The Financial Reporting Council (FRC) has responded to investor calls for better corporate reporting with new guidelines designed to help companies improve the way they present their performance metrics.
Investors use such metrics to make judgements that could affect investment decisions, such as deciding on the value of a company or assessing its use of capital or capacity to add value, so it’s key that the content and presentation of corporate reports meet their needs.
The performance measures used by companies vary depending on the type of business and the industry and countries they operate within, so the guidelines don’t specify which metrics should be used. They do, however, highlight five key principles identified in an earlier report, Performance metrics – an investor perspective, which found that investors want to see performance metrics that are aligned with a company’s strategy, transparent, given context, reliable and consistent over time.
Metrics aligned to strategy
It’s important for companies to monitor how they are delivering on their business plans for their own information, but investors also want to see metrics that give them insight into a company’s performance against the aims of its strategy.
The guideline authors acknowledge that it can be challenging to report all the metrics. But they say it might be useful to explain how metrics are used internally (and comment on their reliability), which may help companies decide what to disclose. Highlighting the metrics that align with long-term strategy is likely to reinforce the company’s message, they say. For example, providing a combination of metrics linked to their strategic objectives and business model may involve incorporating operational metrics alongside higher-level key performance indicators.
Transparency of information
Performance metrics are only useful if it’s clear which area of performance the metric is being used to measure and why. Investors want to see metrics reported together with clear definitions and calculations. Such transparency is key, as it not only supports understanding of performance and helps build credibility, it also helps investors to accept, reject or make their own adjustments to the metrics if they wish.
To support transparency, the recommendations include providing an explanation for the use of each metric and a full breakdown of non-GAAP to GAAP (generally accepted accounting principles) metrics, ensuring metrics are consistent and in the same format over a number of years and demonstrating that the metrics which investors would expect to be attributable to specific numbers in the financial statements or reconciliations are directly drawn from them. In addition, the guidance states that companies should continue to focus on explanations for specific adjustments.
Context is key
When reporting on performance, companies should always be clear on what they were trying to achieve compared to what they have achieved, with explanations for both good and poor performance. The wider context should also be reflected through information on the company’s position and prospects in the market and its longer-term objectives.
Companies can put their metrics into context by being clear on targets and whether or not they have been met, by referencing an industry benchmark where possible and relevant and by showing where the company sits in the wider market context.
Metrics you can rely on
For investors to have confidence in the metrics being presented, they want to see evidence that the numbers are being calculated appropriately and that there is sufficient governance and oversight over their use and reporting. While investors won’t necessarily expect performance metrics to have been audited, they do want to understand the level of oversight. This will enable them to judge how reliable the metrics are and whether they have received enough oversight from the board and audit committee.
To demonstrate the reliability of their metrics, companies can make clear the level of governance and oversight, explain the levels of scrutiny to which metrics have been subjected and highlight third party information in conjunction with internal information where relevant to strategic objectives.
Consistency over time
Consistent reporting across time and formats helps build credibility, as investors feel that they are getting a consistent and solid view of the state of the company. While the new guidelines say it’s important to align metrics to strategy, they also acknowledge that some investors seek more industry standardisation, either because it fits more effectively with their investment approach or role, or to guard against what they see as ‘flexible’ definitions.
Companies can ensure consistency of reporting by providingconsistent information across reporting formats – even if it is presented differently for different audiences – by presenting details of their performance compared to industry benchmarks or standards and by providing a five-year track record.
While the Performance metrics – principles and practiceguidelines focus on what investors want to see, the principles outlined above should also improve the usefulness of the metrics used for anyone involved in judging a company’s performance – including team managers, risk managers and boards – to understand whether a company is performing as it should.