Increasing demand for more transparency in corporate reporting has put new burdens on companies worldwide. Tim Ambler and Andy Neely provide their insights on writing the more difficult sections of annual reports.
Want to know if a company is healthy? Just check the numbers. Isn’t that as true today as it has always been in the past? No
In an era in which intangible assets of a corporation are increasingly dominating tangible assets in value terms, formal accounts are becoming less reliable indicators of a company’s trading and financial position. As a result, there is increasing pressure for company reports to have greater transparency and better narrative sections. The fall of Enron in the US, whose accounts were misleading but (and this is debatable) technically correct, marked a watershed. Consequently, greater transparency in reporting was demanded by regulators in the European Union, US, Japan and elsewhere. Given the limitations of formal accounting, these demands have to be met through the narrative sections of company annual reports. Although the terminology varies, the Chairman’s Report, Business Review, Director’s Report or Operating and Financial Review are where you’ll most likely find the narrative report. But what makes a good narrative report is the issue nowadays.
Recent developments in the UK, which pioneered the mandatory publication of the balance sheet back in 1906, have implications for other developed countries, especially in a world in which reporting practices are converging and companies are multinational.
In this article, we will set out the broad requirements for the narrative sections of UK annual reports; we will then review the advantage to companies from greater transparency and how companies themselves are changing their practices in that direction. Key areas of difficulty are the provision of non-financial Key Performance Indicators (KPIs or metrics) and forward-looking information. Of course, the key question is whether these developments represent measured behavioural change or whether they are merely good intent. We review results from the quantitative scoring of narrative sections of annual reports against the Accounting Standards Board (ASB) guidelines. Investors and analysts are demanding “forward-looking information” and the question is whether that demand should be met in narrative reports and, if so, by providing company forecasts or current and historical market metrics which investors and analysts can use to predict future outcomes. What should narratives contain? The UK government and the Companies Act 2006 have largely delegated to the ASB the specification of narrative sections of annual reports. The specification is mainly advisory (best practice) rather than mandatory. This is wise: businesses differ too widely to allow standardization. What is crucial for one company is not important for another. Furthermore, it seems better to promote the benefits of transparency than create legal requirements for companies to weave their way around.
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