BY PAUL QUIGLEY
After nearly two years since former Chancellor Gordon Brown killed off the Operational Financial Review as just more gold-plating of European accounting directives, what future is there for the Business Review and narrative reporting?
When the erstwhile Chancellor of the Exchequer announced in late 2005 that the Operational Financial Review, OFR, was to be scrapped, you could be forgiven for thinking that a large, collective sigh of relief would have been felt along the corridors of corporations and financial advisers. But there was no such phlegmatic response. Indeed, many in the industry heard shouts going up of wasted time, effort and resources, barracking the Chancellor’s proclamation as a U-turn on a useful new tool.
With the Business Review and the changes within new Companies Act 2006, the reality today is that despite the official dumping of OFR, most if not all large corporations have kept the spirit of OFR alive. Why? Not least because a raft of its requirement overlap with other EU-enforced codicils such as interim management statements of the Transparency Directive and the Accounts Modernisation Directive-driven Business Review. Why? Because there was a lot of positive and useful content being promulgated; narrative communication between organisations and stakeholders was to do much to mend financial fences wrecked by Parmalat, Barings, Enron and the like.
Furthermore, the analyst community liked it. Not only were shareholders to be wooed, there were a raft of other stakeholders who would appreciate the clarity through the words of directors, rather than the obfuscating quasi-legalese of yesteryear.
So, in the two years since the much-lamented passing of the OFR, has the beneficial rift-healing, bridge-building effects of narrative reporting been resurrected by more circuitous routes? As Paul Robeson might say, it ain’t necessarily so.
Tim Copnell, director in corporate governance at KPMG, said: “The business review is, at least for quoted companies, almost as onerous as the OFR it replaced. Nevertheless, narrative reporting provides companies with the opportunity to better communicate corporate performance, the risks and uncertainties facing the company and the company’s future prospects” Copnell added. “Good communications have always been important, but increased stakeholder expectations and the volatility and complexity introduced by IFRS have made this even more imperative.”
ICAEW’s head of financial reporting Nigel Sleigh-Johnson said around the time OFR was jettisoned, that it was a vital element of the corporate communication process. He said it also provided “a platform for subsequent dialogue with investors and other stakeholders and provided management with the opportunity to take stock and convey a clear, coherent account of their strategies and objectives and their success in implementing them.” That was OFR, much if not all of this holds true for the Business Review. Yet even back then, ICAEW’s Sleigh-Johnson warned that there were concerns that liability, due to the forward-looking orientation of the requirements and the lack of a legal ‘safe harbour’, may have led to ‘bland and highly-caveated OFRs’. Fortunately, for directors responsible for narrative reporting, this aspect was catered for in last year’s new Companies Act.
Moreover, not only has OFR raised the bar, the challenges facing organisations extend well beyond just their own shareholders. Influential external watchers may also be prepared to hold firms to account for what strategic claims they make, retrospectively. Ken Williamson, head of financial reporting advisory at Ernst & Young concurs with Sleigh-Johnson’s early concerns. “The inclusion of forward-looking information in the Business Review is going to bring new challenges for companies. Analysts will expect a strong linkage between historic narrative reporting in any given period and the forward-looking information provided in previous periods, that is, how has the company done against targets and goals previously highlighted. This will test the company’s appetite for open and robust reporting. Those companies that can balance discussions in the boardroom, with the disclosures on executive remuneration targets, key performance indicators and ongoing reporting of financial information to the market will maintain and potentially enhance their financial reputation.”
Despite the concerns, empirical evidence is proving that despite the disillusionment post-OFR, a sizeable contingent used the experience of preparation and sunk costs to disclose anyway. “Even though quoted companies are no longer required to prepare an OFR, PricewaterhouseCoopers has found that most quoted companies are providing disclosures that go beyond the minimum required by the Business Review legislation, and instead are working towards best practice as envisaged by the Accounting Standards Board Reporting Statement,” notes Janice Lingwood, director of corporate reporting at PricewaterhouseCoopers. “PricewaterhouseCoopers has long believed that good quality narrative reporting is fundamental to a full understanding of business performance. This view is based on a decade of our own research that has shown that investors need a good understanding of both historical and likely future performance to properly assess and value a company,” she added. “Investors require good quality narrative information, supported by quantified metrics, to supplement and complement the information in the financial statements.
Back to basics
But at the crux of the generic narrative reporting regime, from whatever original source, getting down to brass tacks about the business is all that is wanted. But there’s the rub.
Isobel Sharp, partner in Deloitte’s audit practice explains, narrative reporting is vital. “It explains the performance and the position of the business in words, making it more accessible to more people than the relatively complex financial statements. Our concern, ” she stressed, “is that its content is being so prescriptive that companies may produce similar looking reports. Uniformity is at the price of individuality.” And it is this pivotal, board-level directors personal touch that may be the baby that gets thrown out with the business bath water. “I fear that investors may be losing that important flavour of how and what management reports,” opined Sharp, with narrative reporting just becoming another compliance burden.”
Such sentiments echo many of those heard surrounding other box-ticking exercises, of red-tape compliance, and whether codes of practice of legal form-filling actually do more to waste companies’ time than shed light on the key issues.
Ian Mackintosh, Chairman of the Accounting Standards Board stressed earlier this year in an annual review on the subject: “Many companies are reporting beyond simple compliance with the law and moving towards best practice,” he said. “We hope that more and more companies will regard good narrative reporting as a means by which they can achieve transparent and open communication with their shareholders. However,” Mackontosh admonished, “there is room for improvement in the difficult areas of providing forward looking information, describing available resources, disclosing principal risks and uncertainties and on identifying key performance indicators”
Whatever the pros and cons of narrative reporting, the elephant in the room will remain the boardroom’s fear of divulging too much, potentially commercially confidential strategic information in the name of compliance – information that can be seen by competitors – whilst simultaneously being open and honest and providing a fair and reasonable verbal account of what is going on, duly backed up by the numbers, as well as quantitative and qualititatve KPIs.
It may be a tall order, and yet reporting generalistic statements is not an option. CEOs and FDs may be damned if they do, and damned if they don’t. But going back is not an option.