OFR and reporting

Kieron Blakemore, corporate responsibility consultancy at Bureau Veritas Consulting, examines how the OFR will impact on traditional environmental reporting

January 2005 represents a milestone for company reporting. For the first time large quoted companies will be required to include social and environmental matters within a company report in the form of an Operating and Financial Review (OFR).
While the OFR represents an opportunity for the communication by companies of material non-financial factors affecting company performance to shareholders, there may be a down side. Will the advent of the OFR have a negative impact on existing non-financial reporting?

Intentions of the OFR

The OFR is intended by government to expand the scope of company reporting, enabling shareholders to make informed judgements on the merits of investment in a company.

The expectations of shareholders are changing; while once they demanded that companies provide short-term profitability, they now expect companies to communicate how they will deliver long-term returns. The sustainability of a business is determined by a variety of factors managed in order for the business to maintain its licence to operate.

A company’s performance may be plotted by its profitability, but underpinning profitability are other factors than those traditionally espoused. The environment, company employees and society all impact the long-term profitability of a company, hence the inclusion of a requirement to report on these issues within the OFR.
The traditional annual report will require the inclusion of an auditable statement, the OFR, describing the issues affecting current and future financial performance. Large companies will need to report the main trends underlying the development and growth of the company as well as those factors likely to affect future performance and development.

Included in this information should be the influence that society, environment and employees has on the business and, specifically, the risks these elements represent to the business. The responsibilities to be placed on medium sized companies are reduced and the requirement to report on non-financial influencing factors is removed.

With a remit to include environmental, social and employee factors will the OFR unduly affect current non-financial reporting?

Non-financial reporting

The advent of tools such as the Global Reporting Initiative and the AA1000/AA1000AS have gone some way to formalise both the format of non-financial reporting and the standard to which the reports are assured. Despite vagaries that may exist in scope and quality, the driving force of non-financial reporting remains almost universal in re-enforcing a company’s licence to operate, mitigates risk and respond to stakeholder demands.

Non-financial reporting communicates to stakeholders that a company understands its impact in terms other than economic. A proactive and dynamic approach to non-financial reporting leads potentially to increased investment, greater employee attraction and retention and a stronger company brand.

In turn this should increase share premium and help to ensure the sustainability of the business.

While the OFR should communicate how a company is affected by the external environment, the non-financial report is concerned with the company’s external effects.

Making the right link

The OFR is not intended to compete with non-financial reporting but the relationship that will exist between the two should be examined. Non-financial reporting and the non-financial aspects of the OFR have much in common but there are some important differences that should ensure they compliment each another.
Companies may conclude that the content of the OFR will be a reasonable substitute for existing non-financial reporting. Those operating under this perception may choose to stop (or not to start) producing such information.

If the OFR were to become the popular alternative to fuller non-financial reporting, then companies may be encouraged to exclude their key stakeholders from their opinion forming, and so forfeit some of the significant benefits that non-financial reporting can bring.

The transparency and trust that successful companies seek to realise through fuller non-financial reporting could be dissipated, leaving companies vulnerable to reputational damage and potential diminution of investment sources.

A wider audience

Whilst the OFR is aimed at shareholders, it would be naïve to believe that, as an alternative to non-financial reporting, it will not reach a concerned wider audience.

Those companies which already adequately report their non-financial impacts should find that satisfying the non-financial component of the OFR is relatively straightforward. After all, they’ve done most of the hard work already – a good non-financial report should provide the perfect foundation for the non-financial aspects of the OFR.

However, there is a further consideration. The OFR should only contain information that is clearly ‘material’ to the performance and development of the business. This concept of ‘materiality’ is key to a meaningful OFR.

Separating the ‘material’ from the immaterial

As only those environmental, social, community and employee issues that are likely to affect a company’s performance should be included in the OFR, are investors then supposed to trust that each company has the specialist knowledge to decide which factors are of material concern?

A company that has been proactively in non-financial issues will be aware of how this affects them, whilst a company without such a track record will find it difficult to pick its way through the material and immaterial maze.

Firms that are involved in non-financial reporting have a clear advantage. The process that companies use in the preparation of a non-financial report, and the report itself, can be used to inform and compile the OFR. For example, it is increasingly recognised that stakeholder engagement is key to the reporting process.

Canvassing the opinion of those individuals who are directly or indirectly affected by a company’s operations leads to a more comprehensive understanding of the extent and seriousness, and therefore materiality, of a business’ impacts. This allows business to attempt to identify and then mitigate these impacts and so manage risk.

Aiding OFR delivery

Clearly the lessons learned from non-financial reporting will aid the delivery of a competent, robust OFR. Whilst non-financial reporting holds some elements in common with the non-financial aspects of the OFR, the latter informs us as to what impacts are anticipated for the immediate future. In addition, non-financial reporting tells us what impact a company has had over the period of the reporting cycle.

A requirement of the OFR is that directors be aware of those factors that have the potential to impact company performance. For example, with retail companies extensively re-locating their manufacture and supply base to places such as China and India, should we not expect that a company reasonably assume that an understanding of supply chain issues might be apposite? As soon as the decision is made to re-locate the supply base a potential risk is created. This risk may not represent an immediate threat to performance but may well do in the future.

A positive step?

The impact that the OFR will have on non-financial reporting is, in the short term at least, dependent on the way in which directors approach it. Directors may choose to hide behind the regulations and publish the minimum, in so doing, foregoing fuller non-financial reporting. This, in turn, could represent one of the risks to business performance that the OFR itself is aiming to highlight. Poor reporting is a business risk in itself.

The proliferation of non-financial reporting within the FTSE 250 is testament to the value of its benefits to business and suggest that, as a voluntary action, there can be limited need for mandatory measures, certainly for proactive companies. Duplication seems inevitable in producing the OFR as the same processes, skills and knowledge will be required in assessing and presenting ‘material’ non-financial risks.

For those proactive companies, there will be a strong case to integrate the two reporting processes, and if effective and timely, then this should enable the social, environmental and employee aspects of the OFR to ‘fall out’ of the fuller non-financial report.

For those companies not producing a non-financial report, the OFR requirements should encourage reporting that is focused and relevant, even if brief and less informative than it could be. Overall, if the OFR means that more companies will report on non-financial matters, increasing the awareness of their impacts on the environment and society, then this is surely a move in the right direction, prompting mitigation and improvement where such needs are identified.

What is more, the processes underpinning the reporting will be subject to independent assurance. This is good news for increased accountability and transparency in business.

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