The Meaning of Financial Disclosures
Financial Disclosure is the process of making a company’s financial information like balance sheets, income statements, and cash flow statements, available to a diverse group of stakeholders such as shareholders, investors, and regulatory agencies. In addition, a disclosure also contains information regarding the company’s operations, assets and liabilities, and even future goals and plans. Financial disclosures help companies build credibility and a positive reputation and maintain a healthy relationship with their investors by providing them with the needed material information.
Lack of transparency and accountability in the capital markets have been the root cause of most of the financial crises the world has faced.
Financial disclosures are tools to ensure transparency and accountability in the market hence are required by all the leading regulatory bodies (SEC, ESMA, Companies House UK, amongst others) and across geographies.
Financial disclosures are of two kinds – Voluntary and Mandatory.
Mandatory disclosures are required by law, while voluntary disclosures are information shared by an organization that is over and beyond required disclosures but could be relevant to those who use financial reports. Voluntary disclosures may include information like sustainability reports, corporate social responsibility reports, and other disclosures that provide additional insight into the finances and operations of a business.
But is there a need to disclose what is not required?
Companies that choose voluntary disclosures enjoy better reputations and stakeholder trust. It also helps to put their financial performance in perspective for the investors whenever there is a deviation from the usual and increases trust and transparency.
Investors seek companies that are transparent and inclined toward sharing information than disclosing the bare minimum required by the law. Companies that opt for voluntary disclosures also project themselves as attractive investment opportunities.
Voluntary Disclosures are also a source of insight for businesses regarding risk assessment as they provide an opportunity to identify potential risks and create mitigation plans.
Let’s take a closer look at understanding the purpose and importance of financial disclosures.
Purpose and Importance of Financial Disclosures
Financial disclosures allow investors and analysts to access critical information regarding the financial health of a company and aid them in making informed decisions.
Financial disclosures contain all the information about a company down-to facts, figures, data, procedures, new products, technological innovation, senior leadership changes, and everything that is material for a company and relevant to all the stakeholders.
For investors, such detailed information paints a clear picture regarding the financial situation of a business and aids them in making informed investment decisions.
Regulators use the information to ensure that the business is adhering to all the statutory and regulatory requirements applicable to it.
In addition to the compliance aspect, financial disclosures also help regulators in monitoring and detecting fraud. Detailed financial disclosures allow regulators to identify irregularities or potential risks related to fraud and misrepresentation.
Regulators use the information provided in the disclosure to create and improve upon the existing regulations for enhancing investor protection, ensuring market stability, and also ensuring that the businesses care about the non-financial aspects too. The proposed ESG disclosures, climate-related risks, and GHG emissions disclosures are all a step in the direction of making businesses more responsive and responsible.
For the market, financial disclosures ensure that market participants have access to accurate and reliable information about a company’s financial performance and position. It promotes market efficiency by allowing capital to flow to the most efficient and profitable investments.
Another benefit that the market gets from financial disclosures is price discovery. It is important to ascertain that a company’s securities reflect the authentic underlying value and allows fair comparison.
As we saw above that regulators use financial disclosures to ensure regulatory compliance. Regulatory compliance supports and maintains market integrity. It helps prevent fraud, and manipulations and ensures that the market operates fairly and transparently.
Accurate, timely, and relevant information in the form of disclosures builds investors’ confidence and trust. It provides stability to the market and alleviates panic and risk anticipation.
So, financial disclosures are relevant for a diverse set of stakeholders, and companies can use financial disclosure reports to assess their financial situation and risks better with data-backed insights.
Financial Disclosures in The Digital Age
The digitalization of businesses has made data the most important asset that can be capitalized and used for insights. Data-based insights can impact long-term business performance and goals, and among all the data, financial data remains critical that now comes integrated from multiple sources.
The digitalization of businesses has made data the most important asset that can be capitalized and used for insights. Financial data in the digital age remains critical and now comes integrated from multiple sources. Therefore, financial disclosures have become far more expansive and complex.
Recent trends in financial reporting in the digital era indicate a shift toward automated, multi-sourced, and diverse data.
Financial Reporting in Digital Era
Automation and Digitization – As we discussed before, data has become an asset for businesses but for a long time the latent potential of the business and financial data remained unexplored and undervalued. Technology-based solutions brought about several improvements and made it possible to automate and digitize the processes involved in financial reporting, such as data collection, analysis, and dissemination. Automation also made authoring and publishing financial disclosures more efficient, cost-effective, and accurate as teams could collaborate on platforms to ensure data sanctity at all times.
Improved Data Analytics – Another benefit of technology and automation was the capability to enter into the data jungle and come up with actionable insights. Processing and analyzing a large amount of data became cheap, easy, and real-time. It meant richer insights for the businesses and a completer and more accurate picture of a company’s financial performance and position for the investors and regulators.
Real-time Reporting – In a rapidly evolving business environment, financial reporting or financial data analysis is no longer an exercise performed at the end of the month or the year. Businesses need real-time data-backed insights to respond effectively to changing business needs. Investors need timely insights to have a complete and clear picture to make sound investment decisions. Digital reporting made financial data tangible pieces of information that could satiate the needs of all stakeholders by providing data-backed insights in real-time.
Increased Access to Information – Digital financial disclosures have simplified the process of accessing financial information. Easy access to financial information has increased accountability and openness and built trust in the financial system while empowering the stakeholders with accurate financial information about businesses. XBRL/iXBRL format for digital reporting has allowed companies to publish machine-readable and human-readable financial information, making it easier for regulators, analysts, and investors to access and process financial data.
Enhanced Cybersecurity – As financial information becomes increasingly digitized, robust cybersecurity measures are needed to help protect sensitive data against cyberattacks and data breaches. Emerging technologies like Blockchain (Projected to grow from $7.18 billion in 2022 to $163.83 billion by 2029) will further revolutionize financial reporting by providing a secure and transparent platform for recording and sharing financial information. This will increase the efficiency and accuracy of financial reporting while reducing the risk of fraud.
Challenges of Financial Disclosure in the Digital Age
Digital Financial Disclosures promise several benefits, but that is just one half of the tale. Technological solutions come with challenges in the implementation and integration of these solutions with both the existing systems and the way people work. Digital disclosure management solutions are no different.
Challenges in Data Management, Storage, and Analysis – The financial data generated by businesses are often very high in volume. The high volume of data is challenging to manage and analyze and impacts the accuracy and timeliness of financial disclosures.
Complex financial information requires sophisticated technology to process and analyze data increasing the risk of technical errors. It can also make it difficult for stakeholders to understand and interpret financial information.
Rapidly Evolving Compliance and Regulation – The non-financial disclosures are becoming integral to the financial reporting process considering the recent regulatory changes and sustainability standards being created by bodies like ISSB and are likely to be introduced sooner than later. The new compliance mandates care not just about the financial data, numbers, corporate fraud, and scams but also about the ethical conduct of businesses while measuring the impact they create on the environment and communities within which they operate. Financial disclosures have expanded in scope and need increased investment in time and effort to ensure non-financial reporting standards and compliances are met with complete and accurate information.
In addition to the changing regulatory landscape, most businesses have global operations with a diverse and complex set of compliance mandates in each jurisdiction that increases the cost and complexity of financial disclosures.
Integration of Automated Solutions for Disclosure Management with Legacy Systems – Legacy systems or the systems traditionally being used in an organization may use different technology and data structures than new automated solutions for DM, making integration difficult and challenging with the scope of errors and inconsistencies in financial information. Additionally, legacy systems may contain outdated or inaccurate data and digital financial disclosure reports created based on them may lead to inaccuracies and misrepresentation.
Integrating new DM solutions with the legacy system also involves costs incurred in upgrading or replacing the existing systems and developing new interfaces and data exchange protocols.
Existing workflows can get impacted while integrating legacy systems with new DM solutions and the users need sufficient training to adopt the new technology. If the learning curve is steep, the employees may lose motivation to adopt the new system and become less productive.
Cybersecurity and Privacy Concerns – The most critical challenge for digital financial disclosures is data security. The high volume of complex financial information that is often sensitive and confidential is vulnerable to cyberattacks and data breaches. Data breaches can result in reputational damage for the business and loss of trust in the financial system. Regulatory authorities view this as a non-commitment towards compliance goals, and investors lose trust. Both these scenarios are detrimental from the business perspective.
Lack of Digital Literacy – Digital reports may not be an easy document to read unless it is in the iXBRL format, and therefore some stakeholders may lack the skills needed to access and interpret financial information in a digital format which reduces the purpose and effectiveness of digital financial disclosures and result in misunderstandings and misinterpretations of financial information.
Solutions to the Challenges of Financial Disclosure in the Digital Age
Adoption of Technology – Investing in technology can improve the accuracy, reliability, and security of financial disclosures. Automated solutions for digital disclosure management, blockchain, and cybersecurity measures to protect financial information from cyberattacks are some tools to consider.
Choosing disclosure management solutions with in-built XBRL/IXBRL tagging can help companies meet regulatory compliance requirements of these formats but also make their financial information standardized and easy to share within the organization. Investors also find it easy to access, analyze and compare financial information when presented in the XBRL/iXBRL.
Blockchain can store and verify financial transactions and ensure the authenticity and accuracy of financial information while enabling stakeholders to access financial information in real-time, providing greater transparency and accessibility of financial information in a digital format.
Standardization of Financial Reporting Through Organizations like XBRL International – Standardized financial reporting makes financial information efficient and consistent and reduces the risk of errors. Standardized information is easier to compare and analyze financial data across companies and over time. Automation becomes easy when financial reporting is standardized, it reduces the workload on finance teams, and improves the accuracy and timeliness of financial disclosures. And for the same reason, regulatory bodies prefer financial disclosures that are XBRL tagged. Organizations like XBRL constantly update the XBRL definition and improve XBRL taxonomies to strengthen standardization in financial disclosures.
Implementation of Robust Cybersecurity Measures – Data integrity is central to maintaining the accuracy and transparency in digital financial disclosures and hence requires strong cybersecurity measures. Cybersecurity measures help to prevent unauthorized access to sensitive financial information and come with technical controls such as firewalls, encryption, secure authentication, and access controls. Organizations should conduct regular security audits to identify risks, threats, and system flaws. Personnel training programs and incident response plans are other measures to consider in enhancing cyber security efforts.
Cybersecurity Training and Awareness can reduce the risk of cyberattacks and data breaches and ensure the confidentiality and integrity of sensitive financial information in line with the compliance program.
Investment in Data Management and Analysis Tools – The data management and integration solutions ensure that financial information is accurate and consistent by implementing data quality controls and integration solutions, such as data warehousing and data mapping.
By automating data entry, validation, and reconciliation procedures, firms can lower the chance of errors and increase the accuracy of financial data. Businesses can analyze financial data to find trends, patterns, and connections that can assist in accurate financial planning and forecasting. A consolidated repository of financial data facilitates information exchange with stakeholders and helps different teams to collaborate, enrich, and get empowered to make business decisions backed by financial data.
Collaboration with Regulators and Industry Stakeholders – Consistent and effective disclosure practices are beneficial for everyone involved, businesses, investors, customers, and regulators. Therefore, organizations should seek collaboration with regulators to receive guidance on best practices for digital financial reporting and disclosure. In return, they can support the development of standards and guidelines to ensure the accuracy and reliability of financial information and learn from industry experts regarding the best practices and tools to improve the financial disclosure process.
Education and Awareness for Investors and Companies – Increasing awareness regarding disclosure management best practices and educating investors and companies can ensure the quality, accuracy, and reliability of financial information.
When organizations understand and appreciate the relevance of disclosure management, they are better equipped to stay updated with evolving regulatory requirements and are more open to adopting technology and best practices to improve their financial planning, analysis, and disclosures.
Investors can engage and participate with the companies and make informed investment decisions. Better quality financial disclosure leads to increased trust and transparency and can improve the overall health of financial markets.
Digital financial disclosure has made financial information streamlined, standardized, and easy to use. It has allowed regulators and investors to gain access to complete and accurate financial information in real-time. Businesses are using technology solutions to automate the financial reporting process and gather data from multiple sources and analyze it to arrive at better financial decisions.
But the digital age also means increased cyber security threats and risks to critical and sensitive financial data. Also, a large amount of financial data generated by businesses pose challenges in managing, storing, and analyzing the data. The constantly evolving regulatory landscape and new mandates mean that digital disclosure management must keep up and meet compliance requirements effectively by constantly improving the existing processes.
If technology is a challenge, it is also emerging as a solution in the form of blockchain and improved cybersecurity solutions to ensure companies manage their digital disclosures with confidence.
Financial disclosures will continue to expand in scope, complexity, and granularity as and when the proposed sustainability, climate-related risks, GHG emissions disclosures, and ESG mandates get implemented. Organizations need to prepare and augment their current processes with better solutions and tools to meet the new compliance standards and requirements effectively.
Companies, investors, and regulators can collaborate to make financial disclosures reliable and accurate based on which sound capital investment decisions are made, and market stability is maintained.