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Narrative reporting continues to evolve, according to a UK review, but some companies are still struggling with it. By Nick Topazio, financial reporting specialist, CIMA.
‘With the current economic recession a consequence of the financial crisis, narrative reporting has never been more important in its role as a communications tool. Management around the globe should be using narrative reporting to effectively summarise its strategy, risks, performance, position and prospects.’ So said Charles Tilley, chief executive of CIMA, on the launch of the International Accounting Standards Board’s (IASB) Management Commentary consultation in June 2009. CIMA called on international bodies to consider ways in which they could encourage adoption and widespread use of the commentary.
The UK Accounting Standards Board (ASB) is another supporter of narrative reporting. It has published 'Rising to the challenge', a review of narrative reporting in the UK which examines the annual reports of 50 UK listed companies, focusing on:
The review shows that the best reports continue to evolve narrative reporting but other companies continue to struggle with some of the requirements.
So what was done well?
Financial review: performance and positionCompanies did well in this area, although discussion of cash and financial position could still be stronger with some 24% of companies categorised by the ASB as either ‘not compliant’ or ‘compliant but…’. Companies looking to incorporate best practice in this area are reminded to consider assets not often captured on balance sheets - intangible assets such as patents and brands.
Financial key performance indicators (KPIs)The ASB found an improvement in the presentation of financial KPIs, although in some cases KPI information was presented in isolation with no link to the remainder of the report. The Report Leadership group (comprising CIMA, PwC and Radley Yeldar) has presented a model strategy progress statement in their report ‘Tomorrow’s reporting today’ that demonstrates how strategic priorities, KPIs, performance, accountabilities and risk could be linked effectively. The model statement contained about a dozen KPIs; contrast this with one of the companies in the ASB survey that had 68 KPIs scattered throughout its report.
StrategyThe message that the best corporate reports contain a discussion of strategy seems to be generally accepted. 92% of the sample companies attempted to outline some objectives or strategies or both. However, nearly half of those that did were regarded by the ASB as falling short in some aspect of the spirit of the requirements.
Other areas reviewed did not fare quite so well.Principal risksIn the ASB’s view 66% of the sample were technically compliant but needed to make improvements to meet the spirit of the requirements. For instance, companies should aim to avoid the following pitfalls:
The provision of contextual information shows that the risk is understood and this is one of the key messages in CIMA’s response to the Financial Reporting Council review of the Combined Code on Corporate Governance. Calling on all large corporates, not just financial institutions, to stress-test their strategies, CIMA emphasised that it is crucial for organisations to have a thorough understanding of their own risks and to demonstrate this understanding through their risk reporting. It is important to not just report the risk but also to say what is being done to manage it.
Trends and factorsAs well as reporting on their stewardship of resources entrusted to them by shareholders, directors need to be aware that their reports are used to assess the future value creating potential of the company. The provision of a forward-looking orientation to corporate reports is essential though understandably difficult for many organisations in the current climate. For companies looking to improve their reporting in this area, the ASB review suggests that they focus on four words: relevant, future oriented, quantified and evidenced. It also suggests that they provide both company specific and macro environment factors.
Non financial KPIsThe review highlighted that too many companies were concentrating on the non financial KPI areas mentioned in the Companies Act – employee and environment – to the detriment of potentially more important key business drivers such as client retention or product pipeline. But disappointingly, 32% of the sample did not disclose any non financial KPIs at all.
Corporate and social responsibility (CSR) reportingCSR reports are still developing and there is significant social pressure to report on environmental and sustainability issues. This is leading to clutter in reports and a trend towards longer and longer statements. The ASB found that nine companies out of the 50 sampled had a CSR section that was longer than their financial review. Only 20% of the sample provided a convincing explanation of why CSR is important to their business. If a company has no material social issues then it should not be afraid to say so rather than comment on areas with no real significance to the sustainability of its business model.
Dos and don'ts'Rising to the challenge' lists a number of ‘dos and don’ts’ for companies aiming to improve their narrative reporting including:
Further information is available from the ASB website. Read the full review.
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