Why We Need to Update Financial Reporting for the Digital Era Summary (Harvard Business Review)

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Financial Reporting…A Dinosaur in the Modern Era?

Digital companies are reshaping the narrative that the numbers tell. What is being done about the reporting process? Harvard Business Review conducted in depth interviews with several CFOs heading up prominent technology companies and investment bank senior analysts. Why? To confirm their suspicions

HBR asked two key questions:

  1. What makes the valuation of digital companies more challenging?
  2. How can digital firms improve their financial reports to communicate sources of value creation in their businesses?

Below are the 7 Insights that emerged:

  • Financial capital is assumed to be virtually unlimited…human capital? Not so much.
    • Metrics like net present value, payback period, and hurdle rates all assume capital limitations. CFOs in digital companies allocate human resources like research and development specialists more diligently than their financial resources, believing that more capital can always be raised.
  • Risk is now considered a feature, not a bug.
    • Boom or bust is the name of this game in the digital world. Well, sort of anyway. Employees are generally evaluated on their contributions toward the next potential billion-dollar idea, as opposed to the bottom line. Digital companies go after home projects, even if it means striking out a little more often.
  • Investors are paying more attention to ideas and options than to earnings.
    • Following the last point, accurately valuing a company based on cash flow or projected earnings is becoming increasingly difficult. CFOs have no inclination to divulge future projects, as they often carry certain risks that would likely only increase the difficulty in accurate valuation. After all, calculating a series of best case scenario payoffs doesn’t exactly inspire confidence in traditional market moguls or valuation competency in day traders.
  • Corporate venturing is becoming more important.
    • It’s obvious by now (or it should be) that long-standing traditional companies have been heavily disrupted by their emerging digital counterparts. The magic corporate elixir is to either create a venture capital wing to invest in innovation, or purchase a company with innovative capabilities outright. This however, risks cultural division between the old guard and “innovators.”
  • Financial reporting requirements won’t change any time soon.
    • Despite the glaring need for new ideas and methods in number crunching, there is little incentive to change anytime soon. Traditional proponents and the SEC still hold ultimate reign over the standards, and until dotcom 2.0 happens, the standard remains the standard.
  • Analysts increasingly rely on non-GAAP metrics.
    • In the meantime, analysts frequently deploy less traditional means that will allow them to change the face of future projection vs. current earnings for reporting purposes. This can be as simple as off-setting R&D expenses with more value-maintaining functions.
  • Accounting is no longer considered a value-added function.
    • Many digital CFOs now view traditional accounting practices a hindrance, and may not even invite accountants to their strategy meetings. Regulatory reports and metrics are still required however, so accounting itself will not go away in the near future. Yet, it is interesting to note that for impactful decision making, accountants are having their voices minimized.

 

Read the full article “Why We Need to Update Financial Reporting for the Digital Era” here.