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TAG overview

Results

Report on Risks and Opportunities

Risks and opportunities are inherent to entrepreneurial activity. We have put systems and processes in place to identify risks at an early stage and counteract them by taking appropriate action. Within the company, opportunity management is an integral component of our internal decision-making processes such as short- and medium-term planning and intra-year business plans.

Risk and opportunity management

We are part of a complex, global business world and is therefore exposed to a multitude of external and internal influences. Every business decision is therefore based on the associated risks and opportunities.

In our internal risk reporting, risks are defined as potential future events or developments that could lead to a negative deviation from our (financial) targets. In parallel, opportunities are defined as potential events or developments that imply a positive deviation from our planned (financial and non-financial) targets. Identified future events and expected developments are taken into account in internal planning, provided that it can be assumed that their occurrence is likely in the planning period. The risks and opportunities presented in the following risk and opportunities report are those potential future events or developments that could respectively lead to a negative or positive deviation from the targets covered by planning.

Risk management process

The objective of our risk management activities is to recognize, assess, and manage risks early on and to implement appropriate measures to minimize them. The responsibilities, objectives, and processes of risk management are described in our internal risk management guidelines. The business heads, managing directors of our subsidiaries, and the heads of Group functions are specified as employees with responsibility for risks. The group of consolidated companies for risk reporting purposes is the same as the group of consolidated companies for the Consolidated Financial Statements. Every six months, the risk owners assess their risk status and report their risk portfolio to Risk Management. We use special risk management software in the context of these activities.

Likewise, risk-mitigating measures are reported and assessed. The effectiveness of these measures and the planned implementation time frame are monitored by Group Risk Management.

The residual risk after the implementation of these measures is presented in the internal risk report as net risk.

Group Controlling & Risk Management forms the organizational framework for risk management and reports directly to the Group Chief Financial Officer. Group Risk Management uses the information reported to determine the current risk portfolio for the Group, presenting this in a report to the Executive Board, the Supervisory Board, and the Finance Committee with detailed explanations twice per year. This also encompasses a probability-weighted aggregation of risks at the Group level using a Monte Carlo simulation. Furthermore, significant changes in the assessment of the risks already known and new significant risks can be reported at any time and are communicated to the Executive Board on an ad hoc basis.

For reporting risks with a potential negative impact on our EBITDA pre, a minimum threshold is set at the level of € 5 million before mitigation measures in the standard process and € 25 million in the ad hoc process. Risks below these thresholds are steered independently within the business sectors. The relevant timeframe for internal risk reporting is five years. It can go beyond five years, e.g. for regulatory risks related to climate change. The effects of risks described in this report on risks and opportunities are presented as annual values. The assessment of the risks presented relates to December 31, 2020. There were no relevant changes after the balance sheet date that would have necessitated an amended presentation of the risk situation of the Group.

Within the scope of audits, Group Internal Auditing regularly reviews the performance of risk management processes within the units and, at the same time, the communication of relevant risks from the operating businesses to Group Risk Management.

Opportunity management process

The risk management system described concentrates on business risks, and not on opportunities at the same time. The opportunity management process is integrated into our internal controlling processes and carried out in the operating units on the basis of the Group strategy. The businesses analyze and assess potential market opportunities as part of strategy and planning processes. In this context, investment opportunities are examined and prioritized primarily in terms of their potential value proposition in order to ensure an effective allocation of resources. We specifically invest in growth markets to leverage the opportunities of dynamic development and customer proximity at a local level.

If the occurrence of the identified opportunities is rated as likely, they are incorporated into the business plans and the short-term forecasts. Trends going beyond this, or events that could lead to a positive development in the net assets, financial position, and results of operations, are presented in the following report as opportunities. These could have a positive effect on our medium-term prospects.

Risk and opportunity assessment

Risks

The significance of risks is calculated on the basis of their potential negative impact on the forecast financial targets in conjunction with the probability of occurrence of the respective risk. In line with these two factors, risks are classified as ”high”, “medium”, or “low”.

The underlying scales for measuring these factors are shown below:

Probability of success

Probability of success

 

Explanation

< 20%

 

Unlikely

20 – 50%

 

Possible

51 – 80%

 

Likely

> 80%

 

Very likely

Degree of impact

Degree of impact

 

Explanation

> 50 million €

 

Critical negative impact on the net asset, financial position, and results of operations

20 – 50 million €

 

Substantial negative impact on the net asset, financial position, and results of operations

5 – < 20 million €

 

Moderate negative impact on the net asset, financial position, and results of operations

< 5 million €

 

Immaterial negative impact on the net asset, financial position, and results of operations

The combination of the two factors results in the risk matrix below, which shows the individual risks and their significance to the Group.

Risk matrix

> 50 million €

 

Medium

 

Medium

 

High

 

High

20 – 50 million €

 

Medium

 

Medium

 

Medium

 

High

5 – < 20 million €

 

Low

 

Medium

 

Medium

 

Medium

< 5 million €

 

Low

 

Low

 

Low

 

Low

Impact
Probability of occurence

 

< 20 %

 

20 – 50 %

 

51 – 80 %

 

> 80 %

Opportunities

Opportunities are assessed in their respective specific business environment. General measures of the business functions are quantified during operational planning, usually in relation to sales, EBITDA pre, and cash flow. Net present value, internal rate of return, the return on capital employed (ROCE), and the amortization period of the investment are primarily used to assess and prioritize investment opportunities. We use these indicators to assess the opportunities arising from the investment opportunities. Similarly, scenarios are frequently set up to simulate the influence of possible fluctuations and changes in the respective parameters on results. There is no overarching, systematic classification of the probability of occurrence and impact of opportunities.

Internal control system for the Group accounting process

The objective of the internal control system for the accounting process is to implement controls that provide assurance that the financial statements are prepared in compliance with the relevant accounting laws and standards. This system covers measures designed to ensure the complete, correct, and timely conveyance and presentation of information that is relevant for the preparation of the Consolidated Financial Statements and the combined management report.

Key tools

The internal control system aims to ensure the accuracy of the consolidated accounting process through functioning internal controls with reasonable assurance. The Group Accounting function centrally steers the preparation of the Consolidated Financial Statements of Merck KGaA, Darmstadt, Germany, as the parent company of the Group. This Group function defines the reporting requirements that all our subsidiaries must meet. At the same time, this function steers and monitors the scheduling and process-related requirements of the Consolidated Financial Statements. Group Accounting centrally manages all changes to the equity holding structure and correspondingly adapts the Group’s scope of consolidation. The proper elimination of intragroup transactions within the scope of the consolidation process is ensured. Group-wide accounting guidelines form the basis for the preparation of the statutory financial statements of the parent company and of the subsidiaries, which are reported to Group Accounting; the guidelines are adapted in a timely manner to reflect changes in the financial regulatory environment and are updated in accordance with internal reporting requirements. For special issues, such as the accounting treatment of intangible assets within the scope of company acquisitions or pension obligations, external experts are additionally involved where necessary.

The individual companies have a local internal control system. Where financial processes are handled by a Shared Service Center, the internal control system of the Shared Service Center is additionally applied. Both ensure that accounting complies with IFRS (International Financial Reporting Standards) and with the Group accounting guidelines.

Group Accounting provides support to the local contacts and ensures a consistently high quality of reporting throughout the entire reporting process.

For Group financial reporting purposes, most of our subsidiaries use standard SAP software. Consolidation software from SAP is also used for the elimination of intragroup transactions. A detailed authorization concept ensures the separation of duties with respect to both single-entity reporting and the Consolidated Financial Statements. The accounting process is generally designed to ensure that all units involved adhere to the principle of dual control.

The effectiveness of our internal control system with regard to accounting and compliance with financial reporting on the part of the individual companies is confirmed by both the local managing director and the local chief financial officer by signing the single-entity reporting. For the accounting treatment of balance sheet items, Group Accounting closely cooperates with Group Risk Management in order to correctly present potential risks in the balance sheet. All the structures and processes described are subject to regular review by Group Internal Auditing based on an annual audit plan set out by the Executive Board. The results of these audits are dealt with by the Executive Board, the Supervisory Board, and the Finance Committee. The internal control system at Merck KGaA, Darmstadt, Germany, makes it possible to lower the risk of material misstatements in accounting to a minimum. However, no internal control system can entirely rule out a residual risk, whatever its design.