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November 15, 2018

SAM NG’ANG’A: Raising the bar on financial reports

Corporate
Corporate

There is very little doubt that financial reporting bar has been rising over the last decades. Traditional financial reporting has been accused of failing to address the information needs for the growing number of stakeholders who are not only interested in the financial performance of the organisation but also non-financial information such governance, business operating model, key risks and opportunities, strategy among others.

The operating environment has also radically changed with the adoption of technology, compliance, regulatory reforms and increased stakeholders’ awareness. Corporate reporting must therefore change to address these information gaps and to communicate in a holistic view the business value creation process over the short, medium and long-term.

The International Integrated Reporting Council (IIRC), a global coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs proposes the Integrated Reporting Framework aimed at addressing these reporting gaps.

An integrated report is a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term. Organisations prepare such reports to communicate how their resources and relationships, collectively referred to as ‘the capitals’, create value.

The IIRC in the framework categorises the capitals as financial capital, manufactured capital, intellectual capital, human capital, social and relationships capital and natural capital which are considered as inputs in a business model. These capitals are transformed (increased and decreased) through its outputs (products) and business operations.

For instance, financial capital is broadly defined as a pool of funds available to an organisation either as debt or equity finance for use in the production of goods or provision of services. The output in application of financial capital would be increased profitability which would then increase retained earnings meaning more funds for future projects.

This transformation eventually affects the availability and quality of the capitals which affects the business ability to create value over time.

An integrated reporting framework is founded on principles other than rules with the idea of recognising the wide variations in the operating environment, at the same time providing a reasonable degree of comparability across different organisations.

Integrated reporting involves more than just producing a combined report of a financial statements and annual report but it involves adoption of integrated thinking across the business which is the active consideration by an organisation of the relationships between its various operating and functional units and the capitals that the organisation interacts with.

This leads to integrated decision-making and actions that considers how business operations transform the capitals leading to value creation over time. Integrated thinking therefore is not an event but a continuous process of improvement through people, systems, behaviours and governance which leads to improved value creation.

Adoption of Integrated Reporting Framework has rich and compelling benefits. It promotes integrated thinking which improves understanding of material issues to an organisation by linking strategy and business models to resources and relationships, ‘the capitals’ leading to a shared understanding of value creation process within an organisation.

Integrated reporting promotes a cohesive and efficient approach to corporate reporting aiming to improve the quality of information available to providers of capitals to enable a more efficient and productive resource allocation. The framework also leads to improved communication by providing information on business model of an organisation, key risks and opportunities and governance.

An important principle in integrated reporting is stakeholder responsiveness which provides insights into the quality and nature of stakeholder relationships within the organisation.

Improved stakeholders’ engagement helps an organisation understand, consider and respond to their legitimate needs and interests collating such issues into strategic planning. Firms that practice integrated reporting have more dedicated and long term oriented investor base and fewer transient investors.

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