I thought it would be useful to relay the results of the Annual Review of Corporate Reporting for 2016/2017, released last month by the Financial Reporting Council (FRC) (the “Report”), to corporate spectators like yourselves.
The Report’s primary audiences are usually preparers and auditors as it engages with companies to encourage compliance and improvement. However, I believe that investors could also benefit from the Report, as it could equip them with the skills to spot the holes in their next venture.
You can rest assured that, generally speaking, the standard of corporate reporting remains pretty good, particularly in relation to the larger listed companies. However, of course, the Report makes clear that there is still plenty of room for improvement. The areas identified by the FRC as requiring the most correction from companies are as follows:
- 1) properly explaining and quantifying key judgements and estimates;
- 2) providing a fair and balanced assessment of performance and prospects that covers both positive and negative aspects;
- 3) ensuring the links between financial statements and discussions of strategy, performance including Key Performance Indicators (KPIs), financial position and cash flows including the use of Alternative Performance Measures (APMs), are clear; and
- 4) providing information that is company-specific.
As a result, if you are looking to invest in a company, and find yourself faced with vague financials, you need to respond by asking company-specific questions. By this I mean questions that are material to understanding the company’s business, performance and prospects. For example, “how do the most recent financial statements of the company correspond with the targets of the business for this year?” “On the basis of the most recent financial statements what are the forecasts of the business for the next three years?”
Moreover, when purchasing a company you should look for a fair and balanced assessment of its performance and prospects that covers the ‘good’, the ‘bad’ and the ‘ugly’. The strategic reporting most concerned the FRC because many lacked balance. In order to extract a fair and reasonable view of a company you need to understand the links between the financial statements and discussions of strategy, performance including KPIs, the financial position of the company, its cash flow, and the use of any APMs. By correlating the financial data with performance information, you should be able to identify trends in the data and be able to separate the ‘one-off occurrences’, which in turn shall give you a more realistic view of the company.
Likewise, you should be weary when changes in performance measures are reported without the reasons for the changes or their impact. The FRC commonly identified corporate reports of companies where not all key aspects of performance had been included. Again, it is important that all key aspects of performance are disclosed so a fair and reasonable view of the company can be collected. Where performance information lacks substance, or is not related to the overall performance or prospects of the company, it is advised that you ask company specific questions that requires descriptions be supported by financial data.
Furthermore, you should be alerted when a corporate report is silent on such matters as political, economic, or environmental factors, which clearly have an impact on the business of the company in question. The FRC challenged a number of energy companies where little or no reference to the possible effects of environmental issues had been made. Corporate reports should discuss factors outside of the company’s control which could affect business activity. Otherwise, it cannot be trusted that the corporate report is fully comprehensive, especially with regard to the strategic report.
Finally, in the corporate report you should be looking for detailed disclosures as to the effects of Brexit on the company’s business strategy. The FRC noted that the majority of companies reviewed reported on continuing uncertainties. A consistent theme was that it was too early to measure the long term effects of the EU referendum. However, the FRC is encouraging companies in their next annual report to provide as much detail as possible on their response to Brexit. Therefore, you should be looking for increasingly focused disclosures, identifying the company-specific risk and opportunities as the economic and political effects of the vote and negotiations develop and become more certain.
Transparent reporting is fundamental when building investors’ confidence in the way companies are run; and is vital to the long term success of UK companies and the wider economy. I hope that by highlighting good practice, while also identifying when correction or improvement is required, you are now able to distinguish an uncomprehensive and vague corporate report from a fully comprehensive and balanced one. This shall assist you when assessing the long-term success of a company.