An integrated future
The development of integrated reporting and why SMEs should be taking note, writes Matthew Cavicchia.
What if there was a way to overhaul reporting that generates enhanced outcomes for both organisations and their stakeholders?
That is what the International Integrated Reporting Council (IIRC) has set out to achieve. In what is labelled the ‘Momentum Phase’ of its strategy, the IIRC has the ambitious mission of solidifying “Integrated Reporting (IR) and Thinking within mainstream business practice as the norm in the public and private sectors”.
The IR framework defines an integrated report as “a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term”. Yes, it is quite a mouthful. However, an explanation of the concept of value creation should help clear things up a bit.
The idea behind value creation is that for every activity the organisation undertakes, value is either increased or decreased. Changes in value are measured through transformations in the six forms of capital, which are the inputs and outcomes of the value creation process.
The foundation of this approach is integrated thinking, which requires us to consider the relationships and interdependencies between each of the capitals, as well other organisational functions and systems, in the context of value creation.
- Financial capital: The funds available to an organisation.
- Manufactured capital: The physical objects available to an organisation.
- Intellectual capital: Knowledge-based intangibles, including tacit knowledge and brand reputation.
- Human capital: The skills, experience and motivation of people, as well as their alignment with the mission, strategy and values of the organisation.
- Social and relationship capital: The management of stakeholder and community relations, with a particular emphasis on the enhancement of collective wellbeing.
- Natural capital: The renewable and nonrenewable environmental resources that support the prosperity of an organisation.
Isn’t value reported in my financial statements?
Financial metrics and performance are adequate to assess the likelihood of an organisation’s shortterm survival; although in isolation, they no longer holistically illustrate their ability to continue creating value over time.
In fact, Ocean Tomo’s Intangible Asset Market Value Study highlights a significant shift over the last 45 years. In 1975, 17 per cent of an S&P 500 company’s value was attributed to intangibles, whereas in 2020 this proportion was believed to be as high as 90 per cent.
Is integrated reporting applicable and relevant to the SME sector? While it is true that large, listed companies are the target audience of the framework, the IIRC and IFAC have made a significant effort to convey the relevance and benefits of IR to SMEs:
- Better understanding: Integrated thinking encourages the collapsing of silos to improve the flow of information across the organisation. With fewer barriers and increased collaboration, everybody from management to administration has an enhanced understanding of how and where they can maximise the creation of value, improving the quality of decision making and the awareness of risks.
- Better communication: SMEs have a fraction of the public interest of major listed companies, although they should never undermine the role of a good communications strategy. The transparency of IR is expected to be highly valued by stakeholders, improving relations and providing reputational benefits.
Where to start
Integration will not come instantaneously, nor is it supposed to. Before you even begin to envision the end-product of an integrated report, the development of integrated thinking is where SMEs can experience many internal benefits.
Integrated thinking requires a cultural change, shifting the perspective away from ‘maximising return’ towards ‘maximising value’. Furthermore, IFAC emphasises that “the level of integration depends on connecting people, functions, information, and systems”.
Associate professor of accounting at Monash University, Nicholas McGuigan, emphasises the importance of developing integrated thinking on the individual level, in addition to fostering an environment and culture that enables the embracement of connectivity.
Developing the skills of individuals
The three key skills to integrated thinking, identified by Mr McGuigan, are the ability to react to complex situations, be adaptable and have an open mind. In our conversation, Mr Mcguigan raised the activity of “social bubble hopping” as an approach for individuals to acquire these skills and build an integrated mindset outside of the workplace. This, for example, could entail going to the pub with your usual friendship group on a Saturday afternoon, before attending Church for the first time the following Sunday morning.
Creating an environment that promotes integration
Furthermore, your organisation’s strategy, culture and values have the capacity to enable integration, working in tandem with the individuals who ultimately execute integrated thinking. Once your organisation’s people possess integrated mindsets, you are better positioned to:
1. Begin building an understanding of your business model within the context of the external environment.
2. Identify which of the six capitals are involved within your business model and how value added to one might impact another.
Integration is a challenging journey that might appear as steep as the Everest Summit for some. However, as the creators of innovation, SMEs might just be where IR gains the traction to reach new heights.
Matthew Cavicchia, analyst, Institute of Public Accountants