Integrated reporting (IR) represents a paradigm shift within the world of financial reporting. IR is simultaneously a more broad-based reporting system, but also requires more detailed disclosures and more comprehensive financial information. The business environment is fluid, dynamic and ever-changing; hence, financial professionals must be prepared to adapt to these changing dynamics and demands.
Integrated reporting is a reporting initiative that is being led by the International Integrated Reporting Council (IIRC), which is an international coalition of investors, companies, regulators and accounting professionals. The IIRC is strongly supported by various NGOs, members of the accounting profession and the International Federation of Accountants (IFAC). The rise of integrated reporting would seem to be a natural extension of the following market trends:
- Increasing interest by stakeholders in non-financial metrics,
- The rise of corporate social responsibility initiatives,
- A greater interest in “other” types of capital, i.e., capital other than financial capital.
The increasing interest, and activism, of non-financial stakeholders (not stock or bond holders) presents both a challenge and an excellent opportunity for the finance department to re-affirm the value proposition they deliver both to their companies and to their investors. As investors and other stakeholder groups begin to demand more comprehensive information from companies in a more comprehensive format than previously delivered, IR represents an opportunity for companies to rise to the occasion. One of the primary components that makes IR stand out from traditional financial reporting is the fact that IR focuses on, in addition to traditional financial metrics, non-financial metrics that have impacted a company’s performance.
The six forms of capital that IR seeks to identify, differentiate and analyze are the following:
- Social & Relationship
Traditional financial reporting has focused on traditional metrics such as return on equity, dividend yields, free cash flow yield, net income, and earnings-per-share. This focus on financial reporting provides invaluable information to the management of the company, to potential investors and to the analysts that provide market coverage of the organization. As recent market events have demonstrated, however, focusing exclusively on this type of information can lead observers astray when it comes to performing a more holistic evaluation of the company. Corporate governance, a summary of the company’s business model, the competitive environment in which the company is operating, risk management techniques, and strategy are all areas that are discussed in more detail in a IR framework than in traditional financial reporting.
This may sound similar to the management discussion & analysis (MD&A) section of financial statements that already exists, but if examined more closely, the differences are readily apparent. The traditional MD&A section that is included with financial filings focuses primarily on the financial results from operations, units sold and market position, albeit in a narrative format as opposed to the quantitative representation that is included within the financial statements. The summary that is included with IR, however, gives a much more comprehensive view of the operations of the business. In addition to focusing on the operations of the company during the period in question, IR also mentions the external environment and the impact that it has on the company’s financial results. In the rapidly changing global economy, this additional analysis of the external environment can provide invaluable information to potential investors and to financial analysts, and can provide management with pertinent insights.
To complement the expanded analysis of the competitive environment, corporate governance and strategy that is embraced by the company, there is another trend in corporate America that is having a definitive impact on both financial performance and financial reporting: corporate social responsibility (CSR). The expectations of stakeholders for businesses to do more for their employees, communities and the environment has led to the development of new metrics, new studies to help determine the impact of CSR on profitability, and the so-called “triple bottom line.”
Corporate Social Responsibility
Corporations are powerful vehicles of change; that much is without debate. Private enterprise has revolutionized industries, created entirely new industries, and led to the creation of enormous quantities of jobs and wealth. Recently, however, business has been asked to do more. Whether it is a result of increased awareness (via increased access to the Internet and the rise of social media), the rise of non-traditional stakeholder groups such as environmentalists, NGOs and private foundations, the trend is definitive. Another possible reason for the increase in CSR programs and initiatives is that private enterprise is being asked to fill an area previously occupied by governmental organizations—as many governments have had to cut back services as a result of the global economic slump, private business is one group that has been looked at as a replacement.
Many companies, such as Johnson & Johnson and Starbucks, have sterling reputations as both profit-making enterprises and as bastions of CSR. The initiatives undertaken by these companies are long-standing, firmly integrated in the business models of the respective businesses, and are well understood by the marketplace. The trend, however, is for more firms to initiate more expansive CSR programs as various stakeholder groups come to expect these things from private business.
One major concern that has been voiced in both the literature surrounding this issue, in addition to passing the common sense test, is that these CSR initiatives cost money. As is always the case in business, the costs and benefits of new initiatives must be carefully analyzed. CSR is a natural complement to IR for the following reason: Both focus on non-traditional measures of corporate performance and success, but both measure different metrics, initiative and factors that can have significant impacts on corporate profitability.