Measuring profit, sharing success

Economic profit offers a simple gauge of business performance —and can translate into a Boeing employee benefit

BY JUNU KIM

If it's July, that means it's time for Boeing to announce its financial results through the second quarter of the year. Business news reporters will most likely use figures such as earnings and earnings per share to assess how Boeing fared in the quarter. Boeing employees, however, should be more interested in "economic profit."* This number isn't normally mentioned in financial reports—in fact, Boeing considers economic profit targets and its performance against those targets sensitive material information and doesn't publicize them. However, economic profit reflects the value Boeing employees are creating for the company's stakeholders and the primary measure how Boeing and its employees are doing.

"All of us at Boeing benefit when the company performs well," said Mike Sears, Executive vice president, Chief Financial Officer and member of the Office the Chairman. "Each individual and team effort to grow revenues, reduce costs and make operations more efficient has a 'big picture' and long-term impact. The challenge is trying relate your own process improvements or project successes to the complex quarterly or annual financial reports. That's what the economic profit measure helps us do."

Specifically, economic profit performance constitutes the basis for annual executive bonuses and a key incentive program for more than 80,000 eligible nonexecutive Boeing employees worldwide, the Employee Incentive Plan. The EIP can provide cash bonuses of up to 20 days' additional pay to eligible employees if the company achieves annual economic profit objectives. In its first three years, the EIP has paid out a total 27.35 days of extra pay. Also, employees in some Boeing unions are rewarded through various gainsharing programs that focus on metrics—such as unit cost reduction, quality improvement and schedule performance—that directly contribute to Boeing economic profit.

So what exactly is economic profit? Boeing defines it as the company's net operating profit after taxes, minus a capital charge.

Net operating profit essentially reflects how much money an entity made from its business operations. Start with its revenues—the proceeds from customers for providing products or services—and subtract the costs needed to run the business, such as labor, overhead, materials, research and development expenses, and sales and marketing expenses. The amount left over is called operating earnings (if the amount is less than zero, this figure represents an operating loss). Taxes are then deducted from operating earnings to get net operating profit after taxes (the numerator in the economic profit calculation).

On the other side of the economic profit equation is the capital charge. Like all companies, Boeing carries on its accounting books "hard assets" it needs to run its business, such as equipment, buildings, land and inventory, as well as other assets such as receivables and intangibles. There is a "cost of capital" associated with holding these assets, since they have value but can't be readily deployed the way that cash can.

Boeing calculates capital charge as a percentage of its net assets. Subtract the capital charge from the net operating profit after taxes, and that leaves economic profit.

The elegance of this figure is that it truly reflects business performance, said Dan Hirner, senior manager, Financial Planning & Analysis: "Individuals, managers and teams can relate to this measure because they can see how they can impact the results of their program or business unit."

So why does the company focus on economic profit instead of earnings or earnings per share? Earnings can distort a company's underlying performance, since they can include charges that have positive or negative effects such as a pre-tax charge for goodwill impairment. Economic profit, on the other hand, illustrates the value created over and above the investment needed to generate a favorable return. "If we have a dollar of earnings and it required a dollar of invested capital, we haven't really created any additional value," Hirner said.

"Since economic profit is based on revenues, expenses and assets, employees, programs and business units all have a direct influence on this figure," Hirner added. The lowdown: economic profit grows not merely by boosting revenues, but also by reducing costs and assets. Costs and assets are reduced through more efficient processes, cost containment, minimized inventory and improved cash management, among many other ways.

"That's why we talk about more efficient operations from a Lean Manufacturing standpoint," Hirner said. "A major driver at Commercial Airplanes and Integrated Defense Systems is, how do we maximize efficiency and remove non-value-added costs from our cost structure? We reduce cycle times on all of our processes, we go to moving lines, we do just-in-time inventory. These are some of the biggest pieces to help reduce assets."

junu.kim@boeing.com

* Represents a non-GAAP (Generally Accepted Accounting Principles) measure. Boeing does not intend for the information to be considered in isolation or as a substitute for the related GAAP measures. Other companies may define the measures differently.