We are a financially focused business. We monitor and challenge financial performance at all levels to probe the health and progress of our businesses and promote accountability. As well as profitability, we use a range of financial measures at Group level. Collectively they form an integral part of the way we build consistent, long term value for our shareholders.
We focus particularly on KPIs in six areas:
- Operating margins
- Free cash flow
- Capital expenditure
- Return on capital employed (ROCE)
- Gearing
- Economic profit
Operating margins
Aim: to maintain and strengthen margins. We constantly monitor operating margins and manage operating costs to keep the business efficient and cost effective.
To achieve this we:
- Focus on adding value and applying innovation
- Use our increasing economies of scale
- Focus constantly on our cost base
- Offshore back office activities to India
- Increase the utilisation of our business centres
- Apply and share technology.
In 2007, we continued our long term trend of improving operating margins (before amortisation) with an annual increase of 14 basis points (bpts) to 13.1% (2006: 19 bpts to 12.9%). This is due to a combination of factors including operational leverage, increased use of offshore facilities, and a continued focus on sharing IT platforms and rationalising infrastructure.
Cash flow
Aim: to maintain strong operating and free cash flow. In 2007, we generated operating cash flow of £334m, representing an operating profit to cash conversion rate of 123%. Our free cash flow, defined as operating cash flow less capital expenditure, interest and taxation, increased by 19% to £184m.
Our success reflects the strength of our business model and management approach, in particular:
- Securing timely payment terms for new contracts
- Focusing on cash generation
- Providing quality service to clients
- Maintaining an efficient internal finance function.
Capital expenditure
Aim: keep capital expenditure (capex) at or below 4% of revenue. This helps us to focus investment on the opportunities that generate greatest shareholder value and avoid tying up too much capital in long term projects.
In 2007 we met this objective, with net capex at 3.5% of annual revenue.
We believe capex at or below 4% is sustainable for the foreseeable future. There are currently no indications of significant capex requirements in our business forecasts or bid pipeline. But we would not rule out the possibility of exceeding 4% if we saw an exceptional opportunity to use our financial strength as a competitive advantage.
Return on capital employed (ROCE)
Aim: steadily increasing ROCE which exceeds our cost of capital. This ensures that we add shareholder value over the long term. In recent years we have successfully widened the margin between the cost of our capital and the returns we generate by investing it.
In the chart below, the weighted average cost of capital (WACC) indicates the return that could be expected from the capital invested in the business. It is calculated by weighting the cost of our debt and equity financing in line with the amounts of debt and equity that we use to finance our activities. We have calculated our WACC assuming a risk free rate of 4.45%, an equity risk premium of 5.4% and a Beta of 0.89%.
During 2007, our post tax return on average capital employed improved to 19.6%(2006: 18.5%). This compares to our estimated WACC which is 8.6%.
