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.
How Accounting and Treasury Can Add Value
Accounting and treasury are natural partners that, unfortunately, are sometimes pitted against each other in business. Due to focusing on different areas, accounting and treasury (A&T) can sometimes start projects, launch overhauls, or want technology that pits them directly against each other. These conflicts and lack of understanding can lead to lost opportunities for the departments to utilize each other’s expertise in order to better position themselves for value creation. The more insight, and therefore value, that the A&T function can generate for the company, the more efficient the company’s reporting and analytic process is.
A more efficient reporting process can enable management to gain insights, spot trends and take advantage of market opportunities in a more timely manner. This creates a virtuous circle of more accurate information, more timely information, and an ability of firms to take advantage of this more comprehensive information to create more value for shareholders.
A&T personnel are trained to be detail-oriented, analytical, to construct variance analyses, and to seek answers to the underlying causes of shifts in the business environment. These skills lend themselves naturally to IR, and the shift to IR by some of the world’s largest companies—Eni, the Italian oil/natural gas conglomerate, is just one of the most high profile firms that have adopted IR into the annual reporting process—has created an excellent opportunity for A&T personnel to once again prove that they are capable of delivering value to the business in which they work. Other corporations that have adopted IR include Clorox, Pfizer and American Electric Power, and the continued development and refinement of integrated financial reporting standards clearly illustrate the growing importance of non-traditional reporting.
Some of the most obvious areas in which the analytic and technical expertise of these personnel can be used to enhance the effectiveness of IR are relatively straightforward and have to do with areas that are in the so-called wheelhouse of expertise. For example, the six types of capital that were referenced above—financial, manufactured, intellectual, human, social and relationship, and natural—should be quantified and factored into the company’s market strategy. The valuation training and market analysis that are already inherent in the traditional roles played by these two departments would come in equally as handy for evaluation of these types of capital.
As intangible assets and other intellectual capital comprise larger and larger percentages of marketplace valuation, the ability of organizations to quantify intangible assets is becoming increasingly critical to organizational success. Intellectual capital and human capital (the employees of the company) will undoubtedly play a more prominent role in the determination of corporate success or failure in the coming years as the economy shifts to a more knowledge-based economy. This shift is clearly evidenced by the rise of social media firms, such as Twitter and Facebook, and e-commerce giants such as Amazon and Alibaba.
Risk management is another area in which A&T can play a prominent role in shaping the IR process and helping deliver value to the company. By leveraging the understanding of financial metrics, market conditions, interest rates and pending financial regulation, it is logical to envision A&T employees having valuable input regarding the risk management objectives of the company. Strategy and risk management go hand-in-hand, and both are given much more analysis in the IR format—the ability of A&T personnel to help analyze and scrutinize strategic initiatives through a financial lens that might lead to more successful rollouts.
Last but not least, corporate governance is a hot-button issue for many firms today. The recent activity of activist investors and the creation of so-called “activist funds” indicate that the marketplace believes there is significant room for improvement in the realm of how publicly-traded corporations are managed. The public disputes between Carl Icahn and the board of eBay clearly link the topics of governance to real-world marketplace activities and financial decision making. A&T personnel, with knowledge of regulations regarding board structures, compensation matters and how financial laws can impact the structure of entities, seem to be a likely resource to be utilized as entities re-evaluate governance. Another key indicator of the importance of governance is the fact that Alibaba, a Chinese e-commerce firm, recently launched its IPO in the United States due to controversy regarding the governance structure of the corporation.
One area, however, that is linked both to IR and to the value that A&T personnel can provide is that of CSR. CSR initiatives have taken on a more prominent role in recent years as stakeholder groups, NGOs and governmental organizations expect private business to make a profit, and to do so in a manner that is in alignment with the triple bottom line. Some of the most common concerns within industry, in response to increasing CSR initiatives, center around determining the market impact of these CSR programs. This is of even greater importance when IR is factored into the equation as well—all stakeholder groups are demanding more and more information regarding the overall performance of the entity in the marketplace. This information and disclosure would most certainly include the impact of CSR and other “non-core” corporate activities.
Several areas in which CSR could impact the profitability and success of the firm are as follows:
- Increase in brand equity value due to positive image,
- Other intangible asset creation due to CSR,
- Successful engagement with stakeholder groups,
- Improved governance,
- Superior financial performance due to improved governance and stakeholder engagement,
- Increased market position and favorable opinion could lead to lower borrowing rates,
- Better reputation could lead to new business opportunities.
The above are just a few of the numerous ways in which CSR could impact the operational and financial performance of the firm—A&T personnel are well-positioned to take advantage of the need for data as it relates to these initiatives. Some of the synergies and benefits that are readily available are actually the result of the different technical strengths of these two areas. The treasury function, as traditionally constituted, has expert knowledge of the inflows and outflows of cash through the firm. Accounting, traditionally, is more concerned with ensuring compliance throughout the organization, and the creation of accurate financial statements.
Historically, these differing, and sometimes competing, priorities have resulted in a loss of value and breakdown in communication. With the increasing use of IR, and the rise of non-traditional metrics, there are new opportunities for both departments to leverage their technical expertise and unique insights to benefit the entity as a whole.
A Blueprint for Value Creation
Opportunities abound for A&T personnel to take advantage of the lack of data as it relates to some of the most fundamental aspects of IR and CSR initiatives, as they relate to reporting and corporate profitability as a whole. With that in mind let’s take a look at some tips, strategies and ideas that, combined, can form a blueprint for value creation opportunities that A&T personnel can take advantage of:
- Leverage existing, and develop new, synergies between the accounting and treasury functions to develop tools and metrics to help develop more real-time and comprehensive analysis to management.
- Research, analyze and develop tracking and valuation metrics for intellectual, human and social capital.
- Utilize existing knowledge of market conditions and the impact of CSR initiatives to help develop models and projected benefits of undertaking projects.
- Implement initiatives to improve risk management and strategy at an entity-wide level by bringing enhanced financial rigor and analysis to strategic plans.
- Assist management and investor relations in development of an IR template that successfully highlights and emphasizes all aspects of financial and non-financial performance by using analytic and detail-oriented abilities already present in both departments.
- By incorporating the real-time insights of treasury personnel, as well as benefiting from the insight of accounting regarding the impacts on financial reporting and compliance, the creation of entirely new KPIs is possible to help the company track its performance comprehensively.
While not a guarantee of success, these tips, tools and strategies will certainly help position A&T personnel to take advantage of the coming opportunities in the financial reporting marketplace, as well as to continue to deliver excellent value to the companis in which they work.
Sean Stein Smith is a senior accountant at United Water, a doctoral student at Capella University specializing in strategy & innovation, and the author of three books on financial literacy. Additionally, he is adjunct faculty at both Petrocelli and Silberman colleges at Fairleigh Dickinson University, and serves as the VP of communications for the Bergen-Rockland-Meadowlands chapter of the Institute of Management Accountants. He maintains a daily blog @ ssteinsmith.com.
Roberto Cruz Jr is an alum of Rutgers University, and is the author of Cruzing to Financial Freedom. In addition, he has conducted numerous financial seminars both in New Jersey and Minnesota. He has over 20 years of experience in the accounting and treasury field working with Fortune 500 companies, including Linens N Things and Bed Bath and Beyond.