RSS feedsOne of the keys to corporate governance is that it should all connect. Information should make sense in the corporate context. Everything needs to be in alignment, as the consultants would put it. But this is increasingly hard to do. Corporate reporting is entering a period of unprecedented chaos. To the casual observer there is no reason why this should be so. But anyone observing the changes in the past few months knows exactly why it is so.
The large corporates have now settled into a routine with reporting under international financial reporting standards. They now know several things for sure. It has taken a huge amount of technical resource and effort. The result of the process has integrity. There should not be huge difficulties in the reporting process from hereon. Companies can cope. But, they also know that a great shift has taken place.
Finance directors will think back fondly to their formative years when the goal was somehow to have the external reporting aligned with the information produced internally. A virtuous circle was always sought. The figures for the outside world would be made up of the figures which the management of the company used for their own internal purposes of driving the company forward and forming the strategy to do so.
This is no longer the case. The common view is growing that the internal figures and the external figures are now as far apart as anyone can remember. Some FDs will tell you that the two have almost no connection to each other. They also know that something has to be done about this. And they know that it is down to them. If they are to explain what they are up to in a complex world there is only one route they can take. And that has to be narrative reporting. The finance function has to find another way of explaining what drives the company and what makes it distinctive and likely to be ahead of the game in its competitive sector.
But narrative reporting is hard to pin down. It is, mostly, not a mandatory process. It is only codified through best practice and peer pressure. It can seem to sprawl out of control through the annual report and accounts and other investor relations publications. And, if it is not kept rigorously under control it can fill page after page of an already overlarge publication. It will also tend to be drawn from different criteria, company-to-company.
All this means that we are likely to see a steady movement towards an element of standardisation of narrative reporting. Companies will simply pluck a good idea from here and a thoughtful performance indicator from there. In five years’ time the whole process will be a settled one. At the moment it is not.
In April, PricewaterhouseCoopers produced a survey of the narrative reporting practices and patterns drawn from the information put out to shareholders, investors and analysts by the Fortune Global 500 companies. It provides a useful start. It finds that, for example, narrative reporting is split equally between qualitative and quantitative reporting. It finds that the majority of narrative reporting relates to explaining performance outcomes. But it also shows that only 10% of quantified narrative reporting relates to forward-looking information and only 15% of companies report specific key performance indicators. Those figures will surely rise in coming years.
One point that the survey emphasises is that the lack of such information may be hampering the ability of companies to get across their message in such a way that investors look to them as long-term opportunities rather than a short-term punt. “It is interesting to speculate whether some of the current capital market ‘short-termism' is, in part, driven by the current reporting model and the lack of forward-looking information evident from this survey,” it says. “As things stand,” it suggests, “some of the core components of revenue, operating profit and sources of growth are invisible to investors. How much is due to organic growth rather than acquisitions? Is organic growth a result of realising price increases, or is it more to do with volume changes? Providing more granularity in this critically important area would help investors better understand and interpret the underlying economics of performance.”
It is this confusion that may be at the heart of so much dysfunctional financial reporting. “Even the most technically able within the corporate and investor communities are finding it difficult to decipher the performance message of financial reports,” says the survey. “Further, the data required to address the technical complexities of the external reporting model may not be aligned with the information set being used to manage the business. Sophisticated users of the current reporting model typically pay attention only to parts of the information conveyed by companies and have little choice but to turn to non-company sources to continue to populate their analytic models.”
This is what has to be addressed in the confusion ahead. The winners will be the companies which can escape the tyranny of the figures and put the case for their future success in narrative form.
