Business needs to look beyond financial metrics to recognise and create value
In today’s dynamic and rapidly changing world, the way businesses generate and preserve value is evolving. In the 1970’s over 80% of a company’s market value could be traced through to financial statements. Today, less than 15% of a company’s market value can be accounted for by its financial and physical assets . It’s clear that while financial and physical assets still play an important role in a company’s success, it is now often non-financial assets such as trust, reputation and the long-term viability of the business model that are primary value drivers.
Insight into value creation is critical to business success
To gain a clear understanding of the trends and challenges in measuring, disclosing and understanding the value that companies create, we have conducted a survey in partnership with the International Integrated Reporting Council (IIRC) and Black Sun. The resulting report, titled Purpose Beyond Profit: The Value of Value – Board-Level Insights, shows that more than nine-in-ten (93%) executives think that effectively explaining how a business’s value is created is important. Insight into value creation is not only valuable to investors, but for those within the company who are responsible for making business decisions too.
Despite that, less than a quarter believe non-financial reporting does a very good job of meeting the information needs of investors and other stakeholders. On top of that, only 24% have confidence that they are capturing the right information on the business model, including what, how and by whom value is created. Survey respondents reported three areas where they see significant information gaps in their businesses: quality information about strategy; the business model; and information about other non-financial dimensions of performance.
If executives do not have an accurate picture of how their business is creating value, how can they make decisions that effectively add to and preserve that value? In fact, only one-in-ten (11%) business executives are able to make decisions using data on the business’s value drivers beyond financial metrics.
As a result, almost nine-in-ten (89%) executives agree that organisations need to shift their focus from pure shareholder value creation to wider value considerations such as customer satisfaction and value to society. However, this raises the challenge of how companies can measure and report on non-financial value.
Purpose beyond profit
New reporting mechanisms are required to address the information gaps. If companies really believe that integrating non-financial information with financial information in decision-making has significant benefits, why are so few companies capturing this information? Largely, this is because accounting systems are still best suited for providing information about financial metrics, even while business investment in non-financial assets far exceeds investments in traditional financial assets.
There is a widespread agreement now that new types of information are needed to maximise insight into value creation. One option is to focus on new ways of disclosing what is currently available. In other words, how can reported information be presented in more useful ways?
For long term success however, businesses need to measure the right things, even if doing so is difficult. As a starting point, it is necessary to broaden the dimensions of performance that are considered in accounting and reporting systems, as well as the time horizons used. The good news is that work is well underway to address the information gaps identified by business executives and investors.
Take integrated reporting, for example. The framework, developed by the IIRC and supported by the Association, is an ideal tool that brings together material information about an organisation's strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It therefore provides a clear picture of how companies create value over the short, medium and long term.
At the Association, we have completed a global consultation on a business model framework and are developing a practical toolkit to manage the creation, delivery and sharing of value. These new management accounting tools can make value creation more transparent, easier to understand and manage. The toolkit is due to be launched at the end of May 2018.
10 steps businesses can take to better understand their value creation
In the meantime, there are several questions that businesses can and should ask themselves to get a clearer picture of their value:
- What is your definition of value?
- What is your business model?
- What are the circumstances under which your company operates and how might these change?
- What is special and distinctive about what you do as an organisation?
- What opportunities are you trying to exploit?What are your strategic goals targeted at long-term value creation?
- Do you understand the connection between different value-adding activities and the decisions made?
- How well will your business model stand up to changes in your organisation’s operating environment?
- What are the key risks you need to understand and manage?
- Do existing KPIs align with how your organisation creates value?