Over the past decade, it has become clear that non-financial factors determine the value creation of companies. But while companies are increasingly mapping and reporting their non-financial value drivers, they still overlook non-financial risks and their potential impact.
Non-financial issues determine companies’ value creation. Success or failure are determined by intangible factors: the power to innovate, the power of the brand, the reputation among customers.
However, the reverse is also true: non-financial factors can endanger value creation, corporate processes and the capacity to attract talent. Certainly now when, as a society, we are reaching our limits in a number of areas such as nitrogen emissions, climate change, access to water and social inequality.
Sustainability topics and financial risks are linked
Gaining a clear view of non-financial factors has become a matter of urgency. It has now become clear that the external factors that play a role in the long term can pose a financial risk in an increasingly shorter term.
- In the last six months alone we’ve been faced with a pandemic, anti-racism protests, and water scarcity in the Netherlands is becoming a significant concern. If companies fail to take action to mitigate such risks, their top and bottom lines will be directly impacted.
- But long-term risks are also a substantial threat if a company fails to transition swiftly or in a timely fashion. Here, the investment and financing horizon is vital. A company that invests in a product or asset over a period of 20 years must factor in potential changes throughout those 20 years.
The link between ‘sustainability topics’ and the financial risks is also highlighted by the Global Risks Report of the World Economic Forum. Ten years ago, not a single environmental issue and only one social issue (chronic disease) numbered among the top five. But in 2020, with the exception of weapons of mass destruction, the top 5 consists solely of environmental and social risks.
The stress test
In the longer term, many material topics can have an impact on a company. This is why we analysed the annual reports (financial year 2019) of the 25 AEX companies that included a total of 450 risks. To see whether the companies have a clear view of their risks, we analysed whether the risks could pose problems in the short and long term, whether the risks were well prioritised, and also looked at the extent to which the threats were specifically described. Download the full report.
Dutch companies don’t have sufficient view of non-financial risks
The good news is that, to a certain extent, all Dutch companies are ‘doing something’ to tackle non-financial risk issues in the longer term. The bad news is that there are still plenty of improvements to make. A summary:
- Companies aren’t sufficiently specific in their risk reporting
- Companies limit themselves too much to short-term risks
- Companies don’t sufficiently link risks with the material topics
- Companies don’t clearly prioritise risks in terms of importance and time
Two vital recommendations
Given their potentially catastrophic impact on business operations, it’s vital that companies gain clearer insights into non-financial threats in the short, medium and long term:
- Make the connection between long-term developments and financial risks for the company and define and show the risks broken down into short, medium and long term.
- Long-term risks are more complex to estimate than short-term risks. For the long term, focus on impact rather than opportunity and think in scenarios. What would happen to the company’s financial value if a particular trend or incident actually happened?
For example: how might the company’s value be affected if global warming is limited to 1.5 degrees compared to how it might be affected when the earth warms by another 4 degrees or more. This way, by giving a name to the uncertainty associated with the risk, you can shed light on the possible impact of, in this case, climate change.
- Integrate defining materiality and risk management in a single process using the ‘double materiality’ approach and describe them in the report in one chapter.
White paper – Prioritise your non-financial values
Do you have a clear picture of the factors that really determine your company’s total value? The figures in your annual reporting are important but they don’t show the full picture. To a large extent, your company’s financial value is also determined by non-financials. By integrating these into your management strategy, you create added value for your company’s success.
Over time, companies can lose focus of their ultimate goal; this white paper offers tips and strategies to sharpen that focus and to determine, prioritise and include non-financial values in your reporting and risk assessment. With this, you’ll be able to manage your company more effectively and steer a better course which will probably make your company more financially successful. And above all, you’ll ensure that investors are better informed.