November 7, 2019
By: Kevin Dancey, Charles Tilley
Accounting is a time-tested discipline. It’s been around since Luca Pacioli invented double entry bookkeeping over five centuries ago. It is the means to capture the monetary value that has been realized through transactions. For the better half of the last millennia, accounting has been the language of business, governments, trade and capital markets.
Accounting for value creation needs rethinking. Value is created through knowledge and creativity. Digital disruption is threatening entire industries. Financial markets are fraught with geopolitical and economic volatility. The deepening climate emergency, and other environmental issues such as water and land use, mean that business as usual is not an option.
In this world, achieving a resilient and sustainable business model has never been more challenging. Viewing value creation only through the lens of shareholders means undermining trust in the organization, compromising its reputation, and even threatening its license to operate. A broader set of data, information and insights is needed to provide a bigger picture of how value is created. (For more, visit IFAC’s Point of View on enhancing corporate reporting).
This is a significant challenge for organizations and their stakeholders. For the accounting profession, it represents a unique opportunity.
The Rise of the Chief Value Officer
In contrast to financial reporting, integrated reporting provides a broader foundation for accounting for value creation. It enables greater corporate accountability, communication, and transparency. It allows the organization to better understand and communicate value creation.
Importantly, we know that adopting integrated reporting enables an organization to think in an integrated way, which leads to better business outcomes. Too often, information is siloed, and decisions are made without complete knowledge or context for their ramifications. The more that this integrated thinking is embedded into an organization’s activities, the better the connectivity of information flow into management reporting, analysis, and decision-making.
Integrated thinking requires the Chief Financial Officer (CFO) and their finance team to move from accounting for the balance sheet to accounting for the business and value creation. As Mervyn King, Chair Emeritus of the International Integrated Reporting Council, put it, “the CFO should be known as the CVO – chief value officer.” She or he must be a change-maker inside the company.
The CVO role must ensure that all relevant aspects of value creation and destruction are accounted for and communicated to boards, management, and external stakeholders. To achieve this, the CVO will require deep knowledge and insights about the business to inform discussions on purpose, values and strategy, risks and opportunities, the business model, and relevant resources or capitals that the business depends on or affects.
It will require that material information on value creation is reliable, relevant, and comparable, whether it is derived from financial statements (i.e., “non-GAAP” or “non-IFRS” measures), key performance indicators, or other information related to value creation, such as intellectual capital, sustainability, or environmental, social, and governance factors. Much of this information is generated outside of the business.
Developing a Framework for Integrated Value Creation
We are determined to support the evolution of CFOs to CVOs, if not in name, at least in mindset. To support the role of chief value officer, IFAC, the IIRC and AICPA/CIMA are developing an integrated value creation approach that guides CFOs as they focus on the information, decisions, and trade-offs that matter to the organization and its potential to create long-term value.
The International Standards Organization (ISO) 37000 project “Guidance for the Governance of Organizations” has already incorporated this value creation framework as a distinct part of its work.
The integrated framework has four dimensions to create and communicate value:
1. Defining value. How value is defined is framed by an organization’s purpose, values, strategy and measures of success. Value itself, as well as priorities for value creation, are defined in the context of meaningful engagement with material stakeholder groups, including customers, investors, employees, suppliers, regulators and others. It is also influenced by the opportunities and threats facing the business. Defining value involves establishing and prioritizing stakeholders, understanding how they are relevant to the organization’s purpose and strategy, and assessing how to balance their respective needs and expectations.
Insights on stakeholder value inform strategy, goals, metrics, and incentives. Value created needs to be measured and tracked by integrated financial and non-financial value aligned performance and risk metrics. Incentives should then be aligned to drive behaviors in line with purpose, strategy and values.
2. Creating value. How value is created involves the organization’s strategy and business model, which need to take into account all resources and capitals in an integrated way. Ensuring that value is created over time involves significant decisions on where the business competes (e.g., markets, geography, segments), identifying the principal opportunities and risks related to the business model, ensuring products and services meet customer needs and respond to societal challenges, and collaborating with critical partners in value creation.
Value is created and sustained through strategic choices and investments in the resources and relationships that lead to, or enhance, strategic and competitive capabilities and assets. These assets include people, innovation, infrastructure, brand and intellectual property, etc.
In capital allocation, the priorities and perspectives of different stakeholders might be misaligned. For example, investors might have a preference for the short-term deployment of capital, whereas the board might have a preference for long-term projects. Consequently, it is important to understand and communicate how short-term expectations from different stakeholders might influence long-term choices and prospects. This provides the basis for communicating how short- and long-term and trade-offs are managed.
3. Delivering value. How value is delivered to customers, governments, and society through responsible products, services, and channels to market. This involves leveraging technology, data, and intangible assets to deliver value in new and more effective ways. It also requires delivering value at an appropriate price, cost, and level of performance. Delivering value requires integrated and relevant strategic, operational, and risk information that takes into account the changing external environment and ensures that performance is aligned to value creation objectives.
4. Sustaining value. How value is sustained by retaining value internally in the organization and distributing value externally to shareholders and stakeholders. Capturing value distribution, outcomes, and impacts in a transparent manner enhances accountability.
Value delivered to shareholders, whether through dividends or other financial returns, may satisfy their needs in the short-term. But, if that value is being created at the expense of others and the environment, the company will fail quickly. The company needs to have sufficient resources to be both resilient and adaptable over the long term.
The factors to consider when sharing value with material stakeholders include ongoing priorities for use of cash (e.g., dividend policy, returns to shareholders and capex), tax strategy, desired capital structure, remuneration and benefits for employees, and social (e.g., job creation) and environmental (e.g., enhancing nature) outcomes.
This value creation framework aims to move the corporate mindset from short-term share value to long-term value creation. We intend to develop guiding questions for each dimension to guide CFOs and their finance teams as they focus on understanding and communicating value.
Creating and preserving value over time is at the heart of business success. Maximizing long-term cash flows requires responsibly managing relationships with key stakeholders. A company with a comprehensive, well-defined, and sustainable perspective on value creation will have stronger relationships and greater trust with all its key stakeholders. This must be the agenda of the chief value officer and CFO of the future.