Financial and management reporting by public companies has evolved rapidly over the last five years, driven by the needs to re-establish public trust and to harmonize requirements worldwide. Starting this year, U.K. public companies face far more stringent Operating and Financial Review (OFR) requirements. Implementation of the requirements may force companies to set out their strategy explicitly and develop a detailed plan for how management intends to implement it. Or it may not, depending on how strict enforcement proves to be. In either case, Ventana Research believes most companies would benefit from expanding and formalizing their strategy-plan-budget-review cycle. Abandoning the traditional spreadsheet-based budgeting processes and adopting a dedicated planning application makes both compliance and strategic planning and reporting much easier to do.
Lack of real substance in a public company’s Management Discussion and Analysis (MD&A – the equivalent U.S. term for the British OFR) has been a longstanding issue for investors on both sides of the Atlantic. In Britain, the government is seeking to address this issue for U.K. public companies. Since the Securities Exchange Act of 1934, U.S. regulators have sought to make financial reporting increasingly transparent, timely and trustworthy. Until the Securities and Exchange Commission (SEC) focused on “full disclosure” in the 1960s, the financial content of a typical annual report was slim: two balance sheets and two years of income statements, accompanied by perhaps two pages of footnotes. Audited cash flow statements and business segment data were rare.
The rapid growth of institutional investing and “go-go years” shenanigans led to today’s more comprehensive presentations for U.S.-domiciled SEC filers. In addition to the passage of the Sarbanes-Oxley legislation by Congress, the SEC over the past five years has moved to accelerate filings and has focused on providing investors with more useful content in the MD&A.
European companies have been slower to enact rigorous reporting requirements but they largely now have, mostly in countries with well-developed international equities markets. The most notable was the U.K.’s Companies Act 1985.
Broader adoption of stricter standards was an inevitable result the European Union’s expansion and the creation in 2001 of the International Financial Standards Board. European companies, particularly those domiciled in countries that had laxer reporting rules, have had to grapple with the more rigorous International Financial Reporting Standards (IFRS). Now, just as they are finishing, new expanded OFR reporting requirements are set to go into effect for U.K. filers for their operating and financial review. The new OFR regulations expand requirements that the directors’ report include a "fair" review of the business, and require that auditors express an opinion that the directors’ assertions are consistent with the financial statements. The law also created administrative and criminal enforcement of these requirements.
In the wake of the rollout of the OFR regulations in March, U.K. public companies face an issue in determining the depth of disclosure that will be necessary to comply. If the regulations are taken literally, companies would have to make their strategies explicit and be able to tie it to an operating plan and budget. Using the U.S. experience as a guide, Ventana Research believes what’s required for compliance will not be this onerous. However, this is not a certainty; the decision may be driven by non-executive directors seeking to protect their positions.
U.S. public companies have provided investors with a more comprehensive view of their results and outlook for the past decade. The 1995 “Safe Harbor” securities law reduced the threat of lawsuits, the SEC’s “plain English” requirement eliminated much of the impenetrable legalese, and Regulation FD forced broader disclosure to all investors. Companies now provide more explicit business outlook guidance as well as pages of boilerplate warnings of all the things that conceivably might go wrong. Nonetheless, U.S. company reports still fall short in laying out the company’s strategy, the forces likely to drive its future business results and the specific factors behind the most recent results. Understandably, companies are reluctant to disclose too much for competitive reasons as well as to avoid embarrassment and lawsuits, and historically the SEC has deferred to these sensibilities.
Too many companies either do not have an explicit strategy or do not tie their strategic plan to a formal process of setting objectives, planning, budgeting and performing reviews. In the U.K., the expanded requirements for OFR may spark a movement by non-executive directors to put these in place, and management’s reluctance may yield to these concerns over their liability for the completeness and consistency of the OFR. Ventana Research advises companies seeking to integrate more formally their strategy-plan-budget-review cycle to replace existing spreadsheet-based budgeting processes with a dedicated software package to support that integration. Standalone spreadsheets cannot support repetitive, enterprise-wide processes well because they force companies to spend too much time gathering and organizing information. Dedicated software addresses this shortcoming and allows companies to focus on making planning and budgeting a more effective management tool.
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