Can CFOs step up to the plate?
Financial directors and their departments need to fire on all cylinders to succeed as second-in-command
The role of the CFO seems to be stretching beyond recognition. And while there is a consensus regarding the need to reinvent the role for the digital era, the direction of change mapped out by experts is often conflicting.
One indicator of the number of new hats the CFO is expected to juggle is the increase in the number of functions answerable to them – which, according to a McKinsey report, had doubled by 2019.
The shift itself is not about replacing old hats with new ones but rather expanding the collection. CFOs won’t cease to be number-crunchers at heart, and accounting, reporting and compliance are here to stay. But even some of their traditional responsibilities will need to be carried out with a new mindset.
Annual budgeting horizons are often criticised as unfit for purpose on two opposing accounts. One charge against them is short-termism. Digital transformation projects often span more than three years and will show their true ROI only in the long run as the individual transformation projects in the business’s portfolio mature. Until then, they tend to look more like budgetary sinkholes, the archenemies of financial planning.
Seen from an agile perspective, however, the annual budgeting and funding timeline is way too long. Digital transformation should be iterative in nature, as is agile project management, one of its most effective methodologies, and many argue that succeeding at it requires the ability to fail from time to time. While planning isn’t eliminated from the agile process, being responsive to changes, tweaking and re-planning override adherence to set targets. Therefore, the agile approach to managing transformation calls for a flexible finance function that’s aware of the volatility of disrupted markets.
The traditional image of the CFO as a frugal naysayer that heads of department must coax into sponsoring their projects was perhaps first reevaluated during the 2010s, with the rise of the dual CFO-COO (Chief Operating Officer). This involved the head of the financial function taking on day-to-day operational and administrative responsibilities, as well as becoming a strategic partner to the CEO.
A study published by the American Accounting Association last year found that merging the two roles doesn’t affect the efficacy. To the contrary, the CFO’s more in-depth knowledge of how the company operates resulted in more precise accounting estimates and improved communication between the finance department and other business units. But can the role bear any further expansion without bursting at the seams?
As digital transformation is increasingly putting data and advanced analytics at the centre of businesses, these areas need to be represented in the C-suite too. The fact that the financial function is the most attuned to working with data and statistics makes it the most natural candidate for the role. But data analysis today means much more than deciphering figures from the company’s past. CFOs also need to be able to read the present and predict the future, as well as translate the information they’ve gleaned into layperson’s terms.
Are there any more items on the skillset checklist for the CFO that we haven’t touched on yet? Although requiring CFOs to be technologists may sound like stretching it too far, if they act as arbiters of which technological investments should go ahead, a considerable amount of tech-savviness obviously won’t hurt. Moreover, excellent communication skills are definitely an asset if you serve as the CEO’s evangelist when it comes to the need to digitally transform…
New technologies, techniques and teams coming to the rescue of the CFO
Luckily for heads of finance, there is a formidable toolkit and a range of experts to rely on. First of all, the digitalisation of their own role frees them from the more mundane and repetitious aspects of their jobs, enabling more strategic thinking. Rolling budgets – the idea that a new month is added to the budget period every time one has passed – remove the countdown syndrome and the short-termism between annual budgets. SAFe, or the Scaled Agile Framework, can lend an agile quality to strategic planning by enabling a move from traditional, project-based resource allocation to a leaner, faster and more decentralised financial management model. Meanwhile, new KPIs are being invented that offer a more nuanced picture of digital projects’ progress than ROI.
Keeping data at the heart of digital businesses implies that information is no longer stored in departmental silos but on a unified platform, most of which anyone in the company can access without the finance department acting as gatekeeper. Also, business intelligence (BI) software and analytics tools provide tremendous help with investment evaluation and turning raw data into insights that any line of the business can understand and act upon.
Last but not least, further new roles are being created, such as the CDO (Chief Digital Officer or Chief Data Officer) or the CDTO (Chief Digital Transformation Officer), who can bring the kind of deep expertise and insight to the CFO’s table they could only realistically expect to have if they were they superhuman.
From the outside, the ideal digital CFO of the future will look like the mighty master of the company, second only to the CEO. But their success will hinge upon how successfully they can orchestrate the tools and expertise at their disposal.
Zita Goldman
Zita Goldman covers digital transformation with a focus on demystifying digital technologies and showing how they fit into a broader sectoral, macroeconomic, legislative and societal context. She has a passion for connecting the dots of current business and financial news and explaining inconsistencies, for giving hype a reality check and looking behind buzzwords for fresh meaning.
Putting a dollar value on nature will give governments and businesses more reasons to protect it
President Joe Biden calls climate change “the existential crisis of our time” and has taken steps to curb it that match those words. They include returning the U.S to the Paris Agreement; creating a new climate Cabinet position; introducing a plan to slash fossil fuel subsidies; and announcing ambitious goals to cut U.S greenhouse gas emissions.
But climate change is not the only global environmental threat that demands attention. Scientists widely agree that loss of wildlife and the natural environment is an equally urgent crisis. Some argue that biodiversity loss threatens to become Earth’s sixth mass extinction. But unlike efforts to fight climate change – which centre on clear, measurable goals to reduce greenhouse gas emissions – there is no globally accepted metric for saving biodiversity.
As an expert on budgeting and public finance, I know that governments and private businesses alike pay much more attention to resources when they have a well-defined price tag. I believe that overhauling society’s concept of wealth to include “natural capital” – the value nature provides to humans – is a critical step for slowing and reversing the loss of precious ecosystems.
What is natural capital?
Natural capital can be defined as the world’s stocks of natural assets – soil, air, water, grasslands, forests, wetlands, rocks and minerals – and all of its living things, from mammals and fish to plants and microbes. Conservation experts estimate that these resources contribute more than US$125 trillion to the global economy every year.
Humans depend on nature’s contributions for survival. For example, forests absorb carbon and filter the water we drink. Wetlands and coral reefs mitigate flooding. Bees and other insects pollinate crops, enabling us to grow food.
But human societies don’t formally recognize the economic value of these services. This oversight encourages people to recklessly deplete the natural environment.
A recent review of the economics of biodiversity, commissioned by the U.K. government and led by Cambridge University economist Sir Parth Dasgupta, warns that human prosperity is growing at a “devastating cost to nature” and estimates that it would take 1.6 Earths to maintain the world’s current living standards. The report calls for the world to treat nature as an asset to be reported in financial statements and national accounts.
The Capitals Coalition, a global consortium of 380 initiatives and businesses, is trying to “change the math.” The organization seeks to persuade at least half of the world’s businesses, financial institutions and governments to incorporate natural capital into their decision-making by 2030.
Valuing ecosystems
Current accounting methods used by corporations and governments largely ignore what ecosystems and their services contribute to the economy and to human social well-being, jobs and livelihoods. As a consequence, modern societies spend far more on investments that deplete or exploit natural assets than they do to preserve them.
Under the current model, short-term economic gains typically win out against longer-term ecological benefits. For example, failing to maintain forests can spark wildfires. And constructing homes on fragile coastal wetlands can erode soil and reduce fish stocks, destroying local communities.
A recent study by the Paulson Institute, a research institute founded by former US Treasury Secretary Henry Paulson, estimated that global investments that degrade nature exceed conservation efforts by $600 billion to $824 billion per year.
Natural capital accounting would require businesses and governments to calculate how human activity affects nature, much as they assess the depreciation of buildings or machinery. Analysed in this way, nature is a financial asset, and damage to it becomes a liability. This approach creates incentives to conserve natural resources and restore others that have been degraded or depleted.
Global recognition of this issue is growing. In March 2021 the United Nations updated a statistical framework for standardising ecosystem accounting, which was first published in 2012. These guidelines help countries track changes in ecosystems and their services and provide leaders with a baseline with which to compare their stocks and flows when making policy decisions.
Some 90 countries have adopted this System of Environmental Economic Accounting and produced baseline “national capital accounts.” They include European Union members, Australia, Canada, the United Kingdom and more than 40 developing countries. The U.S is planning to implement this approach but has not done so yet.
Assessing nature’s value
Placing values on natural assets is really no different from government assessments of the benefits of new roads, bridges and other infrastructure. People intuitively understand that natural resources are precious. And the Covid-19 pandemic has made clear how closely human health is intertwined with the health of the planet.
In response to the biodiversity crisis, President Biden has aligned the US with the global 30x30 campaign, a plan to protect at least 30 per cent of the planet’s land and oceans by 2030. Multiple scientific studies have shown that achieving this goal would conserve species, store carbon, prevent future pandemics and boost economic growth.
The year 2021 marks the start of the U.N. Decade on Ecosystem Restoration, which aims to prevent, halt and reverse the degradation of ecosystems worldwide. Today, according to a recent study, less than 3 per cent of the world’s land remains ecologically intact with healthy wildlife populations and undisturbed habitats.
The US has lost decades of potential progress since Congress suspended fledgling efforts by the Bureau of Economic Analysis to develop environmental accounting methods in 1995. Researchers at the US Geological Survey and other federal agencies are now urging the U.S to adopt national capital accounts using the U.N. framework.
In contrast, the UK created public environmental accounts and set up a Natural Capital Committee in 2012, led by its finance ministry, to help corporations develop natural capital accounts. Today, the UK maintains these accounts, which capture data on the size, condition, quantity and value of habitats and ecosystem services. President Biden could empower the US Treasury Department to spearhead a similar initiative.
Adopting metrics to measure and track the benefits people receive from wildlife and ecosystems would clarify how human activities affect nature and show how much investment is needed to reverse humanity’s current destructive trajectory. Conservation advocates will be much better positioned to protect our planet’s resources with a strong balance sheet to back it up.
Linda J. Bilmes, Daniel Patrick Moynihan Senior Lecturer in Public Policy and Public Finance, Harvard Kennedy School
This article is republished from The Conversation under a Creative Commons license. Read the original article.
We studied the world’s top airlines and hospitality firms – many are still poor at reporting risks around climate and pandemics
Many UK companies will have to make statements about the risks of climate change to their businesses under new proposals being put forward by the Financial Conduct Authority (FCA). So-called “premium-listed” companies that follow the highest regulatory standards are already having to make such statements in their financial reports as of this year, but the FCA now wants to roll it out to most other listed companies by 2023 (and other financial bodies such as asset managers).
This will involve UK companies reporting on business risks such as more frequent and extreme weather events, rising temperatures and rising sea levels – in line with the recommendations of the international Task Force on Climate-related Financial Disclosures (TCFD).
A number of companies around the world are following these requirements already, while the G7 finance ministers recently made a commitment to make climate-risk reporting mandatory for companies registered in their countries. In the US, for example, a debate is now underway about what form these disclosures should take and whether firms should be legally liable for their assessments.
This all reflects the fact that political discussions around the world in 2020 and 2021 have been dominated by the severe risks around climate change – and also future pandemics. Leading accounting bodies and others are pushing for companies to disclose risks related to the UN Sustainable Development Goals, which means pandemics as well as climate change.
There has already been a shift in investments to favour companies that address such risks, and making risk-reporting mandatory in company disclosures is crucial to getting this trend to continue.
Yet for now at least, most companies are still reporting on such risks at their own discretion. Our newly published research shows the scale of the challenge. We examined all publicly available disclosures by the world’s top ten airlines and top five hotel and cruise companies. Many are household names, and they are among the most threatened by pandemic and climate risks in the world. Here’s what we found.
The disclosure shortfall
We examined the companies’ disclosures in the months leading up to the pandemic. These included annual reports, sustainability reports, websites, stock exchange submissions, and disclosures under the CDP (Carbon Disclosure Project) global system for reporting environmental impacts.
These risks are about the present as much as the future. Holidaymakers are already being faced with climate effects such as less snow at certain ski resorts, floods, wildfires, heatwaves and other extreme weather events. Loss of biodiversity is making some destinations less popular – not least Australia’s Great Barrier Reef. And before coronavirus, airlines and hospitality companies had already experienced substantial economic costs from Sars and Mers.
Yet only six out of our 20 companies treated pandemics as a separate risk category in their disclosures. Others referred to the lesser risks of epidemics and disease outbreaks, but often did not explain how their business operations and profits could be affected.
One cruise provider had listed controlling the transmission of diseases onboard and protecting employees as its only pandemic-related risks. The bigger risks of reduced passenger demand, route closures and disruptions to operations and supply chains were not mentioned. Few of the airlines and hotel companies discussed these either.
Meanwhile, only four companies explained strategies for mitigating pandemic-related risks. These were limited to assurances of having disaster recovery and business continuity plans.
Disease risks identified by companies
Our 20 companies showed only slightly better awareness of the business risks from climate change. Five of them – including four airlines – did not disclose any potential risks. Among those that did disclose risks, the focus was on reducing fuel or energy use and carbon emissions – reflecting the increased risk of regulation and pressure from stakeholders to reduce emissions.
But other risks such as customers switching to “greener” alternatives or extreme weather were usually not acknowledged. Strategies for addressing the longer-term effects of climate risks were also rarely considered.
Companies and their climate-risk strategies
These limited disclosures show how much needs to change in airlines and hospitality for climate and pandemic risks to be treated appropriately. And when you consider that these firms are among the most threatened, other sectors could well be even worse at risk reporting.
The IFRS problem
One other difficulty in this area relates to the IFRS Foundation, which issues International Financial Reporting Standards that have to be followed in some 140 countries, including the UK (though not the US). The foundation recently published a proposed Practice Statement on Management Commentary, which relates to how companies should disclose factors that might affect their cashflow and value.
In their management commentaries, companies can incorporate any mandatory requirements about risk reporting such as the ones being proposed in the UK, or choose to follow recommendations like those of the TCFD if they are based in a country with looser rules. Unfortunately, the IFRS proposals are not entirely helpful in encouraging companies to make such disclosures.
The proposals require risks to be disclosed only to the extent that they affect a company’s “enterprise value” and future cash flows from an “investor perspective”. This goes against efforts over the past decade to encourage companies to think about the value they create for society and their impact on the environment – including the European Commission’s Corporate Sustainability Reporting Directive.
The problem is that systemic risks such as climate change are impossible to quantify in monetary terms, particularly in relation to a particular date in the future. Trying to do so is both time-consuming and largely futile. Our research indicates that companies are likely to downplay or ignore risks that cannot readily be translated into financial costs or which may take more than, say, five years to come about.
When identifying risks, companies should also consider their effect on the long-term value of society and the environment - not only enterprise value as the IFRS Foundation proposes. As countries put more requirements in place around companies reporting such risks, they need to make this part of their agenda as well.
Carol A Adams, Professor of Accounting, Durham University and Subhash Abhayawansa, Associate Professor in Accounting, Swinburne University of Technology
This article is republished from The Conversation under a Creative Commons license. Read the original article.
Amazon found destroying unsold stock – would better accounting practices help?
A recent undercover investigation in an Amazon warehouse in Dunfermline, Scotland, reported the disposal of more than 130,000 “new or lightly used” objects in a single week in just that one location. Public outrage was clear. Questions were asked about how Amazon could be so wasteful and why weren’t the usable objects sent to those in need?
Amazon responded to the ITV investigation by saying it is “working towards a goal of zero product disposal”, and that “no items are sent to landfill in the UK”. UK business secretary Kwasi Kwarteng responded to the warehouse story with “surprise” implying that this waste was unexpected (both Amazon and the Scottish government have circular economy strategies designed to limit waste to landfill). The Amazon whistleblower behind the story claimed “there’s no rhyme or reason to what gets destroyed” suggesting this “surprise” waste was the consequence of a disorganised system.
But waste doesn’t just happen. Trash is the result of socio-cultural acts of classification in which objects are considered valueless within a particular context. Organisations classify objects within financial accounts. From an accounting perspective, the waste in the Amazon warehouse was neither disorganised nor unexpected but rather was a predictable consequence of accounting designed for a linear economy.
Most objects in financial accounts are classified as stock, a type of asset. Stocks depreciate in value over time, until ultimately – when cost of storage outweighs potential return – that unsold stock becomes a liability. Organisations can choose how to dispose of their liabilities but, in balance-book terms, the stock has become waste: worthless objects to be discarded (in the cheapest possible way).
Society is producing more waste every year and yet, for most of us, that waste remains out of sight. Most wealthy countries have designed waste management systems that remove perceived worthless objects from our economy quickly and cheaply.
The efficiency of these hidden waste management systems is reflected in financial accounts. Traditional waste infrastructure (landfill and materials recovery facilities) is accessible and reliable enough to still be the cheapest disposal option for many organisations, despite landfill taxes designed to encourage alternative paths for unwanted objects.
What makes the Amazon case particularly alarming is the volumes of waste involved (several million tonnes a year by some estimates). Importantly most of this waste is not from Amazon’s own retail business, but rather the unwanted stock from some of the thousands of smaller organisations that use Amazon as a retail platform and distributor. The waste generated by financial accounting is a systemic problem.
The low cost of landfill disposal is another example of the now well-recognised failure of financial accounts to capture negative environmental consequences. However, in the case of waste disposal, it is not necessarily that alternatives to landfill or recycling cost more. Rather, the associated costs (such as the markets for reuse) are unknown and so difficult to include within financial accounts.
Accounting in a circular economy
We should encourage a transition from a linear to more circular economy, in which resources are reused and the need for landfill largely eliminated. To do this, we must begin to understand the financial costs associated with recycling and reuse, how objects retain some value beyond an individual organisational context and how this value might be reported within accounts. We need to envisage a system of accounting for circularity.
Accounting for circularity will inevitably require organisations to produce social and environmental reports in addition to financial accounts, and a recognition that organisations cannot become circular on their own. Accounting in a circular economy requires collaborative accounts between organisations that transcend traditional boundaries and extend across supply chains to consider value in production and consumption systems.
Through these accounts, we can begin to make waste visible, identify ecological limits to consumption and challenge those organisations and organisational practices that test those limits. In the case of Amazon, this might involve both the platform (Amazon) and its sellers collaborating on publicly available accounts that capture the material value of the excess stock.
Efforts to account for the material flow within our production and consumption system are being pursued and Scotland, where I work and the Amazon warehouse is located, is leading the way. This week Zero Waste Scotland publicised its report which found that the total weight of resources used in 2017 by individual Scots (18.4 tonnes) was more than double predicted sustainable levels (8 tonnes). Work is still required to understand the contribution of organisational practices to this national material flow.
Scotland’s proposed Circular Economy Bill – including mandatory reporting of business waste – was put on hold indefinitely in light of the pandemic. However, the Amazon warehouse exposé reinforces that accounting for waste should be put back on the legislative agenda.
Lucy Wishart, Associate Lecturer, University of St Andrews
This article is republished from The Conversation under a Creative Commons license. Read the original article.