In an uncertain world, investors are increasingly looking for more than financial results when making investment decisions.
Memories of the financial crash have cast a long shadow – even when things look good on paper, the examples of Lehman Brothers, Fannie Mae and Freddie Mac have shown that seemingly robust financials are not always as cast-iron as they might appear.
How to address this problem? Integrated Reporting (IR) is a way of creating a more robust picture of your business health. By measuring a range of variables, and focusing on long-term growth instead of (merely) short-term financial soundness, IR ensures the business is geared for sustainable future. Not only does this benefit the company itself, it gives reassurance to your stakeholders that you are a profitable and sustainable business. Further, due to IR’s focus on ethical transparency, you can demonstrate that your company meets its environmental, social and human capital responsibilities too.
At a time when Brexit and other shifting political landscapes make the world even less predictable, more sophisticated reporting than finance-only is increasingly beneficial, to both large and small companies. So what does IR mean in practice – and what do finance professionals need to think about for the future?
What is Integrated Reporting?
IR encourages organisations to think about how all their resources are creating value. In practice, this principally means considering environmental, social and governance (ESG) but also taking into account intangibles that offer value, but are not traditionally measured – brand value and intellectual property being two of the most prominent. The International Integrated Reporting Council (IIRC) was formed in 2009 to oversee the creation of a globally accepted Integrated Reporting framework. For the IIRC, IR is about ‘helping businesses to think holistically about their strategy and plans, make informed decisions and manage key risks to build investor and stakeholder confidence and improve future performance.’
The ultimate aim of this is to create sustainable value – a goal that can be sidetracked in standard financial reporting because of the short-term nature of available financial data. According to ACCA, “it is now widely accepted that traditional financial reporting no longer meets the needs of businesses seeking to develop and maintain resilient and responsible operations, not just in the immediate future but also in the medium and long term.”
The reasoning behind this is simple: financial statements draw on historical information and are therefore backward looking. “They also focus heavily on financial capital,” ACCA points out, “whereas success for many organisations today depends on other resources – such as the expertise of their people, their intellectual property developed through research and development, and their interaction with the environment and the societies in which they operate.” IR is designed to fill these significant reporting gaps.
According to a new report by EY, Is your nonfinancial performance revealing the true value of your business to investors?, “recent events have shown that there are material risks and benefits embedded in non-financial information from corporate issuers. Investors increasingly see that by understanding these risks and benefits, they can avoid the downside and embrace the upside in a valuation that flows from non-financial business activities.” Part of this shift is generational. “Investors often expect that the rising population of millennials — with their views about ESG issues, and the influence gained as an estimated US$30 trillion is transferred to them from their parents and grandparents — will continue to amplify the importance of ESG factors in investing.”
As a philosophy, IR goes beyond the numbers, often being referred to as ‘integrated thinking’. Tom Roundell Greene is senior manager of reporting and communications for global sustainability at finance company JLL. “To my mind, integrated thinking is the prize and Integrated Reporting is incidental to that.” ESG analysis moves beyond basic governance and due diligence, according to Jennifer Anderson, Responsible Investments Officer for the Pensions Trust, responsible for over £8 billion of capital. “In the past,” says Anderson, “the priority was always the governance side. Corporate governance – that was the area that had the most weight or relevance for investors.” More recently, however, “climate change has really accelerated, environmental risks have really gone up the agenda, and at the moment they seem to be of equal weight and importance in the discussion.”
There is a clear trend amongst investors towards wanting to see more non-financial data being used. Skepticism about it has fallen – in the EY survey, the number of respondents saying that non-financial disclosures are “seldom material or have financial impact” has dropped startlingly, from 60% in 2013 to just 16% in 2016. Clearly, interest in IR is accelerating. Globally, there are nearly 2,000 participants in IR networks and the IIRC’s IR Business Network, a group of companies committing to adopting IR, has over 80 members.
Case study – Impahla Clothing
In South Africa, Impahla Clothing “has grown organically over the last 10 years,” according to a report from CIMA, “from an ailing business with 40 employees in 2004 to a thriving business producing in excess of 2.7 million units per year with over 450 employees.” Managing director William Hughes argues in the company’s 2014 Integrated Report that “transparency is vital to the sustainability of Impahla, and we credit our success to our inclusive and transparent business model.” The report identifies the company’s key risks and opportunities as well as communicating how the business itself is run.
This, for Hughes, “is written as much for ourselves as it is for our external stakeholders, for it serves as a yardstick against which we can measure and reflect on our progress from year to year.” In the CIMA report, Hughes outlines what he believes the benefits for the firm to be:
- Helping secure long-term customers. As a relatively small company, Impahla has tried “to create a niche market whereby customers want to do business with them. Adopting a policy which brings with it good practice and transparency has been key to creating this niche.”
- Motivating and protecting employees. Most companies will acknowledge that employees are their strongest asset. Impahla acts on this by including employees in decision-making and recognising that human capital is an important element of IR.
- Gaining access to credit. A robust Integrated Report makes it easier to secure finance as partners have increased access to detail about the company – not just their financial reports.
- Identify risks and opportunities. IR helps Impahla gain a better understanding of its business model, isolates gaps that need addressing, and can stimulate innovative thinking
How is IR measured, and what tools are in place?
IIRC suggests an International Integrated Reporting Framework which is designed to be consistent with a company’s existing reports. Instead of bringing in new KPIs the framework:
- Strikes a balance between flexibility and prescription, recognising “the wide variation in individual circumstances of different organizations while enabling a sufficient degree of comparability across organizations to meet relevant information needs.”
- Identifies information purely relevant for value creation – not benchmarks for strategy or performance levels.
- Creates insight about the external environment in which the organisation operates
- Uses these insights to create value over the short-, medium- and long-term; the end result is a more financially stable global economy.
Case study: Monnalisa SPA
As a medium-sized company, fashion firm Monnalisa has experienced strong turnover growth in recent years with sales more than tripling between 2000 and 2010. Monnalisa published its first integrated report in 2005, making it an IR early adopter. Its earlier form included a section on the value of intangibles – the benefits to a company from less-measured assets such as brand value and goodwill. More recently, Monnalisa’s IR surpasses the traditional financial, social and environmental measures and focuses on seven ‘chapters’ that isolate areas particularly relevant to stakeholders. As reported by ACCA, these chapters are:
- Maintain a strong identity
- Guarantee economic sustainability
- Guarantee high quality
- Excel in innovation
- Promote valorisation
- Communicate and involve in a transparent and effective way
- Contribute to the development of the territory.
For Monnalisa’s CFO, engagement with stakeholders is the key advantage of IR. “Engagement […] enabled us to understand what is important to them. We realised how stakeholders perceive value, opportunities and risks. This was very helpful for the process of identifying material matters and assess the importance of these matters in terms of their effect on sustainable value creation.” IR also means that the company can “rely on the information collected to feed and revise the contents of our internal dashboards and scorecards.” Monnalisa uses its own tailored IR structure “built around strategy execution; a structure that illustrates how financial and pre-financial capitals engage within the company Business Model to sustain value creation over time.”
Collaboration between departments
The accelerating take-up of IR undoubtedly suggests that its focus on value creation is something that resonates with companies; but introducing IR into business can be a complex affair not so much because of the need to generate new data but because of the need to collate that data effectively. “To really get the IR ball rolling a cultural change is needed both in business and from shareholders,” says Phil Hall, AAT Head of Public Affairs and Public Policy. “Most of the FTSE 100 do undertake some form of IR but they’re only scratching the surface,” he adds. “I have little doubt that as they increasingly see the benefits of doing so, companies large and small will start to take IR more seriously.”
What can prevent IR from being implemented effectively?
For smaller companies in particular, the need to commit time resources is a problem that needs to be addressed. The time necessary to isolate, report and interpret data is something that needs to be allowed for. In the Impahla case study, Hughes says that the added resources are worth it for any business “who [is] in it for the long haul”. And his advice? “Stick with it,” because although “in the beginning it can be daunting […] the benefits will come”.
Accountancy and IR
How are accountants affected by IR? Both IFAC and IIRC have established an Integrated Network for Professional Accountancy to seek to encourage wider implementation; but what do individuals in the profession particularly need to remember? ‘Accounting technicians, accountants and agents more generally need to understand that IR is not just a reporting process and likewise cannot be reported in a single reporting period,’ says Phil Hall. With reference to IR being regarded as integrated thinking, “I do think it could be looked at as being a state of mind because it requires those involved to think about all of an organisation’s activities and all issues that impact on an organisation’s ability to create value and be successful over the long term – quite a shift for many.” For Hall, “our members and others in the accounting profession are well placed to give a company-wide perspective of what’s going on. They can provide business insight, establish KPIs and make recommendations accordingly”.
A key benefit for the accounting profession is that “IR is an opportunity for them to upskill and to become an even more vital cog in creating value for their employer,” says Hall. But for this to happen, “IR needs to become a key feature of the reporting landscape, not an afterthought. Our members and the wider profession can help this happen.”
Ultimately, IR helps senior managers make better business decisions. Aided by increased transparency, it also gives shareholders greater visibility of the multiple components that indicate a business’s success, aside from the profit margin. It gives investors confidence that this is a trustworthy, growth-oriented company that shows due diligence in its activities, meets its ethical and environmental responsibilities and is not purely focused on short-term growth.
Mark Blayney Stuart is Business Journalist of the Year, Wales Media Awards 2017 and Former Head of Research at the Chartered Institute of Marketing.