Solvay expected tax rate
Underlying EBIT less earnings from associates and joint ventures, as equity earnings already include tax charges
The values of recurring CAPEX and Tax are not directly extracted from the financial statements.
Denominator:
(1) Working Capital (WC):
Annual average value = 0,25 x (Q1 + Q2 + Q3 + Q4)
WC at Group level = Inventories + Trade and Other receivables (including customer prepayments) + Trade and Other payables (including advance payments)
WC at GBU level = Inventories + Trade receivables + Other receivables + Trade payables + Other payables
(2) Replacement value of fixed assets = gross tangible and intangible assets as a proxy to replacement value
Goodwill is excluded
In the absence of replacement value, take the gross value
The values of replacement value of assets are not directly extracted from the financial statements.
(*) EVA = Economic Value Added (or created)
See EVA indicator.
Also see point related to CFROI versus EVA
WACC = Weighted Average Cost of Capital:
Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for what it finances.
WACC is often used to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows.
Economic interpretation of CFROI
CFROI is to be compared to WACC: Everything ABOVE WACC is Value Creation
CFROI is equivalent to the IRR (Internal Rate of Return) of an existing business; IRR being the discount rate bringing the Net Present Value to zero.