External Environment Management Process and Value - Essay Example

Financial Reporting Appraisal s Annual reports have changed quite dramatically between the mid 1970s and today. The overall amount of information given has increased considerably, and this is equally true for the financial statements and the discussion section of the annual report. In this report the 11 models of business reporting proposed by ICAEW are reviewed and criteria is developed. The annual reports of three companies Johnson Matthey plc, Smith and Nephew plc and Smiths Group plc are judged according to the criteria. The Award is given to Johnson Matthey plc since the annual report of the Company fulfils the maximum criterias. 2. Purpose One of the main purposes of annual reports is to provide information that is useful to their users (Day, 1986). Many authors have dealt with the issue of clarity and understand ability of the annual reports (Lee and Tweedie, 1975; Smith, 1992; Keane, 1977). In fact many authors emphasised the fact that shareholders tend to read the narrative part of the annual report which normally includes good news, rather than reading statutory part and usually investors make their investment decisions depending on those good news (Tauringana and Chong, 2004; Smith and Taffler, 1992). However In order to make an informed investment decision, an investor who is contemplating investment needs to understand both the potential rewards and the associated risks (IOSCO, 1995). The main aim of this report is to summarise what has been proposed so far about improvement in effectiveness of annual reports in shape of 11 models discussed in ICAEW report. A judgement criterion has also been prepared according to which the annual reports of three company Johnson Matthey plc, Smith and Nephew plc and Smiths Group plc will be analysed. An award will be granted to the Company, which has adopted most of these models in order to improve business reporting and serving the needs of the users. Appraisal Framework Criterion no. 1: Value Dynamics: (ICEAFW Report, p.44) The model emphasises the need of changing the concept of assets. It presents a whole new concept of assets as compare to those used in the traditional accounting. Problems addressed: With the changing business methods and environment the values playing important part in business has also changed. The label of assets has transformed from tangible to intangible assets. In this scenario it is become difficult for the users to analyse the future performance of the company. The companies mostly practise the old traditional accounting techniques according to which intangible assets such as knowledge brand etc are not included in the financial statements as assets. Although in today's business scenario it is important for the users to have complete knowledge of these intangible assets in order to undertake their decisions accordingly. Solution provided: The authors of the model proposed that in order to help the investors and users to evaluate the value of the company the information provided needs to be more transparent regarding the intangible assets as compare to the past. The model suggest that all the tangible and intangible assets need to be continuously, means used to their fair values and should be reported in order to provide the clear and transparent information. The model gives three dimensions to the information 1) Assets and their configuration represented by company. 2) Information on assets relating to external environment management process and value. 3) Time. The model suggests the businesses to reveal information about their mission, strategy, and business process and risk management. The model can best serve the purpose of today's users since it provides information in many segments, which can help the user to find out the information, related to him. The model is the best way to respond to the needs of openers and transparency, which will be the most attractive value generating forces in the future. Criterion no. 2: Hermes Principle: (ICAEW, p. 65) Problems addressed: The model addresses the problems of long time value delivering process by the companies and the return maximisation on capital. Solution Proposed: The Hermes principle find the open communication with shareholders a key issue in order to help them asses the present situation of business and the future performance. The companies should properly communicate about their future business plans. The companies should use different measures and systems in order to make sure the maximisation of shareholder values. A Company must disclose the weighted average cost of capital. Modern financial activities must also measure the true value of company. The proper report on cash returns from any investment can play an important role in managing the business and motivating the shareholders to invest in a company. Through the application of this model the company can gain long term interest of shareholders and will also benefit economy. By stating proper information to the shareholders a company can get the maximum capital. By disclosing information about the company's goals. Financial and strategic disciplines the company can be better evaluated by the shareholders. But this principle can only be effective if the process of providing and correcting information is undertaken on continuous basis lack of proper communication with the share holders can adversely effect the process of credit generation for the company. Criterion no. 3: Balance scorecard: (ICAEW report, p. 23) It is considered as the strongest ideas in the last 15 years covers all the aspects from customer to business process and learning and growth. The model is a response to the dissatisfaction with the external reporting models. Problem addressed: The model addresses the current reporting practices heavy reliance on accounting measures which cannot serve the purpose of the large scale transactions taking place now days. Since it is information age therefore the old models cannot serve the purpose of effective reporting. The practice should be upgraded taken into account the valuation of intangible assets of the company success products, well-trained and enthusiastic staff and loyal customers. Although these intangible assets are not easy to be valued on the balance sheet. The financial measures undertaken by companies are not feasible due to their outdated principles and short termism. The management and appropriate use of intangible assets are much more important rather than managing the physical assets. Proposed Solution: The managers should undertake the measures in order to keep on improving all the perspectives of business, i.e. value delivery, manufacturing cycle time, innovative products. Score card is a management tool but it should become the base of the external reporting in order to improve the value for shareholders. The maximum benefits from the sore cards can only be achieved by developing common understanding among all the stakeholders. Criterion no. 4: Jenkins Report: (ICAEW, p.27) The model emphasis the importance of the relevance of the information provided to the shareholders financial statements in order to effect their decisions. With changing and innovative business environment the information provided should also be changed in order to effectively fulfil the needs of the users. The model put greater emphasis on the needs of those who value equity securities. Problems addressed: The financial statements are loosing their relevance and usefulness to business reporting. It is an accepted fact that the financial statement of a company effects the decisions of investors. The use of financial statement as a decision effecting tool is decreasing due to the irrelevance and inappropriateness of the information provided in them. Following problems are addressed through the model. Broad definition of segments rather than industry. In sufficient information. Outdated accounting standards. Lack of risk disclosing information. Lacks of correct imprecision of measurement of assets and liabilities. In short in the model addresses all the important areas, which the information is required for the users. Solution proposed: The model does not address all the information needs of the users but it addresses the information which is related to management and the management can play an important role in making the most of these information. It suggests that an effective business report must have More forward looking information Have more coverage of non-financial value creating information. Should align internal and external information. The model includes different components of business reporting, which are: 1) financial and non financial data 2) Management's analysis of financial and non-financial data. 3) Future forecasting information. 4) Shareholders and management related information. 5) Background information. 6) Proper disclosure of information 7) Proper information regarding each business segment. The model provides the shareholders and investors with the case of proper information regarding the securities in order to save them from being misallocated. Criterion no. 5: Tomorrow's Company: (p.33, ICAEW) The model puts more emphasis on stakeholders' relationship rather than on financial measures. Problem addressed: Heavy reliance on financial measures has damaged most of the company's reputation. The financial performance does not represent the overall performance of the business. The position of the company in the market and the performance cannot be judge by only addressing the financial measures. The model recommends that the role of the intangible assets is growing in determining the future performance of a company. Solution provided: The model provides the solution in shape of focusing more on qualitative measures rather than quantitative measures. According to the model for a company needed to be successful it must reveal the information about its stakeholders and the way these stakeholders are being dealt which are for more different from the traditional accounting. The model emphasises the needs that the company should clearly state the information about its purpose, mission, goals and strategy. It states that the financial reporting should go beyond only disclosing the financial information. In short the model recommends an extension of financial reporting rather than transformation. Tomorrow's company presents the idea of easy, to the point and frequent business reporting. The model indicates the following portions of business report Financial report. Value chain report People document. Sustainability document. Support provided: The model supports inclusive manner which will required the companies comparatively betters from its competitors. This will generate value for all stakeholders including shareholders. Criterion no. 6: The 21st Century Annual Report: (ICAEW, p. 37) The model emphasises the need of disclosing a wider range of financial information. The model takes into consideration how the business report can effectively address the needs of the changing information demands of the users. The model provides solution to the problems in following four areas. Increased no. of financial instruments and innovative accounting techniques. Increase in reliance on intangible assets. Differing levels of information provision to different people through the use of technology. Pressure for more transparency from international stakeholders. The model is a step forward from the above proposed models it assets that a successful business report should not only address the leading financial indicator and stake holder value but should also make use of IT and Internet to provide the information on easy to reach and cheap basis. The model emphasises the transformation of old accounting techniques to whole new value added and customised information. Through the use of technology it is easier to provide layered information to the stakeholders so that they can easily find information according to their needs. The introduction of technology will also be helpful in increasing the frequency of information disclosure. Criterion no. 7: The Inevitable Change: (ICAEW, p. 39) The inevitable change also requires the business reporting to be done by using technology in order to cater the need of versatile, fast and frequent provision of information for today's broad business environment and increasing kinds of the stakeholders. It is found that the business reporting is more effected by the will of producer's rather than users. Solution Provided: On line database regarding information required by customers Links to information beyond the information provided by the company. Live broad cast to general company meetings. One to one meeting with investors. On line question from management should be facilitated. Availability of wider range of information. Provision of non-current information. This will help the investors in getting reduced cost information and filling the gaps between the expectations of the shareholders and information provision by the company. Criterion no. 8: Inside Out: The model demands an increase in disclosure about the strategic indicators and performance of the business. Problems addressed: Most of the companies often report only about the past performance. In order to attract the attention of the shareholders it is important provide information about the potential of the company in order to gain the strategic goals and achievements. In order to create customer value it is important answer all the suspicions of the shareholders regarding the strategic direction, implementation and achievement of the goals. Companies often cannot keep up the pace with the information requirements of the users. Solution: The model offers inclusion of qualitative information regarding the potential of the company in order to gain the purpose of value creation in the shareholders. Management must disclose more indicators used at board level in order to make the stakeholders more aware about the future plans and prospects of the company. The model helps to cover the gap between the internal and external perception about the potential of the company. Criterion no. 9: GRI It is a reporting template for the businesses, which takes into consideration social, economic and environmental performance of a company. Problem addressed: Non recognition of intangible assets, like most of the other models GRI also emphasise on the transformation of assets from tangible to intangible in order to fulfil the needs of today's business environment GRI addresses the economic, social and environmental costs of business. Solution: The GRI model suggests that the following elements should be included in the business reports. Vision and strategy. Profile. Governance of the company. Performance indicator. Guidelines related to economic, social and environmental performance indicators. Results: GRI model helps the companies to gain the outcomes, which are socially, economically and environmentally better for them. Criterion no. 10: Unseen Wealth: (ICAEW, 2003) The model offers importance to the value chain of intangibles, and suggests that the assets should be disclosed to a certain level. The Companies should keep on discovering, developing and commercialising the stages of the value chain for intangibles. It is also suggested that the reporting of the intangibles should be done with great care since poor reporting of intangibles leads to under valuation of, and increased cost of capital for knowledge intense companies. Criterion no. 11: ValueReporting: The model put forward the suggestion that the proper reporting can lead to cost reduction and the value improvement of a company. A framework is also provided by the model, which includes: 1. An overview of overall market. 2. Information about the strategy of the Company. 3. Information regarding the value creating activities of the Company. 4. Performance overview of all the segments of the business. Assessment of Three finalists: The annual reports of the three Companies are analysed below keeping in view to the criteria designed according to the 11 models. The grading is done according to the following scale. Good: the criterion is well fulfilled. Bad: Criterion is not well fulfilled. Criterion is not fulfilled. Award will be given to Company the annual plan of which will have covered the maximum number of criteria. Johnson Matthey plc Criteria's Characteristics described Status of Company's annual report Criteria no.1: Value Dynamics Provision of information in many segments. Emphasis on transparency in reporting intangible assets. Good Criteria no.2: Hermes Principle Open communication with customers about future plan and strategy. Good Criteria no.3 Balance Scorecard Covers all aspects from financial information to intangible assets information. Innovation and value delivery should be reported. Good Criteria no.4 Jenkins Report Effectiveness as decision making tool. Future information regarding value creation. Good Criteria no.5 Tomorrow's Company Importance is given to stakeholders relationship rather than financial measures Good Criteria no.6: The 21st Century annual report Wider range of financial information. Should cater the changing information needs of users. Good Criteria no.7: The Inevitable change Technology driven. Live questioning and meeting facilities. Criteria is not fulfilled Criteria no.8: Inside out Disclosure about strategic indicators and business performance. Value creation in shareholders. Good Criteria no.9: GRI Covers Social, Economic and Environmental performance of the Company. Good Criteria no.10: Unseen Wealth Reporting value chain for intangibles. Good Criteria no.11: Value Reporting Overview of market, Information about the strategy, Value creation and performance overview of all segments. Good Smith and Nephew plc: Criteria's Characteristics described Status of Company's annual report Criteria no.1: Value Dynamics Provision of information in many segments. Emphasis on transparency in reporting intangible assets. Bad Criteria no.2: Hermes Principle Open communication with customers about future plan and strategy. Criteria is not fulfilled Criteria no.3 Balance Scorecard Covers all aspects from financial information to intangible assets information. Innovation and value delivery should be reported. Criteria is not fulfilled Criteria no.4 Jenkins Report Effectiveness as decision making tool. Future information regarding value creation. Good Criteria no.5 Tomorrow's Company Importance is given to stakeholders relationship rather than financial measures Criteria is not fulfilled Criteria no.6: The 21st Century annual report Wider range of financial information. Should cater the changing information needs of users. Good Criteria no.7: The Inevitable change Technology driven. Live questioning and meeting facilities. Criteria is not fulfilled Criteria no.8: Inside out Disclosure about strategic indicators and business performance. Value creation in shareholders. Good Criteria no.9: GRI Covers Social, Economic and Environmental performance of the Company. Criteria is not fulfilled Criteria no.10: Unseen Wealth Reporting value chain for intangibles. Criteria is not fulfilled Criteria no.11: Value Reporting Overview of market, Information about the strategy, Value creation and performance overview of all segments. Good Smiths Group plc: Criteria's Characteristics described Status of Company's annual report Criteria no.1: Value Dynamics Provision of information in many segments. Emphasis on transparency in reporting intangible assets. Good Criteria no.2: Hermes Principle Open communication with customers about future plan and strategy. Good Criteria no.3 Balance Scorecard Covers all aspects from financial information to intangible assets information. Innovation and value delivery should be reported. Good Criteria no.4 Jenkins Report Effectiveness as decision making tool. Future information regarding value creation. Good Criteria no.5 Tomorrow's Company Importance is given to stakeholders relationship rather than financial measures Good Criteria no.6: The 21st Century annual report Wider range of financial information. Should cater the changing information needs of users. Good Criteria no.7: The Inevitable change Technology driven. Live questioning and meeting facilities. Criteria not fulfilled Criteria no.8: Inside out Disclosure about strategic indicators and business performance. Value creation in shareholders. Good Criteria no.9: GRI Covers Social, Economic and Environmental performance of the Company. Good Criteria no.10: Unseen Wealth Reporting value chain for intangibles. Criteria not fulfilled Criteria no.11: Value Reporting Overview of market, Information about the strategy, Value creation and performance overview of all segments. Bad Conclusions and Recommendations: By applying the criteria to the annual reports of all the three companies, it is found that Smith & nephew plc: The reporting pattern followed by the Company is still that of the traditional one, which gives the whole importance to the financial indicators of annual report in order to, present their performance rather than intangible assets. Smith plc: Although the company is adopting the new reporting trends but value chain management needs to be concentrated. Johnson Matthey plc: The annual report of the company fulfils the most criteria although the Company does not undertake the technology availability, but the annual report of the company undertakes all the aspects of reporting from financial to economical, and societal. The concept of the intangible asset is also well addressed in the report. Keeping in view all the discussion it is recommended that the Award go to the Johnson Matthey plc. Hope the company will continue the practise and will make improvement in the remaining aspects. References Day, J. 1986. The use of annual reports by UK Investment Analysts. Accounting and Business Research, 16(64): 295-307. Institute of Charted Accountants in England and Wales (ICAEW), (2002). No surprises: the case for better risk reporting, ICAEW, London. International Organisation of Securities Commissions, (1995). Disclosure of risks a discussion paper. Available from: http://riskinstitute.ch/135610.htm Keane, S. 1977. Examining the Problems of Understandability. Accountancy, June, 88 (1006): 82-84 Kerlinger, F, N, 1970. Foundations of behavioural research. New York: Holt, Rinehart and Winston. Lee, T.A. and Tweedie, D.P. 1975. Accounting Information: An Investigation of Private Shareholder Usage. Accounting and Business Research, 5(20): 280-291. ICAEW, 2003. New Reporting Models for Business, available from:http://www.icaew.co.uk/viewer/index.cfmAUB=TB2I_59349&tb5=1&CFID=4671330&CFTOKEN=87121964 Smith, M. and Taffler, J. 1995. The Incremental Effect of Narrative Accounting Information in Corporate Annual Reports. Journal of Business Finance & Accounting 22 (8): 1195-1210 Tauringana, V and Chong, G. 2004. Neutrality of narrative discussion in annual reports of UK listed companies. Journal of Applied Accounting Research 7(1): 74-107. Read More