Operating and Financial Review - PwC · The Operating and Financial Review in a nutshell 04 A...

Operatingand FinancialReviewGive yourself a head start*

Preparers’ Guide

Contents

Page

Give yourself a head start 02

More of the same? Far from it 03How the regulations differ from existing practice

The Operating and Financial Review in a nutshell 04A summary of the new regulations

Companies will get out what they put in 06The risk of ignoring the regulations, the benefits of embracing them

What are the challenges? 08The key implementation challenges companies will face

What should companies be doing now? 1210 key steps to a successful implementation of the regulations

Process of evolution, not revolution 19Recognition that change will not happen overnight

Contacts 20Specialist support for the Operating and Financial Review

and their areas of expertise

01

Give yourself a head start*

Company executives often bemoan the factthat they barely have time to actually runtheir business due to the ever-increasingmountain of regulatory and legislativedemands being made of them. Under such pressure, it is not surprising thatcompanies often adopt a narrowcompliance-based response to thesedemands. However, the new Operatingand Financial Review (“OFR”1) is actuallyfocused as much on how businesses arerun, as on reporting. For those whoembrace the spirit of the new regulations,rather than the letter of the law, theopportunity exists to use them as a basisfor creating real competitive advantage.

The OFR offers a mechanism to supportthe creation of a more commerciallyattractive and differentiated picture of the business which can lead to betterinvestor understanding and improvedstakeholder relationships. Furthermore,the underlying process necessary toproduce an OFR can also enhance Boardeffectiveness and improve governance.

Forward-looking companies are alreadyseeking ways to turn a mandatoryrequirement from a burden into anopportunity by going beyond merecompliance. However, if theseopportunities are not grasped and theprocess is not planned adequately,businesses run the risk of damaging

their reputation among stakeholders, their market rating and ultimately theircompetitive positioning; never mind therisk of legal and regulatory challenges.

So how can executives identify and maximise the opportunity the OFRprovides while ensuring the risks aremanaged? At PricewaterhouseCoopers,we have used our expertise to create thisessential guide to preparing the OFR inorder to help executives meet thischallenge and enable them to generatethe benefits. The task of realising theopportunities needs time and effort, butour 10 point plan (see pages 12-18)provides clear guidance on where thisshould be directed.

The OFR is coming and the soonercompanies start to prepare for it, thebetter positioned they will be to avoidthe pitfalls and reap the benefits – act now and the benefits are there for the taking!

“For those who embracethe spirit of the newregulations rather thanthe letter of the law, the opportunity exists to use them as a basisfor creating realcompetitive advantage.”

Give yourself a head start

1 Throughout this guide “OFR” refers to the Companies Act 1985 (Operating and Financial Review and Directors’ Report etc.) Regulations 2005.02

Operating and Financial Review – Preparers’ Guide

03


Why the regulations representmore than a minor amendment to existing practice

• For the first time an OFR will bemandatory for all quoted companies

• It demands greater transparency onthe information needed by investors to assess the strategies adopted by a company and the potential for thosestrategies to succeed

• All of the risks, resources andrelationships important to successfullyimplement strategies and achieve goalsand objectives need to be explained

• It requires not only historical analysis,but an explanation of the main trendsand factors likely to impact futureperformance

• Directors will be required to exercisejudgement to determine whatinformation is important – a merechecklist will not suffice

• Directors will be required tocommunicate financial and non-financialKey Performance Indicators (KPIs) and other measures, as appropriate,consistently year on year

The new regulations will require companiesto reveal just what information Directorsrely on to manage their business. Some of this information may already be reported, but not necessarily in theannual report, whilst other informationmay currently be used internally, but notreported. If this is the case, Directors willneed to assess whether the information is considered robust enough to disclosepublicly. At the extreme, a review of theinformation-set available to understandstrategic progress may highlightinformation that is missing. In this situation,Directors will need to consider how toclose the information gap(s) that exist andhow to improve the nature and quality ofinformation used to manage the business.

More of the same? Far from itHow the regulations differ from existing practice

The Operating and Financial Review has been around for many years. The AccountingStandards Board (“ASB”) issued its first statement on the Operating and FinancialReview in 1993, and two-thirds of listed UK companies already prepare something theyrefer to as an ‘Operating and Financial Review’.

However, you would be wrong to think the Government’s new initiative to improvecompanies’ reporting to shareholders represents a minor amendment to existingpractice. The reality of the new regulations are that they will, over time, extend thescope, transparency and content of corporate reporting and in doing so will challengethe quality, reliability and availability of information provided by companies’ internalmanagement systems.

04


The Operating and Financial Review in a nutshellA summary of the new regulations

Objective of the OFR The key objective of the OFR, as set out inthe regulations, and reinforced in RS1, isto provide “a balanced and comprehensiveanalysis, consistent with the size andcomplexity of the business, of:

a) the development and performance of thebusiness of the company during thefinancial year,

b) the position of the company at the endof the year,

c) the main trends and factors underlying the development, performance andposition of the business of thecompany during the financial year, and

d) the main trends and factors which arelikely to affect the company’s futuredevelopment, performance and position,

prepared so as to assist the members of the company to assess the strategiesadopted by the company and thepotential for those strategies to succeed.”

Principles of the OFR Unlike traditional financial reportingstandards, RS1 does not represent anaccounting technical challenge. There are no hard and fast rules for whatinformation a company must include in itsOFR. Companies can only make thisdecision on the basis of their own uniquebusiness dynamics and those of theindustry sectors in which they operate.However, RS1 does set out seven keyprinciples which should be applied bycompanies when they are preparing an OFR.

The OFR shall:

1. “set out an analysis of the businessthrough the eyes of the Board ofDirectors

2. focus on matters that are relevant to the interests of investors

3. have a forward-looking orientation,identifying those trends and factorsrelevant to the investors’ assessmentof the current and future performanceof the business and the progresstowards the achievement of long-termbusiness objectives

4. complement as well as supplement thefinancial statements, in order toenhance the overall corporatedisclosure

5. be comprehensive and understandable

6. be balanced and neutral, dealing even-handedly with both good and bad aspects

7. be comparable over time”

The Companies Act 1985 (Operating and Financial Review and Directors’ Report etc.)Regulations 2005 introduces a new requirement for Directors of quoted companies to prepare an OFR for financial years beginning on, or after, 1 April 2005.

The Government has determined that this statutory requirement should be supported by a reporting standard (“RS1”) issued by the ASB. Companies that are compliant with RS1will be presumed to be compliant with the corresponding requirements of the regulations.

Directors will be required to state in the annual report whether the OFR has been preparedin accordance with RS1 and explain any departures. Auditors will be required to state inthe auditors’ report whether, in their opinion: the OFR is consistent with a company’saccounts; and any other matters that have come to their attention in the performance oftheir functions as auditors of the company are inconsistent with information in the OFR.

05


The nature, objectives andstrategies of the business

Description of business and external environment

Objectives to generate or preserve value over the longer term

Strategies for achieving the objectives

Underpinned by the financial and non-financial KPIs used to assess progress against stated objectives, as well as other measures and evidence

Resources, risks anduncertainties, and relationships

Description of resources,tangible and intangible,available and how they are managed

Description of principal risksand uncertainties and theDirectors’ approach to them

Information about significantrelationships with stakeholdersother than investors who maydirectly impact performance

Current and futuredevelopment of performance

Significant features of the development andperformance of the business

Main trends and factors likelyto impact future performance

Financial position

An analysis of the financialposition and criticalaccounting policies

Discussion of the capitalstructure

Discussion of the treasurypolicies and objectives

Discussion of the cash inflowsand outflows, ability togenerate cash to meetcommitments and fund growth

Discussion of current and prospective liquidity

Exhibit 1: Disclosure Framework

Disclosure Framework To assist companies, RS1 also sets out a Disclosure Framework (see Exhibit 1) forDirectors to apply in order to meet therequirements of the regulations and whichmay assist them to structure theinformation more effectively. It emphasisesthat Directors’ judgement should be usedin “determining how best to use thisframework” when structuring the OFR

and considering the level of detailrequired as it will depend on the“particular circumstances of the entity”.

The framework set out below builds onthe one featured in RS1 to create a morelogical flow:

06


Companies will get out what they put in

Risks The OFR raises many risks for theDirectors of any company. Neverthelessthe greatest of these risks lies in failing to plan and respond to the regulations –resulting in long-term damage to thecompany’s investor relations, itsreputation among stakeholders, its levelof public trust, its market rating andultimately its competitive positioning.

Information gaps may be identified too late in the process

Consideration of the content at the lastminute may highlight information gapswhich cannot be addressed in the timeavailable. Even if the content of acompany’s OFR is comprehensive, it mayhave the effect of highlighting strategic and operational weaknesses in its businesswhich could have been identified, andactions taken to address them, earlier in the process.

Competitors may achieve first mover advantage

The OFR will open up new areas ofcorporate reputation to scrutiny anddebate. Failure to paint a convincingpicture on this broad canvas will exposecompanies to unjustified comparisonsand difficult questions from investors and other groups who monitor businessperformance on behalf of society. If competitors gain first mover advantagethey will be able to help shape the

information demanded by these investorsand other groups. Companies will then be encouraged, if not forced, to providesimilar information, regardless of whetherit is appropriate to their business model.

Regulatory challenge

Directors may risk legal or regulatorychallenges if their OFR appears factuallywrong, or contains an opinion that noreasonable Board could have formed. The Financial Reporting Review Panel,which has regulatory responsibility foroverseeing the quality and compliance of company reports, will start to look atthe content of OFRs for financial yearsstarting on, or after, 1 April 2006.

The risk of ignoring the regulations, the benefits of embracing them

While the new regulations will not apply to annual reports for another year, manycompanies already provide an OFR-type section in their annual report. Furthermore, by requiring management to provide information routinely used to manage their business,the regulations imply that the information should already be available. Surely with all theother reporting pressures placed upon companies, Directors will not have to considerthe implications of the new regulations for another year? The risks and benefits outlinedbelow suggest they will.

07


Benefits While the OFR brings a number of risksthere are also benefits for thosecompanies who truly embrace the spirit,and not just the letter, of the newregulations in a timely fashion.

Enhanced business understanding,improved governance and Boardeffectiveness

The OFR process can provide anopportunity for Boards to question thedepth and breadth of information theyuse and, as a result, assess whether thelimited time available in Board meetingsis being focused on the right issues. How many Boards routinely receive leadperformance indicators that go beyondtraditional financial numbers and howmuch time is devoted to strategy andactivities critical to value creation? Over time, the OFR will provide Directorswith a more comprehensive picture ofcorporate performance, which willprovide new insights into the health and sustainability of the business.

Enhanced investor understanding and improved relationships with keystakeholders

A company with an effective OFR willgive investors and other stakeholdersdeeper and clearer insights into whatreally drives value in its business, anddemonstrate clearly why its chosenstrategy is the right one to take thebusiness forward. Among otheradvantages this will enable it to improveits reputation and market rating, lower

its cost of capital, and attract and retain the best talent.

Aligned reporting and communicationstrategy

Corporate reporting is going through a period of unprecedented change. As reported earnings become morevolatile under International FinancialReporting Standards, corporategovernance guidelines become moreextensive, and socially-responsibleinvestment indices become morechallenging, the discipline of the OFRoffers Directors a common framework for articulating underlying corporateperformance.

Internally the OFR provides companieswith an opportunity to reassess thepractical aspects of how information ischannelled into the outside world both interms of the messages being given, butalso the costs incurred by various groups(from corporate communications, investorrelations, environmental and socialreporting, employee communications etc).

08


What are the challenges?The key implementation challenges companies will face

Meeting investor needs

Do you understand what information yourinvestors need?

Directors will need to exercise muchgreater judgement than historically todetermine what information investorsneed to assess the strategies adoptedand the potential for those strategies tosucceed. They will also need to considerthe extent to which issues relevant toother stakeholders (such as: customers;suppliers; employees; and the widersociety) are also of significance toinvestors, because of their influence onperformance and value creation.

But what exactly are the needs ofinvestors and the issues affecting otherstakeholders? Have they been asked?Understanding their reaction to the lastanalyst presentation may not be enough.Do competitors have a betterunderstanding of, and response to, theseneeds or issues? It is vital that Directorsunderstand from the outset what investorneeds are if they are to be appropriatelyaddressed and peers aren’t given theopportunity to steal a march and extractcompetitive advantage.

The introduction of the OFR regulations has implications both internally and externally for companies.

Internally, the disclosures required by the OFR will necessitate that companies challengethe degree to which they have robust and timely processes capable of collecting, validatingand reporting a wide variety of information on a timely basis, some of which may not havebeen collated, or reported externally before.

Externally, it will shift the relationship with shareholders and other stakeholders onto an entirely new footing – one in which the transparency and credibility of the business’sstrategy as expressed through the OFR will become a key competitive differentiator.

A cohesive team

Do you know which “information owners”should have input into the OFR?

The annual report has traditionally beenthe domain of the CFO and finance team. Given the breadth of informationencouraged by the OFR regulations, it will now require the input of a number of other key individuals and teams tomake it happen. From those involved in strategy, to those involved in humanresources, R&D, customers, brands andmarketing and the environment.

The challenge for Directors will be toconnect these various “information owners”with potentially competing agendas andto manage their expectations as theoverall structure and content of the OFRis developed and finalised. Only in thisway will a fully integrated and coherentOFR be produced.

09


“The regulations aren’t just about transparency, theyare as much about the effectiveness of the Board”FTSE 100 Finance Director

Information used to manage the business

Are you comfortable enough with therobustness of the information to place it in the public domain?

Most companies will already havesystems and procedures in place toproduce information which enablesDirectors to determine and manage the risks to achieving strategic success,and to assess and challenge performanceagainst strategic objectives. But, critically,some of this information may have neverbeen reported externally before.

a) How relevant?

The appropriate areas to be covered maydiffer for every industry and for eachcompany within an industry. The abilityfor a generic template to be developedwhich Directors may usefully apply as aninput into their OFR development processwill therefore be limited to an industry-level at best. Accordingly Directors mayconsider meeting with competitors toform consortia to help develop and defineappropriate industry KPIs and agree on how information should be reported.

Other guidance on what to report andhow best to structure it may be soughtfrom examples of good reporting practicefrom companies in the same industry, orindeed, other industries (see Exhibit 2).

b) How reliable?

Directors will have to decide whether theyfeel comfortable enough with thereliability of the information to place it inthe public domain. The informationpresented in accordance with RS1 shouldbe the information that Directors use tomanage their business. Accordingly, whatgets reported externally will need to bethe output of a formalised process, bothin the determination of the shape andnature of the content and in the actualproduction of the information itself.Directors will therefore need to considerwhether, or not, the information to bedisclosed is derived from establishedmanagement processes and whether, or not, this information is sufficientlyreliable and has been subject to adequatecontrols, Board scrutiny and governance.

Clearly, in determining what informationto report there may need to be a trade-offbetween relevance and reliability.

A picture of sustainable value

Do you understand what actions drivesustainable value in your business andcan you articulate this?

For the first time Directors will be requiredto identify, quantify and report publicly on the areas of their business which drivesustainable value – both financial andnon-financial. This presents the challengeof whether companies truly understandhow the effective management of theirrisks, resources and relationships (e.g. employees) actually creates value intheir business and whether they canarticulate this?

Directors will have to consider, ‘to theextent necessary’, what information relatingto key relationships (e.g. customers andsuppliers), brands, innovation, employees,

suppliers and social and environmentalissues are important in evaluating strategyand performance. Furthermore, they willneed to consider whether robust,quantifiable financial and non-financialKPIs, or other measures, are available to support assertions made in respect ofthis information.

A review of the internal information-setmay identify gaps in the informationavailable for disclosure. Companies willneed to consider the extent to which thegaps need addressing in order to present a coherent picture of sustainable value.

10


UK listed companies anticipating thepreparation of their first mandatoryOFR face a tough challenge: they musttransform regulatory requirements intouseful reports, with little direction as towhat good reporting under these newrequirements might look like.

Trends 2005: Good Practices inCorporate Reporting (Trends 2005) is intended as a guide and source ofinspiration for all preparers of corporatereports. It is a compendium of goodpractice reporting examples fromforward-thinking companies thatappear to have recognised the valueand competitive advantage to begained from improved communication of both financial and non-financialinformation.

The good practice examples featured in Trends 2005 are structured around the PricewaterhouseCoopersValueReporting Framework (see Exhibit 3 on page 18), which is the codification of nearly a decade of

capital markets research into theinformation needs of management andinvestors. Drawn from 42 companiesworldwide, the publication outlines indetail some of the companies that arealready embracing demands for greatertransparency.

The examples featured illustrate howcompanies can provide a linkage intheir reporting between the externalmarketplace, strategies adopted tocompete in that market, how the risks, resources and relationships aremanaged to deliver on these strategiesand ultimately the resulting financialand operational performance. Precisely the outcome that the OFR is trying to achieve.

Exhibit 2: Trends 2005: Good Practices in Corporate Reporting

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Alignment and corporateconsistency

Is your communication strategy fully integrated?

As Directors reflect on the depth andbreadth of information that might beincluded within their OFR and how itshould be structured, they may identifythat much of the information is alreadyreported elsewhere; whether it be on theweb site, in corporate responsibilityreports or analyst/investor briefings.

Whilst not all information presentedthrough these other media will be entirelyrelevant for the OFR, the presentation of a broader information set may provideDirectors with an opportunity for a review of their wider reporting andcommunication strategy.

The content in these other media used to communicate with a wider group ofstakeholders may need to be reassessedfor on-going relevance, in the light of theOFR. Where information reported in theOFR continues to be presented throughother channels there will be a need toensure overall consistency of message.

Structure and coherence

Have you considered the impact of theOFR on the overall structure and contentof your annual report?

Current reporting of strategy is notsomething many companies typically dowell. When reporting is extended to anexplanation of all the risks, resources and relationships that are critical to thesuccessful implementation of businessstrategies and achievement of statedgoals and objectives, there are even fewerexamples of good practice.

The information required by the OFRchallenges the traditional structure of anannual report. At present most annualreports focus on reviewing historicalfinancial performance within their OFR,and cover information on strategy, andthe risks, resources and relationshipsnecessary to successfully implement thestrategy in varying degrees of detailelsewhere, such as in the Chairman/CEO

statement. Much of this information,however, will now fall under therequirements of the OFR.

Directors will therefore have to considerhow transparent they wish to be and what format the front of their annual report takes. Do the Chairman and CEOcontinue to produce their statementsseparately from the OFR, potentiallyleading to excessive repetition, or will the whole of the front end of the annualreport, excluding the remuneration andcorporate governance reports, becomeknown as an OFR?

“If you can’t positively respond to the OFRregulations, you don’t deserve to be in business”FTSE 100 Non-executive Director

12


What should companies be doing now?

10 keystepsto a successfulimplementation of the regulations

13


1

2

3

4

5

6

7

8

9

10

Adopt the right mindset

Obtain Board sponsorship and buy-in

Develop a picture of possible content

Build a blueprint report

Benchmark the blueprint

Identify the information gaps

Assess adequacy of supporting systems and procedures

Determine the level of accuracy and reliability

Create cohesion and clarity

Develop an implementation plan

14


As with any regulatory change, there is a temptation to wait until the OFR is upon usbefore responding. The challenges, risks and benefits outlined earlier should persuadecompanies that delaying their response could well be a serious error – not least becausethe OFR involves not just the way information is reported, but its reliability and the qualityof the processes and controls supporting it.

Set out below are 10 key steps that Directors may practically undertake over the comingmonths to successfully implement the OFR regulations while avoiding the pitfalls.

The first step lies in adopting what wehave termed an ‘OFR mindset’ – one thatis quite distinct from the compliance-based approach usually taken withtraditional financial reporting.

The OFR mindset has three majorcomponents. It involves seeking out,ensuring there is sufficient comfort over the reliability of, and reporting information that is:

• seen through the eyes of the Board of Directors

• focused on matters that are important for investors

• forward-looking in its implications forthe business

This approach, when applied consistentlyacross all areas of the business, willenable companies to produce an OFRthat fulfils the fundamental requirements.

Companies will also need to consider the degree to which they respond to theOFR regulations. Will they be a leader, a follower, or simply take the middleground? Given the risks and benefitshighlighted earlier this is not a decisionwhich should be taken lightly. The answerwill not negate the need to follow thesteps set out below, but it will impact thedegree to which they are followed.

Meeting the requirements of the OFRneeds to be treated as a project in itsown right, with sponsorship from amember of the Board and ownershipclearly taken by the Board or a Boardsub-committee. Whoever takesresponsibility will need to oversee a planned and transparent process.

A first step should be to nominate anindividual with responsibility forunderstanding the implications of thenew regulations and for coordinating theOFR’s development. This individualshould then brief the Board on what theimplications are for their company.

It will also be important at this stage toidentify the relevant “information owners”who may be required to contribute to the OFR. Some individuals may not havecontributed to the OFR, or workedtogether, before, some may havealternative agendas. It is thereforeimportant that this individual should be of sufficient authority to manage thevariety of influences and personalitieswhich may exist among the contributors.

The breadth of the OFR will also require a new approach at Board level if anintegrated response to issues is to begenerated. Directors will need to access a broad range of skills and knowledge inorder to filter and challenge every item ofinformation, not just for its accuracy, butalso for its relevance to their owndecision-making and value creation. At the outset, the Board should determinewhether they have the appropriate skillset, or whether they will need to obtain it from elsewhere (e.g. cross-functionaladvisory panels or external parties).

It is critical at this stage that Directorsdebate and agree what it is they aretrying to achieve, their expectations forthe OFR, their level of ambition and howtransparent they wish to be. Furthermorethey need to express their views on theimportance and relevance of information,financial and non-financial, up front so asto avoid wasted time and effort.

1 Adopt the right mindset

2Obtain Board sponsorship and buy-in

15


3Develop a picture of possible content

Having formed a view on the level ofambition, Directors should apply RS1’sdisclosure framework (see Exhibit 1, onpage 5) as a basis for developing a broadpicture of possible content for the OFR.However, it will need to be tailored toreflect the unique dynamics of thecompany’s industry and business. A number of sources of informationinternally may be applied in building thisbroad picture, including the corporate riskmatrix, stakeholder surveys, monthlyBoard reports, analyst presentations andcorporate responsibility report.

Having created this picture, it may benecessary to question again whether theright individuals are involved in thedevelopment of the OFR.

Having built a skeletal picture of theinformation which may be included withinan OFR, the next step is to calibrate thecontent by applying a strategy filter todetermine what information is critical toassess the existing strategy and thepotential for that strategy to succeed.This filtered picture should then act asthe blueprint against which the content of the OFR being developed should beconstantly compared and challenged.

The blueprint should not be a static tool,but something which can be flexed toaccommodate changes in companies’circumstances and developments in theavailability of internal information.

4 Build a blueprint report

The blueprint should now be comparedagainst the information currently reportedexternally. In performing such acomparison Directors should take intoaccount all mediums of communicationused to report information internally andexternally, including web site, corporateresponsibility report, investor/analystbriefings and marketing publications.

In building up a comprehensive picture of current reporting, consideration shouldalso be given to assessing wherecompanies stand in relation to

competitors, industry norms and goodpractice (see Exhibit 2 on page 10) andthe extent to which they wish to alignthemselves with these benchmarks.

Directors may also find it beneficial tochallenge the contents of the blueprintagainst an objective reporting framework,such as Kaplan and Norton’s BalancedScorecard or PricewaterhouseCoopersindustry-tailored ValueReportingframework (see Exhibit 3 on page 18), for completeness.

5 Benchmark the blueprint

Once the blueprint has been developed,an assessment of the supporting systemsand procedures should be undertaken to determine whether they can providethe relevant information and whether it is sufficiently robust to achieve Boardcomfort and publish externally. A usefulfirst step is to start at the top of theorganisation and consider the scope, and nature, of the information beingpresented to the Board in routinemeetings, and the degree of process,control and assurance applied to it in its journey up the organisation.

Where this analysis highlightsshortcomings consideration should begiven to the actions which are necessaryto remedy the situation, ranging fromrethinking the Board agenda, toestablishing robust and reliable systemsand controls.

Questions which Directors may like to consider include:

• Is standard group-wide informationavailable?

• What degree of segmental informationwill have to be provided to make thedata meaningful?

• Are systems in place to gatherfinancial and non-financial information?

• Are there appropriate KPIs and othermeasures to support all strategicdrivers and are they consistentlycalculated?

• Is both qualitative and quantitativeinformation available and is itsufficiently developed?

• Is there sufficient transparency in areas of judgement?

• Who is routinely challenging andvetting the information?

7Assess adequacy ofsupporting systems and procedures

16


An output from the benchmarkingexercise should be an analysis of the gapsbetween current reporting, competitorsand the information set required for theOFR. Some gaps may simply point toinformation which is available, but notreported. Other gaps may relate to more fundamental issues such as dataquality, or where information is simply not produced within the existing systems

or consistently across business units.This is considered further below.

Creating a gap analysis will be veryrevealing and should provide the basis for developing an implementation plan for both the short and the medium term.It is critically important to remember the development of the OFR is anevolutionary process, not one ofimmediate revolution.

6 Identify the information gaps

17


The introduction of the OFR provides areal opportunity for Directors to considerwhat impact it will have on the existingstructure of the annual report. Will thehistorical format used allow for theeffective communication of thecompany’s strategy, management activityand performance? Or will it simply resultin excessive repetition, increased lengthand an unclear story?

Two extremes which Directors mightconsider are:

• use the traditional format ofChairman’s/CEO statement andfinancial review but wrap the wholefront end of the report under theumbrella of the OFR

• radically restructure the front end ofthe report around a logical frameworkwhich helps to tell a coherent andclear story

Each has their pros and cons, but RS1cannot provide any guidance on whatformat is most appropriate. We stronglybelieve, however, that the report shouldbe personalised and that this can beachieved without necessarily followingthe traditional model. The approach takenwill ultimately depend on the culture ofeach company, the depth and breadth ofinformation available and above all, theleadership provided by the Board.

9 Create cohesion and clarity

Directors must determine the level ofaccuracy and reliability they wish toachieve for the information to be includedwithin the OFR. This may vary dependingon the strategic importance, nature, or source of the different informationprovided. In forming a view, Directorsmust balance the risk of publishingvaluable information, which may bedifficult to obtain with complete accuracy,with remaining silent.

Factors to consider include:

• whether the data is routinely used in the management of the businessand is subject to sufficient challengeand validation

• whether a greater level of assurance is required for non-system generatedinformation/data (e.g. spreadsheets or stand-alone analyses)

• whether external sources of data canbe used and referred to, to support theoverall picture of performance

• the degree to which some informationnecessitates the involvement ofinternal audit or independent thirdparty assurance

In reaching a decision it will also beimportant to consider the margin of errorDirectors are willing to accept and towhat extent that might differ dependingon the nature of the information reported.

8Determine the level ofaccuracy and reliability

18


Market Overview

• Competitive environment• Macro-environment• Regulatory environment

Strategy & Structure

• Goals and objectives• Organisational design• Governance• Risk framework

Managing for Value

• Physical assets• Financial assets• Customers• People• Innovation• Brands and • Intellectual capital• Supply chain

Performance

• Economic• Operating• Environmental, Social

and Ethical• Segmental

Exhibit 3: The ValueReportingTM Framework

Our ongoing global industry research with more than 3,000 CFOs, investorsand analysts focuses on determiningwhat information is of particular valuein managing an entity (management’sview) and assessing an entity forinvestment purposes (investors view).

This research has highlighted that thesetwo seemingly disparate requirementscan be largely addressed using a singleinformation set. We have codified thesefindings into the four building blocks ofthe ValueReporting framework shownbelow. The first category of informationinvestors need is an analysis of theeconomic and competitive landscapeof the company, followed by anarticulation of the strategy and structurerequired to compete within this

landscape. Next comes thecompetencies, relationships andresources that will enable the companyto achieve its strategy. Last but not leastare the financial and non-financialoutcomes of their corporate activity.

Here we present a generic framework,but in reality it can be tailored to reflectthe findings from each of our globalindustry surveys. By applying theframework, directors will be able toaddress the critical components of theOFR and meet the information needsof its primary audience. Its logicalstructure can assist directors inproviding a clear link between businessobjectives and strategy, the criticalcomponents of performance that willaffect whether these strategies succeed

and shareholders’ understanding ofbusiness risk and how value is created.

Furthermore the focus of the OFR shouldbe on the quality, not quantity, ofinformation. By placing strategy at theheart of the OFR, Directors shouldidentify only those risks and resourcescritical to understanding its executionand potential to succeed. Applying aframework tailored to meet the keyinformation needs of Directors andshareholders in a given industry, means companies avoid falling into the trap of the ‘checklist’ approach to developing content, which usuallyresults in reporting excessive and often unnecessary information.

Following steps 1 to 9, Directors will be ina position to develop a short/medium-term implementation plan to address thegaps identified and deliver on their overallobjective for the OFR.

For information that is currentlyunavailable Directors need to considerwhether to seek to obtain the informationand, if so, to provide disclosure of theirintent to report on these matters in futurereporting cycles.

For information that is available, but notsufficiently robust and comparable topublish, Directors must determine howthey obtain the appropriate level ofcomfort on the reliability of theinformation. This may range from thedevelopment of new internal controls andprocesses to independent verification.

10Develop an implementationplan

19

Process of evolution, not revolution

The challenge should not beunderestimated

The OFR regulations apply for financialyears beginning on, or after, 1 April 2005,yet ultimately, the breadth and depth ofreporting in the OFR cannot change overnight. The development of an OFR shouldtherefore be seen as a process ofevolution, not revolution.

However, the challenge to somecompanies should not be underestimated.Information may need to be captured and its reliability challenged. Or, ifinformation does not exist, reportingsystems may need to be enhanced. It istherefore important that companies preparethemselves for the new regulations now,even if it is deemed inappropriate tocommunicate the information externallyuntil it is mandatory to do so.

Critically, information should not bereported unless it is used to routinelymanage the business. Directors shouldalso constantly reassess the nature andscope of what is being reported againsttheir blueprint, the actions of theircompetitors and other externaldevelopments. There will be an expectationthat the information provided in the OFRwill need to be consistent over time. Yet the content of the OFR cannot remainstatic as information needs will shift as a result of changes in the business, itsstrategy and risk profile, and the overallmarket environment in which it operates.

The OFR is coming; there is no time to lose. The soonercompanies start to prepare for it, the better positionedthey will be to avoid the possible pitfalls (e.g. competitorpressure, regulatory challenges, unreliable andincomplete data) – and reap the potential benefits (e.g. competitive advantage, improved boardeffectiveness, enhanced investor understanding).

Recognition that change will not happen overnight


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OFR strategyDavid [email protected] 804 5055

Environmental, social and community issuesGeoff [email protected] 213 4378

People measurement and reportingRichard [email protected] 842511

OFR process, internal management systems and proceduresDavid [email protected] 804 2911

Assurance of non-financial dataPaul [email protected] 213 3789

ContactsSpecialist support for the Operating and Financial Review and their areasof expertise


Set out below is a list of individuals who can help you to beginto consider the implications of the new OFR regulations, bothinternally and externally, and how you might address them. In particular they have specific expertise around the followingareas critical to the OFR:

© 2005 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP (a limited liability partnership in the UnitedKingdom) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.Designed by studio ec4 17242 (02/05).

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