The widely held view that there is little reason to be bothered about producing a good annual report is about to become even more outdated.

New requirements about narrative reporting within annuals were laid out in last year’s Companies Act, and while businesses were allowed some breathing space this year, regulators will expect to see the new rules reflected in the forthcoming 2007 reports.

Three aspects of last year’s Companies Act stand out. Firstly, directors should try to ensure that all stakeholders are treated equally.

Secondly, businesses must include key performance indicators (KPIs) that represent a genuine measure of performance and are as forward-looking as possible. Thirdly, companies should list the main risks and uncertainties that they face.

While it’s clear that many companies are already working towards improving narrative reporting – which includes non-financial aspects of the business review such as management, human resources, strategy, KPIs, identified risks, social responsibility, sustainability and forward-looking information – many still have a long way to go.

First impressions

This year, the Institute of Practitioners in Advertising (IPA) convened a panel of judges to review narrative reporting in FTSE 350 annual reports. The findings were grim. 
‘Our judge who looked at risk assessment reporting was very unhappy with the quality,’ says Simon Thwaites, marketing executive at the IPA.

‘We also felt some of the environmental/sustainability reporting was excessively focused on issues that did not impact on the business in hand. For example, environmental record was the second-biggest group of non-financial KPIs in 2006 reports – 13 companies use CO2 emissions as a KPI. Are you seriously telling me that this is one of the five most important measures of whether your business is running well or not?’

Earlier this year, the Accounting Standards Board (ASB) completed its own review of narrative reporting by 23 of the companies listed on the FTSE 350. Its main findings were that businesses still had great difficulty providing forward- looking information, most likely due to a fear of being held to account if forecasts don’t come true, even though ‘safe harbour’ provisions in the 2006 Companies Act neutralise this risk. 

Size matters

Sallie Cooke Pilot, director of corporate reporting at design agency Black Sun, agrees that there is a correlation between good annual reporting and business success. ‘Increased transparency of narrative reporting actually leads to people running their businesses better,’ she says. ‘Doing a proper annual report means getting people from different departments round the table to agree what should go in. We have seen cases where people are meeting for the first time and have never even spoken to each other before. 

‘In one survey we did, 86 percent of respondents agreed that drawing clear lines between strategies and future goals helped to realise those goals,’ she adds.

Ian Mackintosh, chairman of the ASB, adds: ‘Narrative reporting is an increasingly important feature of corporate reports, providing an opportunity for directors to set out a clear and balanced analysis of the strategic position and direction of their business. We hope that more and more companies will regard good narrative reporting as a means by which they can achieve transparent and open communication with their shareholders.’ 

The new narrative reporting requirements in last year’s Companies Act are designed to nudge companies towards a firmer grasp of this point. While they stop short of prescribing the format that narrative reporting must take, they are aimed at encouraging greater transparency.

Mind your language

Be prepared to start from scratch, says Cooke Pilot. ‘Companies tend to take last year’s report and just add to it,’ she explains. ‘You need to take the opportunity to completely rethink the way it is written. I would first ask clients to outline what is happening in their market, then ask them to explain their strategy for tackling the market and their own business objectives. What risks are there that might keep them from attaining these goals, and what are they doing to mitigate them?’

Be balanced and neutral, advises Cooke Pilot: ‘Identify the business-critical issues. What are the things that will kill the business if they are not properly managed?’

Cooke Pilot adds that a good report should be forward-looking. ‘We are not demanding profit forecasts, but a description of the market environment,’ she explains. And she also recommends that companies ensure that the tone and clarity of their narrative reports match that of their other company literature. ‘We often find that a client’s marketing material articulates their strategy better than the annual report, does’ she says.

Finally, all experts recommend that companies use joined-up thinking. Thwaites suggests, for example, linking the risk report to strategy and objectives to make it more forward-looking and to show a willingness to tackle risks and uncertainties in the business assertively.

And what better place to do so than in the annual report? 

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