CorpComms Magazine

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held view that there is little reason to be bothered about producing a good annual report is about to become even more outdated.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

Design agency Merchant's report on FTSE 500 annuals is even more scathing. Using a scale of 1 to 5, Merchant reported that only 12 percent of companies scored above 3 (satisfactory) for reporting, while 86 scored 0 (waste of paper).

Merchant further concluded that, when it came to demonstrating the skills of senior management, 323 of the 500 reports were a 'waste of paper'. This was also true of 364 reports in terms of reporting on relationships with suppliers, and 287 when reporting on relationships with customers. Overall, 340 were ranked either 'waste of paper' or 'statutory/zero value added' for reporting on human resources.

Even more alarmingly, Merchant ranked 127 reports a 'waste of paper' and only six as 'inspired' for risk reporting, while labelling 243 a 'waste of paper' and only six as 'inspired' for governance reporting.

Size matters

Robert Moser, managing partner at Merchant, says: 'Very few companies out there are doing good reports. The biggest change is that books have grown much bigger. The average report now for a FTSE 100 company is 140 pages, but just being long doesn't make it good - in many cases it is just dumping data, like a telephone directory.'

Anyone still unconvinced by the need for a good annual should pay close attention, as Merchant has established a link between those companies that produce excellent reports and those that experience high shareholder return.

Shareholder return among the best communicators of strategy is 24 percent on average, according to Merchant. Shareholder return among the best communicators of market opportunities is 18 percent. Average shareholder return in the FTSE 100 is only 13 percent.

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.

As Moser points out: 'All this is not actually about the annual report - it is about the attitude of the company. If you are good at annual reports, you are probably good at articulating your strategy to investors. If people understand your business, they will be better able to put a value on it.'

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.

Excuses, excuses

The reasons that companies use for not investing effort in their annual reports are many and varied, and all can be easily knocked down.

Excuse: They don't want to disclose information about their management because their people could be poached by competitors. Answer: 'Their competitors already know who their senior managers are,' says Moser. 'If they aren't treating these employees well enough to retain them, that's the real problem that needs to be addressed.'

Excuse: They don't want to disclose forward-looking information about their business that competitors might use. Answer: 'Most of the information is available in the public domain already,' says Thwaites.

Excuse: Nobody really reads the annual report, so why bother? Answer: 'That is a failure to understand how long-term some investors are,' says Thwaites. 'We recently did a study of analyst presentations and found that if a company mentioned marketing metrics, for example, then analysts would ask questions about that. If not, they wouldn't bother. Analysts are interested; they just don't expect companies to give them the information.'

This last point is particularly important when you take into consideration the new duty of care that directors have to all sets of shareholders.

Going private

While institutional investors enjoy access to detailed analyst briefings, private investors have no such luxury. So getting the annual report right - and particularly its narrative reporting - is now essential. If you are providing high-quality information to your institutional investors, you must provide at least the same to your private investors in a format they can easily understand.

Banking group HBOS has a very high number of private investors - currently 2.2 mn. These have mostly been inherited from the demutualisation of Halifax Building Society, in which 8 mn people received windfall shares.

HBOS has seen the light on this score, and the group won the IR magazine award for best narrative reporting this year, as judged by the IPA's panel. The main reason for HBOS's award, says Thwaites, was the group's ability 'to engage with the idea of using the annual report as a communications tool, rather than just taking a tick-box approach.'

Understanding that the annual report must serve more than one purpose is also key. In a written account of HBOS's approach to narrative reporting, investor relations manager Lauren Hendry says: 'For existing investors and observers in the City, it is an indispensable reference guide. For potential investors, it's a job application and CV. For colleagues, it's another tool in their fact-finding repertoire about their business and the contribution they make to its success.'

From the outset, therefore, HBOS's efforts were geared towards the creation of clear and comprehensive narrative reporting with the objective of producing a document that was easily accessible to all of the group's major stakeholder groups. 'The requirements really did make us focus on the business harder than ever before,' says Hendry.

Shane O'Riordain, head of communications at HBOS, says this is the reason it is so important to take narrative reporting seriously. 'It is a good exercise for us, as it focuses the mind,' he says. 'We try to set out the business story with some character, with examples from brands, product launches and so on. We deliberately use photographs of colleagues throughout. We are very much a people business, and you see that in all our communications - our advertising as well. We try and put a human face on the business.'

HBOS also makes ample use of visual aids such as graphs, drop-down boxes and illustrations.

Hire thinking

Another group that produces a particularly good annual report, according to Robert Moser, is tool-hire business Speedy Hire. One strength is its market report, which demonstrates Speedy Hire's good grasp of its own business and the wider market in which it operates.

'Speedy Hire employs a specialist writer to draft the market report on the tool-hire industry each year,' says Moser. 'If you have a leading expert to write this report, you are communicating to your investors that you know your market. It also makes your annual report the first port of call for people who want to find out more about the market.'

Speedy Hire is very open about its management, with pictures, CVs and a table showing how long they have worked in the industry, for the company and in other roles.

The group's risk reporting is equally clear, with identified risks plotted on a graph showing the likelihood of each risk becoming a problem versus the impact on the business if it does. Each identified risk is then allocated to a board member, who writes a report about what the company is doing to manage it.

In the corporate governance section, Speedy Hire includes a checklist showing whether the company has managed to comply with each element and where investors can go to find the proof that it has complied.

'This shows very robust corporate reporting,' says Moser. 'The whole thing makes you, the investor, much more favourable towards the company.'

Mind your language

Another tip the experts give is to use everyday language. 'Why is it that only a handful of companies use everyday language in their annual reports?' asks Moser. 'Why do they insist on slipping into corporate-speak?'

Reports should 'be comprehensive and concise, and focus on issues that are material to the business', says Thwaites. This means selecting KPIs that really measure the success of your business.

'The annual report is a tool in the box,' comments Moser. In his opinion, if companies are reporting clearly and concisely about corporate governance, it means they have the structures in place to manage it. 'And the same goes for risk management strategies.'

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.

Moser suggests weaving the corporate responsibility report into the main business review. 'When done properly, corporate responsibility is an integral part of the business,' he says. 'If you are using energy-efficient light bulbs, you may be saving significant sums of money. If you are not polluting rivers, then you are not getting fined, and that is an investor issue.

It also helps to be seen as a good local employer, according to Moser. 'If a local mother is proud to say you are her son's employer, she may be less likely to object when you apply for planning permission,' he suggests. ' It makes good business sense to treat people with respect, and to communicate that.'

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

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