Spotlight

An integrated approach to financial reporting

Aug 01, 2018
Integrated reporting isn’t just for large entities. It can also help SMEs develop and grow in a strategic manner.

It is generally recognised that the financial picture is only one facet of the performance of a business and that there are risks and opportunities associated with broader issues such as social, environmental and economic challenges.

To give a simple example, a business’ financial report may show high profits, but if the organisation is also creating pollution and likely to be regulated out of business in the future, it is not a good long-term investment. Rather than providing a mere snapshot of historical performance, Integrated Reporting (IR) seeks to provide a more complete and accurate picture of the performance of the business and how it will continue to create value in the short-, medium- and long-term by bringing together financial information with other information that is material to the organisation’s success.

The IR framework refers to different capitals – manufactured, intellectual, human, social and relationship, and natural as well as financial – recognising that value is not stored only in the financial. In looking to provide the broader range of measurements that contribute to longer term value and the role the business plays in society, it takes account of intangible as well as tangible assets. Ocean Tomo’s 2015 Intangible Asset Market Value Study demonstrated that 84% of the S&P 500 market value was accounted for by intangible assets, so their impact cannot be ignored by anyone seeking to understand the true value of a business.

The benefits of IR

IR provides benefits within the organisation and to external stakeholders. It allows for the uniqueness of the organisation, enabling the business to tell its story of value creation. Doing so provides better quality information and a far more complete picture of material issues to a greater range of stakeholders (e.g. customers, suppliers, employees, communities, legislators and regulators, as well as the providers of financial capital). Stakeholders can gain a deeper understanding of the company’s strategy and performance, and how value is being created. The quality and breadth of material information also enable better
understanding of risk and interdependencies for both internal decision makers and other stakeholders. With the growing emphasis on ESG (environmental, social and governance) investment, there is a strong argument that IR may help attract investment. Better quality information also allows for a more efficient allocation of capital.

Integrated reporting requires integrated thinking, and that prompts management into integrated decision-making about what is truly material in creating value in the short-, medium- and long-term, thereby making the business more resilient. IR also encourages management discipline. You manage what you know is going to be measured, so IR helps drive the performance and management of what is really important for business success for the longer term. The aim of IR is not just the report. Far more important is the integrated thinking and better decision-making that it encourages in management.

We have seen moves towards broadening the range of reporting such as the EU Directive on Non-Financial Reporting, which requires larger organisations to disclose information relating to environmental matters, social and employee aspects, human rights, anti-corruption and bribery, and diversity in the board of directors. Since it is anticipated that IR will become the norm over time, it makes sense for all businesses to be early adopters, develop the processes and skills required to report in this manner, and realise its benefits sooner rather than later.

The challenges of IR

A business may not be capturing all valuable data. Legacy systems often fail to capture data that, with our integrated thinking hats on, we see as necessary for the proper long-term management of the material issues and the determination of strategy. So managers need to review measurement systems and determine the metrics they need for the future. This challenge is, of course, a benefit since without the right data, the managers and board will not be enabled to make good decisions about strategy.

Comparability and consistency of metrics across a number of years is sometimes challenging. This can be related to legacy measurement and capturing of data, as previously described, or it can be related to changes within the business, which may require explanation to help readers get behind the surface data. For example, increased emissions for manufacturing per tonne could be due to a business getting more orders last year for units of a complicated product which utilises more energy in the manufacturing process rather than poor management of energy, which might be the initial interpretation. The greater focus on the more complicated product may not be an industry norm, thus making comparisons with industry benchmarks difficult and again requiring explanation to create clarity for the report reader.

Organisations that currently prepare an annual report often have a well-oiled system for doing so. The challenges of integrating a much greater range of data, which comes from a variety of sources within the organisation and is possibly collected for the first time, should not be underestimated. Even in organisations that currently publish a corporate social responsibility (CSR) report or sustainability report, it is my experience that combining data in one report to meet a required annual report deadline can be very difficult.

Connecting the dots to develop a holistic picture of the inter-relatedness and dependencies between the factors that affect the business’ ability to create value requires the collaboration and input of individuals throughout the organisation – not just in finance. People need training to understand IR and what organisations seek to achieve with it. They often need help to step out of a siloed mentality and leave behind their need to put a positive ‘spin’ on information and metrics arising from their area of responsibility. IR demands that material matters are reported in a balanced manner, both positive and negative, which precludes cherry-picking what you will report in any given year.

The focus on stakeholder relationships in IR often proves challenging. Despite the positive narrative from organisations about their engagement with stakeholders, many businesses lack evidence and data to support the extent to which they understand, take into account and respond to the needs and interests of their stakeholders. Or they focus on too narrow a range of stakeholders, perhaps giving lots of attention to customers but excluding other legitimate and important stakeholders such as suppliers or local communities.

Is IR useful for SMEs?

The simple answer is yes. SMEs can gain all the benefits described above – better ability to tell their unique story; better communication with a broader range of stakeholders; attraction of investment; better management decision-making and discipline; and enhanced understanding of risk and how value is created.

There are other potential benefits for SMEs. Compared with large businesses, SMEs are often more reliant on their connections with specific stakeholder groups such as the local community, specialised suppliers or providers of finance. IR forces a focus on stakeholder engagement and enables a much better sharing of information with stakeholders, which builds trust and understanding. SMEs can be seen as high-risk or assessed only by their most recent financial performance, which can be a significant barrier to development. IR gives the business an opportunity to counter this by presenting a fuller picture of how it is creating value, reducing risk and how it intends to do so in the longer term. With smaller management teams and less siloed structures, many SME management teams are actually more adept at collaborating effectively and engaging in IR thinking than those from bigger organisations.

Gráinne Madden is a corporate responsibility and business ethics specialist, and lectures in corporate responsibility to MBA students.