Unilever 2006 Annual Report Download - page 27

24 Unilever Annual Report and Accounts 2006
Report of the Directors (continued)
Financial review (continued)
Demographic assumptions, such as mortality rates, are set having
regard to the latest trends in life expectancy, plan experience and
other relevant data. The assumptions are reviewed and updated
as necessary as part of the periodic actuarial valuation of the
pension plans. Mortality assumptions for the four largest plans
are given in more detail in note 20 on page 104.
Provisions
Provision is made, amongst other reasons, for legal matters,
disputed indirect taxes, employee termination costs and
restructuring where a legal or constructive obligation exists at the
balance sheet date and a reliable estimate can be made of the
likely outcome.
Advertising and promotion costs
Expenditure on items such as consumer promotions and trade
advertising is charged against profit in the year in which it is
incurred. At each balance sheet date, we are required to estimate
the part of expenditure incurred but not yet invoiced based on
our knowledge of customer,consumer and promotional activity.
Deferred tax
Full provision is made for deferred taxation at the rates of tax
prevailing at the year-end unless future rates have been
substantively enacted, as detailed in note 1 on page 76. Deferred
tax assets are regularly reviewed for recoverability, and a valuation
allowance is established to the extent that recoverability is not
considered likely.
Reporting currency and exchange rates
Foreign currency amounts for results and cash flows are translated
from underlying local currencies into euros using annual average
exchange rates; balance sheet amounts are translated at year-end
rates except for the ordinary capital of the two parent companies.
These aretranslated at the rate prescribed by the Equalisation
Agreement of 31⁄9p = €0.16 (see Corporate governance on
page 39).
Non-GAAP measures
Certain discussions and analyses set out in this Annual Report and
Accounts include measures which are not defined by generally
accepted accounting principles (GAAP) such as IFRS or US GAAP.
We believe this information, along with comparable GAAP
measurements, is useful to investors because it provides a basis
for measuring our operating performance, ability to retiredebt
and invest in new business opportunities. Our management uses
these financial measures, along with the most directly comparable
GAAP financial measures, in evaluating our operating
performance and value creation. Non-GAAP financial measures
should not be considered in isolation from, or as a substitute for,
financial information presented in compliance with GAAP.
Non-GAAP financial measures as reported by us may not be
comparable to similarly titled amounts reported by other
companies.
In the following sections we set out our definitions of the
following non-GAAP measures and provide reconciliations to
relevant GAAP measures:
• Underlying sales growth;
• Ungeared free cash flow;
• Return on invested capital; and
• Net debt.
We set out ‘Measures of long-term value creation’ as an
introduction to the following section, in order to explain the
relevance of the above measures. At the end of this section
on non-GAAP measures, we summarise the impact on Total
Shareholder Return (TSR) which is our key metric.
Measures of long-term value creation
Unilever’s ambition for the creation of value for shareholders is
measured by Total Shareholder Return over a rolling three-year
period compared with a peer group of 20 other companies.
Unilever believes that the contribution of the business to this
objective can best be measured and communicated to investors
through the following measures:
• The delivery, over time, of Ungeared Free Cash Flow (UFCF),
which expresses the translation of profit into cash, and thus
longer-term economic value; and
• The development, over time, of Return on Invested Capital
(ROIC), which expresses the returns generated on capital
invested in the Group.
Unilever communicates progress against these measures
annually, and management remuneration is aligned with these
objectives. The UFCF over a three-year period is incorporated
as a performance element of Unilever’smanagement
incentive scheme.
UFCF and ROIC are non-GAAP measures under IFRS and US
GAAP. We include them in this respect since they are the way
in which we communicate our ambition and monitor progress
towards our longer-term value creation goals and in order to:
• Improve transparency for investors;
• Assist investors in their assessment of the long-term value
of Unilever;
• Ensurethat the measures arefully understood in the light of
how Unilever reviews long-term value creation for shareholders;
• Properly define the metrics used and confirm their calculation;
• Share the metrics with all investors at the same time; and
• Disclose UFCF as it is one of the drivers of management
remuneration and therefore management behaviour.
As investor measures, we believe that there are no GAAP
measures directly comparable with UFCF and ROIC. However,
in the tables on page 26, we reconcile each as follows: UFCF to
cash flow from operating activities and also to net profit; ROIC
to net profit.