A recent survey of more than 290 investment professionals by the CFA Society of the UK (CFA UK), found most respondents (60 per cent) believe that financial reports contain too much irrelevant information, while 55 per cent feel they omit important information.
However, most (71 per cent) agreed that the quality of financial reporting has improved over the last 10 years.
The frequency of reporting has become an issue of debate with many (including John Kay) arguing that quarterly reporting drives short-termism. Our survey respondents were evenly split between those who favoured quarterly reporting and those happy with just semi-annual, with both options receiving 43 per cent of the votes.
When asked about the length of future financial performance forecasts, nearly 80 per cent of respondents, admitted to forecasting financial performance for 3 or more years, with 47 per cent forecasting on a three-year horizon and 32 per cent forecasting for longer than this. In contrast, just 3 per cent of respondents said that their company financial forecasts were for less than 1 year, with 18 per cent forecasting for a single year. Investment horizons also demonstrated a longer-term perspective. Just 14 per cent of respondents indicated that their investment horizon was less than 1 year, 31 per cent said a year, 26 per cent said 3 years and 29 per cent had a time horizon of more than 3 years. It is interesting to note that nearly 80 per cent of respondents forecast company financial performance for 3 years or more only 55 per cent have an investment horizon of three years or more.
Regarding the use of annual reports, 36 per cent of respondents said that the statutory accounts were their main source of financial information for analysing companies, contrary to frequent assertions that the annual report is irrelevant. However, a number of comments suggested that annual reports had “evolved into a corporate brochure and regulatory box ticking exercise”. Some 47 per cent of respondents believe that the area of the annual report that shows greatest need for improvement is the disclosure of principal risks and uncertainties.
Non-GAAP reporting (also referred to as adjusted earnings measures, eg underlying or recurring profits) remains a contentious issue. In our survey, 61 per cent of respondents said they use IFRS adjusted numbers in their analysis. However, only a third (33 per cent) of respondents say they that prefer non-IFRS measures over IFRS, with over half (56 per cent) trusting the IFRS numbers more. When asked to consider which items should be excluded from IFRS figures to arrive at a measure of underlying earnings, the majority of respondents (65 per cent) were against exclusion of any of the items we had suggested. Two-thirds of respondents favour looking at both IFRS and adjusted numbers as the combination of the two offers greater insights into the company and its management.
Overall the biggest concerns that respondents have with regard to financial reporting are in the following areas:
• The abuse of non-GAAP/IFRS adjusted earnings measures
• Excessive and redundant information in financial reporting
• Fair value movements obscuring underlying earnings measures
• Excessive focus on the income statement and not good enough disclosure of cash flows
• Poor disclosure of off-balance sheet exposures
With regards to the use of IFRS adjusted figures, and building on what ESMA, IOSCO and others have done CFA UK has put forward the following suggestions to companies to improve the quality of reporting:
• Clearly state what the corresponding IFRS figure is.
• Do not place non-IFRS measures more prominently in company announcements than the corresponding IFRS measure.
• Show a clear reconciliation of non-IFRS measures with IFRS measures. The reconciliation ideally should be done on a line-by-line basis.
• Explain how and why the non-IFRS measure is more relevant to the company’s circumstances than the IFRS measure.
• Explain the rationale for each adjustment made to arrive at the non-IFRS measure.
• Apply the same principles to credits as debits when considering whether these should be stripped out of adjusted earnings measures (i.e. don’t be biased).
• Apply adjustments consistently across different time periods, restating prior years if necessary. If there are any changes to methodology these should be explained.
• Explain whether the non-IFRS measures are subject to any assurance from independent third parties, such as auditors. Clearly identify non-IFRS measures as unaudited if this is the case.
• Explain deviations from common practice, especially with regards to sector peers.
Adds Will Goodhart, chief executive of the CFA Society of the UK, says: “Despite the huge volumes of available data in the market, the statutory accounts remain the most popular source of financial information on a company. It is slightly concerning however, that they are seen to include more and more irrelevant information, whilst often omitting more pertinent detail. An inconsistent treatment of adjustments meanwhile, is often leading to an obfuscation of the underlying performance.”