I’ve long been troubled by the reporting problem of externalities. Externalities are off-the-books factors that corporations might not report on, but these factors affect communities, economies, and certainly investors. In the wake of financial crises where inadequate reporting played a major role, getting corporate reporting right is high stakes.
At Intacct Advantage, the main reporting concern of CFOs was revenue recognition, and rightfully so – revenue recognition changes are legally pending and deadlines are near term. But Intacct also exposed me to the concept of Integrated Reporting. Though Integrated Reporting is not yet widely practiced, it can present a holistic view of a company’s health and assets.
During a recent follow up with Intacct CTO Aaron Harris, we discussed why Integrated Reporting matters, and the barriers to adoption. Harris also aired out provocative topics involving open APIs, and why some “cloud” vendors create obstacles to better reporting.
An indirect consequence of production or consumption that affects not the producer or consumer but a third party — society as a whole or some sub-population. Because the costs and benefits of externalities are not included in the price of the product, externalities have the potential to distort markets, where prices are theorized to reflect the “real” value.
Why Integrated Reporting matters
Integrated reporting addresses these issues but from a different angle. The home base of the Integrated Reporting movement is The International Integrated Reporting Council (IIRC) web site. The IIRC describes itself as a global coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs. Their goal? To “promote communication about value creation as the next step in the evolution of corporate reporting.”
It’s easy to get lost in the idealistic weeds here. But what I like about Integrated Reporting is its attempt to quantify corporate assets across a broader spectrum. Integrated Reporting attempts to quantify six corporate assets, or as the IIRC puts it, six capitals: financial, manufactured, human, social and relationship, intellectual and natural:
[These six capitals] represent all the resources and relationships organizations utilize to create value. An integrated report looks at how the activities and capabilities of an organization transforms these six capitals into outcomes.
Integrated Reporting – the Intacct view
So what does Harris think about Integrated Reporting? Harris agrees that revenue recognition has center stage right now. That’s why Intacct has focused on adding revenue recognition functionality:
Obviously Integrated Reporting is not as urgent as things like revenue recognition. We’re in a world right now where we are compelled to produce information often required by auditors, or required by public institutions. That’s squarely where revenue recognition fits in.
If Integrated Reporting isn’t mandatory, why should we care? Because today’s reporting regulations are tunnel vision. Harris:
Integrated reporting is essentially a reaction to the idea that today’s requirements are fairly short sighted. If you look at how companies are forced to report, there’s a view that it enables investors to take the short view on a company’s performance. Integrated Reporting is a reaction to what happened with the big financial crisis, and the problem with a short term view of asset utilization. Integrated Reporting was the outcome.
And how does Intacct, a SaaS financials/ERP offering, fit into the picture?
I think the scope of what’s required today is going to expand as Integrated Reporting takes hold. Where Intacct fits into that is assuring that this fundamental architecture of your transactional system of record enables that broader scope. We’re not just capturing revenue, and we’re not just capturing the revenue by your traditional dimensions of your business. We’re capturing anything that might be relevant to report on the performance of your business across all dimensions. Not just your GAAP dimensions – it could be how you are utilizing the resources that are critical to your industry.
Harris used a housing example:
Maybe the mission of your business is to create affordable housing. Great mission. Can you report to your shareholders on your efforts to deliver against that mission? It gets back to being able to capture all of that information in a single system.
If you go and you look at some of the reports that some of these more forward-thinking organizations are reporting, you’re going to see a lot of subjective stuff in them. A lot of it is just text, but the surprising thing to me, was how much of it looks like traditional BI dashboards. What is our KPI for training our employees and progressing their skills? How is that turning into sales increases? You’ve got to architect your GL to think more broadly than just GAAP.
Data integration is key:
We’re not going to be so conceited as to say we’re going to be the only system of record for Integrated Reporting. There are direct ties between the economic activity and some of the other activity. If you can enrich your data capture to get those additional attributes, it allows you to draw correlations between your economic results, and some of these other results.
Data silos are the enemy of Integrated Reporting:
If you’re keeping some data completely separate, you’re losing that ability to show correlation and to show which of your strategies, which of your objectives are actually fielding the outcome for the business that you and your investors want… We do a lot of the work of making sure that the data is structured. We’ve got pre-defined ways of reporting on that data.
Incentives and barriers to adoption
Formal adoption of Integrated Reporting is limited, but some big names are getting involved. South Africa is considered an early leader, with a web site dedicated to their approach. In March 2010, the Johannesburg Stock Exchange (JSE) adopted the King III principles as part of its listing requirements. Listed companies are required to apply King III, or explain which recommendations have not been applied and publicly provide reasons why (King III recommends Integrated Reporting).
In 2011, the IIRC launched a pilot program which gives organizations the chance to contribute to the reporting guidelines. Over 90 business are involved, including Unilever, Coca-Cola and Microsoft. Given that adoption is limited and gathering such data can be expensive, why should companies bother? Harris:
It’s going to sound a little dramatic, but I think long term survivability. I just saw a headline today from one of the big oil extractors. They said today that the world has turned against carbon emitting sources of energy. We have to start aligning ourselves with trends like carbon taxes because as sentiment continues to shift in that direction, that sentiment’s going to just punish our business. That is in no way a traditional way of looking at the financial results of the business, but it’s forcing a strategic view.
It’s getting harder and harder to “externalize” things in the connected world we live in. People see cause and effect, and digital data allows us to track it. We can quantify concepts like customer sentiment:
You can quantify things like this by looking at customer sentiment, which is actually something you can measure and you can track over time. You can see how that perhaps correlates with other activities.
Few companies can suddenly do Integrated Reporting across the board. So what’s a good way to get started? Harris:
It’s gets back to what are the most important sources of capital in the company. We’re already reporting on cash. The next one would be your employees, your human resources. How are you tracking the satisfaction of your employees? How are you tracking your talent investments, and proving the skills and the careers of the people who work for you? I think that’s critical. You can track brand sentiment. Companies also have intellectual property, intellectual capital that they need to start tracking. It could be patents; it could be trade secrets.
The wrap – real-time KPIs and cloud integration have a role here
Intacct has two approaches that fit into the Integrated Reporting push. One is the emphasis on real-time information, dashboarding and KPI monitors. Getting business “health indicators” up and running lays the groundwork for more holistic reporting (see my talk with Intacct CEO Rob Reid, CFOs need real-time metrics to change the status quo).
Intacct is also a huge believer in enabling ease of cloud integration. In the case of HCM, they don’t offer a talent solution, though they do track time and expenses and resource management. That means for integrated HR reporting, integrating with a third party might be needed – and it better be dead easy.
A core precept of Intacct is interoperable cloud integration. It is something Harris is passionate about; he doesn’t believe every SaaS vendor shares Intacct’s core commitment to multi-tenancy and open APIs. He gets ticked off about misinformation “clouding” the market. Harris thinks some vendors talk too loosely about flexible deployment, putting too much burden on customers:
When we launched our product as one of the very first cloud solutions seventeen years ago, we had open APIs on day one. If you fast forward to today, we actually process more transactions over the API than we do through the user interface.
To bust free from data silos and integration headaches, open APIs matter:
Whatever cloud we happen to deploy our system to, we’re completely agnostic to where other solutions might be deployed. We have direct communication, API to API, with various other products, some of which live on AWS, some of which live in Azure. Some are doing their own hosting. The fact that it’s on AWS, Azure, Google, whatever, is completely irrelevant as long as the system is developed with open APIs. We have been huge advocates for an open platform.
For Integrated Reporting to work, companies need to reduce the cost of data gathering and integration. Harris sees SaaS platforms as a way to boost that effort, and run your business better:
We have some customers with 15 or 20 different integrations, running through our APIs. It’s really pretty staggering how important it becomes to their choice, and their success.
Widespread Integrated Reporting is a long ways off. But the framework and technology are there for companies to make strides – and those strides matter.
Image credit - Feature image - No more excuses © sean824 - Fotolia.com. Photo of Aaron Harris from Intacct web site.
Disclosure - Intacct paid the bulk of my travel expenses to attend Intacct Advantage.