Business must help investors to join the dots

THROUGHOUT the last decade, companies have expanded considerably the depth, breadth and reach of their financial communications to the market, in response to heightened investor and analyst demands and as a result of enhanced financial-reporting requirements. <br /><br />But the financial crisis has magnified market sensitivity to these communications &ndash; often described by analysts and investors as complex and detailed &ndash; and the value of business reporting has been bought back into the spotlight.<br /><br />There is some rationale behind this. Management has sought to tell a cohesive &ldquo;story&rdquo; about company performance and future prospects. However, despite the wealth of publicly available information on company performance, stakeholders still struggle to see the bigger picture. <br /><br />Financial statements are a core building block and critical component of the story about company performance, but some elements of the story aren&rsquo;t always fully or well told. As we pull back from the brink of recession, now is a potentially once in a lifetime opportunity to review this issue. <br /><br />Analysts have been devising their own stories to validate what management is telling them for some time, increasingly relying on non-audited sources of information which place greater value on qualitative, non-financial information that gives them an explanation of financial performance, key performance indicators and future prospects. The financial crisis has made investors and analysts even more vocal in their demands, and more sceptical of management&rsquo;s narratives. <br /><br />This was shown in a recent report by Tapestry Networks for Ernst &amp; Young called The Financial Communication Challenge, based on interviews with stakeholders. This showed a demand for financial statements, but also broader information, so stakeholders can construct a picture of performance. As one participant put it: &ldquo;Companies are putting out more and more information &mdash; more dots, if you will. But not all are good at helping us connect the dots.&rdquo; <br /><br /><strong>AUGMENTING INFORMATION</strong><br />It was notable in the first half of 2009 that analysts sought to augment information coming from management, for example market data, competitors&rsquo; performance and even the views of key suppliers and customers. &ldquo;When everything was going fine &hellip; analysts did not spend as much time checking as in this difficult period,&rdquo; said one survey participant. This year analysts have also focused much more on the balance sheet, particularly the debt profile and maturity schedule. <br /><br />Credit rating agencies are now more willing to move their ratings. They have upgraded their methodologies and analyses and are using these to ensure data is more comparable across companies, sectors and geographies. Rating agencies and debt investors are now also more sensitive to management&rsquo;s ability to achieve its stated performance targets and more willing to adjust their ratings or investments further and faster in reaction to incorrect or misleading information. <br /><br />Audited financial statements are a critical component of the story and, as such, a major focus for companies. Several participants said that the preparation, distribution and communication of the core published financials consume 80 per cent of the investor relations team&rsquo;s time. <br /><br />Stakeholders say that the quantity and comparability of financial statements has improved considerably in the last 10-15 years. Before IFRS (International Financial Reporting Standards) there was no real comparability across countries, and convergence towards global standards is moving everything in the right direction. <br /><br />However, although convergence aims to increase comparability, the process can make this more difficult in the short term. One report participant said, &ldquo;I&rsquo;ve been very frustrated by the degree of accounting changes my companies have undergone in their reporting recently.&rdquo; <br /><br />Participants also highlighted that financial statements have become bigger in recent years. The reason is clear: &ldquo;Business transactions have become more complex. For example, a decade ago there was almost no securitisation &mdash; and then it exploded. Those securitisations are complex &mdash; and almost all are unique &mdash; and because of that they are hard to compare,&rdquo; said one.&nbsp;&nbsp; <br /><br />As accounting and reporting standards have sought to keep pace with business, those who rely on financial statements have become increasingly frustrated. Several survey participants pointed out that the changing nature of accounting standards and the complexity of financial reporting have accelerated a trend among investors and analysts toward reliance on other forms of financial communications. <br /><br />Companies have significantly ramped up their financial communications over the course of this decade. Evolving accounting and reporting requirements have necessitated more complicated and detailed financial statements. Meanwhile, investors and analysts continue to demand more and faster information, and companies have responded with a broadening range of media. <br /><br />Audit committees have traditionally sought to limit their role in financial communications to the financial statements and earnings releases, given their close connection to the financials. Many continue to take that position. However, the increasing focus of financial stakeholders on the non-audited elements of the financial story begs the question as to whether this is still sufficient. And, as the role of non-executive directors continues to come under scrutiny as a result of the financial crisis, it is a topic audit committees may wish to address in the very near term. <br /><br />Richard Wilson is senior audit partner and leads the Independent Director programme at Ernst &amp; Young.