Reporting in times of uncertainty
The quality of a company’s response during a crisis will determine its ability to survive. Companies have had to adapt and, in many cases, make changes to their business model. The actions taken need to be clearly communicated to investors and other stakeholders, not just in annual reports but also potentially, in more timely updates to the market.
The Financial Reporting Council’s Financial Reporting Lab (the Lab), like others, changed its focus in response to the pandemic. In March 2020, alongside a joint regulatory statement from the Financial Reporting Council, Prudential Regulation Authority and Financial Conduct Authority, the Lab released an infographic highlighting the key information investors want to understand in the face of the pandemic.
This initial response formed the basis of two reports, published by the Lab in the summer of 2020, under the umbrella theme of ‘Reporting in times of uncertainty’. The first of these, COVID-19 – Resources, action, the future, provides more detailed guidance and examples to help companies answer the questions identified in the infographic. The second, COVID-19 – Going concern, risk and viability, highlights three key disclosure areas within an annual or interim report that may be impacted by the effects of the pandemic. Throughout 2020, the Lab continued to monitor the evolution of practice and in October it released updates to these reports. Some of the reports’ key findings are outlined below.
Resources, action, the future
As the crisis took hold, the need for quick and decisive action, including securing sufficient cash resources, was critical to increase a company’s chances of survival. To remain viable, many companies have had to take action to reduce expenditure and cash outflow. This has included cancelling dividends, reassessing capital expenditure plans, accessing government support schemes (including the furlough scheme) and restructuring operations. Given their impact on stakeholders, such decisions must be carefully considered and communicated by management.
In terms of resources, investors seek information about the amount and sources of financing, and the terms and conditions attached to them. For actions, investors seek to obtain information to understand the decisions taken and how they will contribute to the sustainability of the business. Over time, the focus has shifted from survival through lockdown to recovery and restarting in a new operating environment. Actions taken in response to the pandemic are likely to affect the future direction, purpose and business model of a company. A discussion of any changes to these, and to management’s view of the company’s future, will assist investors in evaluating their opinion of a company’s prospects.
Section 172 disclosures
Some of the information discussed above should be disclosed in a company’s section 172(1) statement – a recently introduced reporting requirement for certain companies. Boards are required to disclose how they have complied with their s172 duty to promote the success of the company and had regard to, among other things, the longer-term impact of decisions on stakeholders. Such disclosures may pose a particular challenge for companies in the current environment.
In July 2020, the Lab launched its ‘Reporting on stakeholders and Section 172 disclosures’ project. The first output of this project was a set of tips aimed to assist companies in the preparation of their s172(1) statements. The tips reflect discussions with investors and other stakeholders about what they consider useful in s172 reporting as well as conversations with companies to understand the challenges faced in preparing the statement.
The tips focus on three areas:
- what the s172(1) statement should ‘do’;
- how it should be presented; and
- practical advice on collating information to be disclosed in it.
What does it do?
The s172(1) statement should be an authentic reflection of what happened during the period that indicates how the board of directors challenge and oversee management’s engagement with stakeholders; it should not be seen as just a compliance exercise.
The statement should explain the board’s reasoning behind why:
- particular stakeholders are identified as key;
- particular engagement methods were effective; and
- key decisions were taken in light of that engagement.
There should also be a clear link to strategy – both how stakeholders are considered strategically and how they affect the development and implementation of strategy.
Decisions that have been made and the impact of those decisions on stakeholders (including related mitigating actions) should be discussed. The statement should be balanced and should include difficulties faced by the board in making decisions, such as trade-offs in the short term for longer-term benefit. Investors also value metrics that are monitored by the board as material key performance indicators on key stakeholders.
Presentation
Presentation of the statement is critical. Companies should consider how it fits within the context of stakeholder engagement and how the statement itself can provide context to other areas of the report.
Practical advice
Planning and compiling information for the statement should be a continuous and ongoing process. Tailoring board papers and other templates to remind the board and management to consider the stakeholders relevant to each decision will focus their thinking. Highlighting the key decisions and engagements to be included in the statement as they happen can simplify the reporting process.
Going concern, risk and viability
The Lab’s second report under the theme ‘Reporting in times of uncertainty’, COVID-19 – Going Concern, Risk and Viability, highlights three key areas of disclosure within an annual or interim report that may be impacted by the effects of the pandemic. Detailed and consistent disclosures in these sections will provide useful insight into a company’s short and longer-term plans in the context of COVID-19.
Going concern
Going concern is not a simple pass/fail concept – a company can report on a going concern basis despite material uncertainties existing. In the current environment, such situations will be more prevalent, and disclosure of these in conjunction with management’s considerations and conclusions will be highly valued by stakeholders.
Risk reporting
The pandemic is having a longer-term effect on companies, rather than being only a short-term shock. In the examples of disclosure provided in the report, many companies identified COVID-19 as a separate risk, while others indicated its effect on their other principal and emerging risks. Regardless of the approach taken, investors are looking to understand how risks have changed, how they are being managed and mitigated, and whether management has identified any opportunities.
Viability
The viability statement was introduced as a result of the 2008 financial crisis to provide investors with better insight into a company’s longer-term prospects and viability. The current pandemic is a test of the value of such disclosures. Companies should outline various scenarios and assumptions alongside management’s conclusions.
Scenario planning and related reporting is vital, especially in times of uncertainty. While scenario planning and forecasting may not be a perfect science, to assess the longer-term value of the company investors want information regarding:
- a company’s base case for recovery;
- any related stress tests;
- mitigating activities; and
- key assumptions.
Discussion of plausible upside and downside cases and the process for updating scenarios could provide further understanding. Scenarios should be realistic, and information should provide insight into management’s thought process to allow users to formulate their own opinions and draw their own conclusions.
Effective reporting
Society and business have been permanently affected by the pandemic. The impact is still being felt, and this may be the case for some time. Such uncertainty only heightens the need for effective reporting, something to which the Lab will continue to contribute. To view the reports discussed in this article, visit frc.org.uk/investors/financial-reporting-lab.
About the author
Phil Fitz-Gerald is Director at the Financial Reporting Lab.
