Looking beyond financials

SUITS THE C-SUITE By Kristopher S. Catalan

Business World (09/15/2014 – p.S1/6)

TRADITIONALLY, a company’s financial statements are considered a good indicator of a business’ viability and performance. In recent years, however, savvy investors have begun finding a company’s non-financial indicators to be a more valuable source of information. Given the complexity of today’s markets, people are finding that wise business decisions are based not solely on number-crunching exercises — it is also necessary to exercise judgment by considering all facets of the business. The depth of this ‘judgment’ is influenced by the years of experience, degree of skills and expertise, and access to relevant financial and non-financial data.

These and other findings are highlighted in the EY (Ernst & Young) global survey of 163 institutional investors titled “Tomorrow’s investment rules: Global survey of institutional investors on non-financial performance.” The survey aimed to examine the respondents’ views on non-financial reporting, exploring how they use the available information, and the value they place on it. In this 2014 report, majority of investors said that in the last 12 months, assessing non-financial performance had played a pivotal role in their investment decision-making process. Of the 11% who said that non-financial performance had not played a key role in the past 12 months, the principal reasons they gave were that it was unclear if the non-financial disclosures were material or had a financial impact.

It is worth noting that non-financial data have become more readily available to investors. In recent years, many companies issued more non-financial reports, such as corporate social responsibility programs, corporate governance scorecards — broadly known as environmental, social and governance (ESG) performance — risk management and employee matters. Granted, in some jurisdictions, these are simply requirements from regulators requiring more information for public consumption. In the Philippines, for example, the Securities and Exchange Commission recently issued memorandum circulars on corporate governance, including a template for disclosures that publicly-listed companies should have on their Web sites. There are also other reporting rules that require more than just a company’s financial information in its annual reports.

The need to divulge non-financial data is driven not only by laws and regulations, but also by investors and the public in general who ‘require’ transparency and access to information. However, we should also consider that unlike financial statements, issuers of non-financial reports have no standard reporting requirement or framework to guide the preparers. This can result in varying degrees of information quality and consistency. This is an increasingly important area of focus for companies who wish to attract investors, especially given that majority of global investors in the survey stated that they use the information for decision-making because non-financial performance is a good measure for how companies manage their risks.

Respondents expressed that the two most important non-financial issues were the business impact of regulation and the ability to minimize risk. They are most likely to take ESG information into account when examining industry dynamics and regulation (53%), risk and time frames (49%), and when adjusting valuations to account for risk (45%).

Non-financial Information Direct from the Company

Generally, the most relevant source of information on the non-financial performance of a company is from its annual report rather than from a third party source. According to the survey, information from third parties (such as index ratings and press or media coverage) is judged as being less valuable.

The survey also indicated that investors have different preferences on the amount and level of detail in the information they wanted. Some investors said they wanted less — but more consistent — information that highlights the most material aspects. Others were more interested in being able to evaluate the data themselves. This suggests that companies should provide a variety of information through different channels to meet the needs of different financial stakeholders as non-financial reporting develops.

Investors want information that is specific to the organization. Almost two-thirds of investors think that it would be beneficial to have both sector-specific key performance indicators and metrics on expected future performance linked to non-financial risks. Sixty percent of respondents want companies to disclose the elements they feel are most material to their value creation story. They also see thorough reporting in this area as a proxy for good governance.

From the findings of the investor survey, companies may consider the following actions:

· Invest in reporting. Companies can ensure that financial stakeholders get greater confidence by providing more information on ESG performance. There is value to be gained from greater transparency. Investors also consider companies who apply their ESG seriously as entities who take risk analysis seriously.

· Report on — and highlight — what’s truly material to your business. Companies should understand the needs of their prospective investors, since most cannot tell if the information currently available is important to longer-term value creation. Learning what key stakeholders believe is fundamental to the company’s sustainable business development will be critical in determining what to measure, manage and report.

· Keep abreast with international developments. This area of reporting is evolving rapidly. Understanding these areas can be vital to gaining a competitive advantage and keeping up with potential new developments.

· Act now to control the information about your performance. Investors are finding their own ways to get data — even without official releases from the company. Organizations would do well to monitor their available non-financial information as they will be judged on that data.

· Ensure board-level oversight and governance. The majority of respondents said that they think a company’s non-financial performance should have audit committee oversight and be verified.

The decision to invest in a particular company can be a complex process requiring a wide array of information gleaned from financial statements and other sources. It goes without saying that stakeholders will continue to evaluate numbers such as cash flow and revenue, but increasingly, strategic investors will also consider the long-term sustainability, risk and management and growth potential of the companies to include in their investment portfolios.

Kristopher S. Catalan is a Partner of SGV & Co.