By Nelson Muia, CFE
The users of financial statements which are normally presented as part of the annual report of a company are increasingly interested in gaining a deeper understanding of the organization beyond the financials. They are interested in understanding the value aspect of the organization and whether it is sustainable. How the organization creates value and how it captures value. Since each company has various stakeholders, the stewards of the company must understand the stakeholders’ expectations and know how to satisfy and meet them. While tools like the power/interest matrix are indispensable for developing strategy in relation to managing stakeholder expectations, they still might not bear a lasting solution. The need for the organization to meet its profitability needs and also to meet stakeholder expectations has been there since time immemorial, sometimes these needs might be conflicting. Indeed, even the needs of different groups of stakeholders are in most cases conflicting, nonetheless, the organization and its senior management must find a balance and maneuver forward.
This is where the Integrated Reporting Framework i.e., the <IR> Framework comes in, it is an attempt at a solution that will possibly effectively prioritize the needs of all parties concurrently and sustainably.
The Integrated Reporting Framework has defined integrated reporting as ‘a process that is founded on integrated thinking that results in a periodic
integrated report by an entity concerning value creation over time and related communications regarding aspects of value creation.’ The purpose of integrated reporting is simple and clear;
- To provide better quality reporting to traditional financial investors.
- To support integrated thinking and contribute to value creation.
- To promote a more holistic approach to corporate reporting.
- To enhance the entity’s accountability on all types of capital.
- To promote decision makers’ understanding of how capitals are interdependent on one another and the impact of decisions.
This brings us to the concept of ‘the 6 capitals’, which the <IR> Framework has identified and emphasized as the key components to the activities of all organizations and every business model. The Integrated reporting concept contrasted with traditional Financial Reporting, reveals a stark difference. The traditional Financial Reporting business model only identified one input, Funding, and one output, Profits, even while we all acknowledge that organizations depend on various forms of capital for them to operate and succeed.
The Integrated Reporting Framework identifies the 6 capitals as;
- Financial capital – The pool of funds available to the organization
- Manufactured capital – Physical objects available for use by the organization e.g., buildings, equipment, infrastructure
- Intellectual capital – Organizational knowledge-based intangibles such as intellectual property, tacit knowledge, systems, procedures, and protocols
- Human capital – Personnel competencies, capabilities, experience, and motivation to innovate
- Social capital – The institutions and the relationships within and between communities, groups of stakeholders, and other networks
- Natural capital – All the renewable and non-renewable environmental resources that provide goods and services that enable the organization’s prosperity
The value created, preserved, or eroded by an organization in the course of time will eventually manifest itself and can be observed from the increases, decreases, or transformations of the capitals, which is brought about by the organization’s business activities and output. In essence, an integrated report helps explain how value is created, preserved, or eroded over time by an organization. It further enables us to understand that value is not created, preserved, or eroded within the organization alone, but is influenced by its external environment, created through its relationships with stakeholders, and is dependent on various resources.
Therefore, the ability of an organization to create value for itself is intrinsically linked to the value it creates for others.
The integrated report is based on 7 guiding principles which underpin its preparation and presentation informing the contents of the report and how the information is presented. The 7 guiding principles are;
- Strategic focus and future orientation
- Connectivity of information
- Stakeholder relationships
- Materiality
- Conciseness
- Reliability and completeness
- Consistency and comparability
For the purpose of preparing and presenting an integrated report, these guiding principles are intended to be applied individually and collectively. Of course, judgment is required when applying them, especially in the case where there appears to be a conflict between them e.g., between conciseness and completeness.
Lastly, the integrated report is also expected to include 8 Content Elements, that are posed in the form of questions to be answered, in doing so it takes into consideration key general reporting matters such as disclosure of material matters, disclosure about the capitals, time frames for the short, medium and long term, aggregation and disaggregation (e.g., by country, subsidiary, division, etc.). Accordingly, the content of an organization’s integrated report will depend on the organization’s individual and unique circumstances.
The 8 Content Elements are;
- Organizational overview and external environment
- Governance
- Business model
- Risk and opportunities
- Strategy and resource allocation
- Performance
- Outlook
- Basis of preparation and presentation
The new lenses that the <IR> Framework avails us have clear positive implications on sustainability. The Integrated Reporting framework was developed by the International Integrated Reporting Council (IIRC). Indeed, it is anticipated that gradually Integrated reporting will be adopted across the board and will become the corporate reporting norm. Eventually, it will no longer make sense for entities to generate numerous, disconnected, and static communications. The Integrated report which is based on integrated thinking and applies the principle of communication connectivity will be instrumental in ensuring communication by organizations is connected and information is collated.
While Integrated Reporting brings valuable benefits, it’s not without its hurdles. For many organizations especially smaller ones, it can be quite demanding in terms of time, resources and coordination. Since there’s no single set standard, reports often vary, making it tough to compare one company’s report to another’s. There’s also the risk that some reports may focus more on looking good than sharing meaningful insights. Internally, shifting from traditional financial reporting to a more holistic approach can meet some resistance and not all stakeholders may easily grasp the integrated format. In addition, non-financial data isn’t always easily quantifiable or independently verified therefore, questions can arise about how trustworthy some of the information really is.
