Financial disclosures are information that companies share with stakeholders, investors, regulatory bodies, and the capital market to remain transparent and compliant.
Most publicly listed companies publish and share their financial disclosures as a part of their financial management practices and because of statutory and regulatory requirements. Even companies not governed by regulations share their financial disclosures as a best practice to ensure transparency and investor trust.
Financial disclosures help put financial statements and performance in perspective, and the two criteria to decide the relevance of information are materiality and impact.
Financial disclosures can be mandatory or voluntary. Financial disclosures that are statutory requirements like income statements, balance sheets, cash flow statements, notes to financial statements and auditor reports fall under mandatory disclosures.
Many companies provide information over and above their mandatory disclosures that contain non-financial information like ethical, social, and environmental impacts and initiatives of a business that have materiality and relevance to investors. This information falls under the category of voluntary financial disclosures. Companies choose to disclose this information to alleviate investor uncertainty regarding the company’s future and performance. It further helps the company lower the cost of raising capital.
Types of Financial Disclosures
The typical parts of mandatory financial disclosure are the financial statements, annual reports, 10-K, and 10-Q reports. However, other components of financial disclosure should find a place in the final document to meet regulatory requirements and provide more granular information to the stakeholders. These components of financial disclosure cannot be excluded from the discussion. This list is not comprehensive but covers some important additional information that should be in financial disclosure.
Accounting Changes – Any accounting changes can make the financial statement of a company read differently. Therefore, changes such as modifications in inventory valuation, depreciation methods, or application of GAAP are important disclosures that have both materiality and impact.
Errors in Accounting – For the longest time, financial statements and disclosures were prepared manually which inadvertently led to inaccuracies and errors. Some common lapses happened due to inaccurate transposition, mathematical computation, incorrect application of GAAP, or failure to revalue assets using fair market value.
However, these inaccuracies can be corrected by a process called “adjustment” or “revision” of prior-period financial statements. If financial statements are restated for error corrections, disclosures must include details about the cause of the error, the process of discovery, and other direct and indirect impacts of the error.
For specific errors, an explanatory paragraph may be required within the auditor’s report with additional details about the restatement.
Asset Retirement – Over time, companies accumulate a variety of assets. However, some of these assets may no longer provide any benefits in the present or future and must be retired. However, the asset retirement process should ensure that the company receives fair market value and salvage value for the asset. Any losses incurred in this process should be shared in financial disclosures.
Changes in Insurance Contracts – Any current or future implications of the changes in insurance contracts and the reason for those changes are important information that should be explained in the disclosures as it impacts the balance sheet.
Management Discussion and analysis (MD&A) – This section in the disclosure document provides an overview of business operations, financial trends, future projects, compliance risks, and management opinion on the company’s performance. Aimed at investors, this section helps them understand the management’s perspective and the way forward.
Proxy statements – Proxy statements contain information for shareholders that can help them make an informed decision about issues of strategic importance to be addressed in an upcoming shareholder meeting.
Public listed companies need to file proxy statements with SEC that contain information like the addition of new board members, executive compensation, and material expenses. It also discusses conflicts of interest, if any, between the company and the board of directors and executives.
Insider trading reports – When a publicly traded company’s officers, directors, and notable shareholders buy or sell company stocks, the SEC requires them to disclose such information. It helps assess the company’s financial health accurately and is a part of financial disclosures.
Debt, going concern criteria, accounts, contingent liabilities, or contextual information explaining the financial numbers come under Notes to the financial statement.
In the next section, we will discuss the importance of effective disclosure management.
Importance of Effective Disclosure Management
Effective disclosure management requires proper planning and extensive groundwork, especially for big organizations that operate in several jurisdictions and are regulated by several regulatory authorities and compliance mandates.
And disclosures are mighty important for organizations.
Meeting Compliance – One of the foremost importance of effective disclosure management is to meet the statutory and regulatory compliance mandates. Most regulatory authorities across geographies require companies operating in their capital markets to abide by disclosure regulations ensuring the protection of investors’ interests and maintaining market stability. Financial intermediaries like banks use the information to effectively allocate debt capital and to ensure capital markets function optimally.
Companies need to ensure that they closely follow the regulations applicable to their jurisdiction and remain aware of any updates or changes in the financial disclosure-related mandates and update their reports accordingly in a time-sensitive manner to avoid non-compliance.
Transparency and Accountability for Enhanced Investor Trust – Organizations that strive for accuracy and integrality of financial information enjoy trustworthy and healthy relationships with their investors.
As discussed above, several organizations opt for voluntary financial disclosures that contain additional information relevant to their shareholders that provides them with vital information to make informed investment choices.
Providing additional information is a step toward ensuring the integrality or completeness of financial information. That, along with accuracy, contributes to credibility and market trust, crucial for business continuity. Effective financial disclosures will have information that will not be a glossy fairy tale of all wins but should contain well-rounded information, even about areas where the business can do better.
Disclosing an accurate and complete picture of a company’s financial health helps investors understand financial information from an enhanced perspective while factoring in external changes. For example, when the coronavirus hit, Apple was upfront about announcing that its revenue numbers may get impacted due to supply chain disruption from China.
Disclosures like the example above are critical and help investors assess the risk and ROI. As disclosures are expanding in scope to include ESG, climate, and GHG-related disclosures, investors will need access to even more granular information from businesses related to impact, risks, and opportunities.
Effective disclosure management also has clear audit trails and accountability information that further helps infuse trust in disclosures shared with investors.
Effective Risk Management – Effective disclosure management practices help organizations as well by improving their awareness of their strengths, weaknesses, opportunities, and threat with better risk assessment and management. Disclosures can help organizations get proactive about the potential and identified risks like debt levels, contingent liabilities, and other financial obligations.
Establish Credibility and Augment Reputation – Organizations with established disclosure management systems and processes are viewed as credible by investors and regulators as it assures them that the financial information, they receive is accurate and transparent and meets their requirements.
It also helps the companies when they try to attract new shareholders and create sustained demands for shares in a liquid market.
5 Key Strategies for Effective Disclosure Management
The above section discussed the relevance of effective disclosure management. The obvious progression of that discussion will lead to strategies that can ensure effective disclosures and efficient disclosure management.
Businesses today have entered the era of digitalization and like most business processes, even financial reporting has taken the digital route. The technological innovations addressing the challenges encountered by the finance and accounts team to manage the financial reporting process have improved the accuracy and efficacy of disclosures by reducing human errors and reporting time cycles. Also, the advanced analytical capabilities of disclosure management solutions have made financial information tangible business intelligence assets that can contribute to developing and shaping the strategic business goals in an organization.
This section of the blog explores strategies that contribute to effective disclosure management practices.
Centralized Document Repository
A centralized documents repository can streamline the first step of your disclosure management process. The data in a digitalized organization are in high volumes with high velocity. In addition, financial documents containing the relevant data sets are created and worked upon by several members of the team. A central document repository with managed access ensures document control and that everyone accesses the most recent version of the documents.
A CDR makes collaboration simple for the teams and ensures documents are not lost or misplaced.
A few best practices to consider include a clear naming convention for document identification, version control, and regular review and audit to ensure documents remain organized and up to date.
Role-based access to ensure only relevant people have access to a specific document, a two-factor notification with a strong password, encryption for sensitive documents, and regular monitoring for unauthorized access attempts are a few other best practices to consider.
Automation of Disclosure Processes
Before technological inventions, financial reporting was a manual process with several human interfaces that led to errors and inaccuracies in financial statements. In addition, several iterations of a single document existed without version control, making it impossible to identify which version contained the most recent updates.
Automation addresses all the challenges while streamlining the disclosure management process by ensuring consistency and accuracy with reduced cost and accelerated disclosures for timely regulatory filings.
Businesses need to ensure that automated solutions have features aligned to their unique business needs with a simple learning curve and are flexible and scalable to meet growing business requirements. Legacy integration is another important aspect that eases the path for end users and ensures a healthy data pool for better financial planning and analysis.
Standardization of Disclosure Templates
Standardization of any process ensures consistency and accuracy, and disclosure management is no different. Along with disclosure policies organizations may consider introducing disclosure templates to ensure consistency across departments and reporting periods. Standard templates ensure ease of use and less confusion regarding the disclosure expectations not to mention far less time taken to prepare disclosure.
Standard templates can also preserve the integrality or completeness of financial information discussed above, which is important to maintain transparency in financial disclosures.
templates can help organizations ensure they cover all aspects of disclosures they need to meet to comply with regulatory mandates in their respective jurisdiction.
And finally, standardization increases transparency and accountability with clear audit trails.
A few best practices to consider are to ensure standardization through templates is creating templates customized to individual organizational needs with regulatory compliances and materiality of information in consideration. The templates should also adhere to the internal disclosure policies of the organization and the audiences for which the disclosures are intended for. Regular audits and monitoring for continuous improvement to enhance the relevance of the document is another good practice to incorporate.
Finally, the templates should be accessible and readable across various platforms and devices.
Standardization helps bring in the Kaizen approach to disclosure management which helps improve the process by continuously monitoring and identifying areas of improvement. Along with standardization, cross-functional collaboration, process optimization through automation and training, and education and training can all bring the Kaizen approach to disclosure management.
Risk-Based Approach to Disclosures
It is only fair that investors, market regulating bodies, and stakeholders have a clear picture regarding the risks associated with the business. Most regulatory compliance mandates have mandatory risk-related disclosure requirements for the same reason.
From the organizational perspective, risk-based financial disclosures provide an opportunity to evaluate and assess the risk exposure that may have an immediate or long-term impact on business performance and continuity. For investors, it helps them gauge the ROI and understand the risk appetite and risk management capabilities of the business.
Risk-related disclosures, however, need to be treated carefully by striking a correct balance between transparency and protecting critical and sensitive information.
Assessing and prioritizing risks begins with identifying potential risks associated with disclosing a piece of information that may include aspects like regulatory compliance, financial impact, impact on reputation, and even investor relationships.
The next step is to assess the risk tolerance and the extent of risk a business is willing to expose itself to achieve its goals. Only now businesses will have a clear understanding and prioritize risks based on intensity and impact.
Internally, organizations can develop a healthy risk management program based on the above information and decide what needs to be a part of financial disclosures.
Some of the best practices to consider include putting a risk management framework with regular risk monitoring and assessment and awareness regarding external and internal factors that might impact an organization’s risk exposure.
Continuous risk monitoring with defined key performance indicators to track and assess risks is another best practice.
Another step that organizations should consider is fostering a culture of risk management by introducing policies and procedures, sufficient training and awareness programs, and encouraging dialogue regarding efficient risk management.
Collaboration and Communication
Disclosure management requires cross-functional teams like audit, legal, finance, and accounts to collaborate on disclosures. Collaboration ensures the accuracy and effectiveness of the financial disclosures and as discussed above, is an important challenge addressed by the automation tools. To ensure effective collaboration, tools like CDR, collaborative tools, and disclosure management solutions allow collaborative workflows to become important.
Establishing channels of communication beyond workflows and spreadsheets with established disclosure-related policies, regular meetings and frequent knowledge-sharing sessions are other best practices.
Disclosure Management is an integral part of financial planning and even analysis as it is insightful for both the external stakeholders like investors and regulatory bodies and for the organizations helping them assess their financial health through numbers, risk exposure, and the impact of internal and external factors. Businesses that opt for voluntary disclosures enjoy better reputations, trust, and investor relations. The way forward for disclosure management is surely moving toward more comprehensive and extensive disclosures related to non-financial aspects of the business.
To ensure the effectiveness of the disclosure management process standardization, automation, CDR, communication and collaboration, and adopting the Kaizen approach to disclosure management are some best strategies and practices.