by John Reiners
In my last blog post I reported from CIMA’s event on the difficulties of accurately reporting intangibles, a situation that is getting much worse with the emerging digital economy. But you could argue that financial reports have always been largely fiction and mostly ignored by decision-makers. What does it matter if they become a bit more unreliable?
Let’s look at the main users of a company’s financial information and reports.
Firms’ own management teams have always created their own sets of management accounts and key performance indicators, which often only have a distant relationship to the official published financial accounts. I expect this will grow more distant as businesses seek to upgrade their performance management systems, taking advantage of new sources of data and more sophisticated analytical tools. But most have a long way to go to generate the information they need to guide their actions at a time of rapid change. Managers still rely mostly on monthly reports of historic financial performance, often not available until several weeks after the month-end. There is very little reporting of the factors critical to success in the digital economy. Our report, with Virgin Media Business (VMB), on the UK’s Digital Opportunity, identified six capabilities critical for success: technology infrastructure, digital workforce, digital information, digital strategy and leadership, open and collaborative partnerships, and digital customer engagement. Very few of these are measured and reported regularly by companies. There is some useful theorizing about how performance reporting needs to adapt for the Information Age. For example, CIMA have produced their General Management Accounting Principles (GMAP)—but adoption is far from widespread. As a result, most companies are reliant on backward-looking data, without solid evidence or insight to guide them as they seek to transform to new ways of working.
Investors rarely take official financial reports as their sole source of information, since they are historic, subject to various adjustments, and represent the company’s perspective. Investors prefer forecasts of cash flow and profitability to studying balance sheets, and are reliant on a community of analysts to interpret the official reports and supplement with insight on the firms’ outlook. In a period of rapid transformation, however, such an approach is less sustainable. Past financial performance is less useful as a guide to future prospects, at a time when 1 in 4 businesses say their industry will be unrecognisable in a years’ time (as reported in the VMB report). Relying on interpretation by the analyst community isn’t optimal either, as you are at the whim of variable, subjective advice. There are efforts to provide a more rigorous, comprehensive and up-to-date approach to financial reporting, like the international Integrated Reporting initiative. But it will take a long time for these concepts to become widely accepted and adopted.
Finally, what is the impact of financial reporting at the macro economy level? Some argue that the failure to account for intangible assets makes it difficult for firms to raise capital to invest in their businesses. It is particularly difficult to measure economic activity in a digital economy, where the business models are often very different (e.g., providing free services, network effects, minimal costs of information, and digital distribution). Conventional measures of productivity and output (GDP) are looking increasingly anachronistic, as recognised by the UK Government’s Bean review into official economic statistics. Trade statistics are geared to counting cargo and less suited to a world of data flows. But once again, though there is recognition of the problems, we are a long way from the implemented solutions.
It’s ironic that in our so called Information Age, where we can measure every step or mouse click, we have such unreliable information to record how companies are performing in the digital economy. It’s important that we fix this—for companies, investors, and all of us with a stake in our growing prosperity. Finding solutions and getting agreement across the various stakeholder groups is a huge challenge, particularly as these are global problems. It’s good that some initiatives are underway, but as transformation accelerates in the years ahead, more urgency is needed to find and implement workable solutions.
John Reiners is Oxford Economics Managing Editor, EMEA. He manages research programs on a wide range of topics, including digital economy, international trade, and development. He also follows emerging trends, like the growing importance of business ethics. He can be contacted at firstname.lastname@example.org