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CFO South Africa: Expert Insight from Alex Watson

AlexAlex Watson talks about rethinking financial disclosures in integrated reports.

Most listed South African companies include either full or summarized financial statements in their integrated reports (In 2013 54 of 100 largest listed companies included full financials and 35 summarized). Are companies doing that in order to be compliant with regulations (as in “the company secretary insists!”) or because they believe that is the best way to communicate the company’s ability to create value in the future?

A company has to distribute either full or abridged financial statements to its shareholders, and is required to make a full set of financial statements available to those shareholders. That is not up for debate. What is up for debate is the best way for a company to present financial information in its integrated report.

My impression is that many companies have prepared their integrated reports by starting with their existing suite of reports and attempting to make them more integrated instead of starting from a zero base and focussing on only that information which is relevant to explain how the company creates value. Inclusion of financial statements prepared in terms of IFRS and detailed information on directors’ remuneration are two areas where the motivation appears to be more compliance driven than fulfilling the spirit of integrated reporting.

Should financial statements be left out of integrated reports?
Apart from the obvious lack of connectivity, a key difference between financial statements and financial information in an integrated report is that financial statements are backwards looking whereas an integrated report is intended to be forward looking. If financial statements are included in an integrated report, the information has to be presented in a way that communicates the potential for increasing financial value in the short, medium and long term as well as the related risks and connectivity to other capitals. Financial statements prepared in terms of IFRS are important and will continue to provide important information to certain users in certain circumstances, but that does not imply that they should necessarily be included in an integrated report. It is worth noting that the integrated reporting framework makes it clear that an integrated report “is intended to be more than a summary of information in other communications (e.g. financial statements ..” and instead “should make explicit the connectivity of information to communicate how value is created over time.”

Understandably there is some reticence to publishing financial forecasts, but that does not mean that forward looking financial information cannot be presented. Integrated reports (IR) have some examples that are useful to look at to get a sense of how historical financial information can be presented to make it more appropriate for integrated reports.

Useful approaches could include:

  • A waterfall graph to explain the movements between current and prior year profits. African Rainbow Minerals did this particularly effectively by grouping the movements between those that were caused by market movements and those that are within its control (2014 IR page 16).
  • Providing information linking the business model to the financial performance. Standard Bank Group did this effectively by indicating how different business activities impact income statement line items and the related risks for that activity (2013 IR page 4).
  • Disclosing the sensitivity of profits to external prices. For example, Sasol discloses the sensitivity of its profits to changes in the oil price and the Rand:$ exchange rate (2014 IRpage 81).
  • For industries that are price takers, disclosure of break-even prices is useful. RBPlat did this particularly effectively by disclosing its break-even platinum price on an industry cost curve (2013 IR page 15).
  • Linking financial results to key risks. By linking interest on trade receivables, cash collection costs and bad debt charges over 5 years, Truworths highlights the financial impact of its credit risk (2014 IR page 52).
  • Using graphs to highlight key ratios over an extended period. For example, Clicks presents a graph of turnover and the operating margin over 5 years (2014 IR page 18), as well as the long-term relationships between dividends, HEPS and dividend cover and another contrasting Clicks Group return on equity compared to average ROE of other food and drug retailers (2014 IR page 19).

Where financial forecasts are published, disclosure of the assumptions used and industry context is useful. Truworths is a good example. In addition to providing targets on a range of financial performance indicators, disclosure is also given of the prior year’s target together with actual performance and local and international benchmarks providing useful context.

A separate document?
While acknowledging that integrated reporting is in its infancy, one aspect that I have found particularly disappointing is the lack of connectivity between financial and other capitals. Many companies talk about the reduction in carbon emissions, water and electricity usage etc., but there is virtually no disclosure of current or future financial consequences arising from those activities. That is what is needed to show the connectivity between different capitals.

Investors and lenders have used, and are likely to continue to use, financial statements in many of their financial models and there may be resistance to excluding financial statements from an integrated report. A good compromise is to distribute financial statements with an integrated report, as a separate document which may or may not be bound as one document. The distinction between being part of an integrated report as opposed to being available with an integrated report is an important one that needs more attention if integrated reporting is to achieve its goals.

This article was first published by CFO South Africa