financial,IQ,information quality

Add financial IQ to your corporate equation

04 Jan 2005 | (Thinking Point)

Increasingly, investors are applying their investment dollars to where they have trust and confidence in the quality of a company's financial information. This can be summed up as part of a "New Math" in the financial marketplace: Corporate Governance + Sarbanes-Oxley = Financial IQ (Information Quality)

Financial IQ calls for transparency, timeliness, accuracy, and reliability.

William Donaldson, SEC chairman, for instance, said at the National Press Club in July 2003, "...If companies view the new laws as opportunities -- opportunities to improve internal controls, improve the performance of the board, and improve their public reporting -- they will ultimately be better run, more transparent, and therefore more attractive to investors."

For years, companies focused on how to improve traditional benchmarks of shareholder value -- such as price/earnings multiple, revenue growth, operating margins, and so on -- but increasingly it has become equally important to understand how to improve a company's Financial IQ and increase investors' trust in the company.

Transparency: Because of recent regulatory actions and continued advances in technology, the markets are demanding more and better information and access. Leading companies will be able to both satisfy their own internal needs and comply and respond to external expectations. The challenge will be to capture and analyze information for internal use that also paints a compelling picture of what the company's business landscape really looks like.

Timeliness: Investors are voracious for information. Companies should give them as much as they can, as quickly as they can. This is a demanding and continuous job. But raw data alone is not the ideal solution. Investors will be more satisfied if companies can also interpret changing business conditions that will impact its performance.

Accuracy: According to the U.S. General Accounting Office, the lopping off of 18 percent of a company's market capitalization is the average loss a company experiences via any financial restatement of its earnings. Given this kind of hurt that investors can impart, it is more than worth it for a company to address its systems, processes, and policies, even if some business initiatives have to take a back seat.

Reliability: That same earnings regression line that used to bring smiles to the faces of financial analysts -- when depicted at a 45 degree angle -- now brings questions about perfection and volatility. Financial markets seemingly have discovered Newton's law of gravity -- earnings go up and earnings go down. Investors are becoming more scientific in their assessment of positive data, in addition to the negative. Mostly, they just want the data to be right the first time.

So, if companies adopt the concept of Financial IQ because it is a good thing for shareholder value, what does it mean to the forward direction of companies? Firms need to be aware of unintended consequences that could impact proven business strategies and business models -- strategies and models such as mergers and acquisitions, outsourcing, decentralization, and shared services.

These challenges should cause companies to test, poke, and prod their thinking in these four areas:

Mergers and Acquisitions: Sarbanes-Oxley increased the cost of absorbing and integrating acquisitions, particularly where the target company is a privately owned enterprise. Is it time to focus on organic growth, or should M&A continue to be a growth driver?

Outsourcing: Sarbanes-Oxley placed a new travel requirement on the growing trend of outsourcing, whether it is moving business processes to a service provider located on Main Street, USA, or in Mumbai, India. Is it time to revisit the company's alliances, strategic supplier, and go-to-market strategies?

Decentralization: Sarbanes-Oxley reopened the debate on centralization vs. decentralization of a company's organizational structure and the need to consolidate certain functional areas. Can standardization be the panacea to mitigate the increased tension between corporate centers and field operations?

Shared Services: Sarbanes-Oxley altered the benefit equation for shared services. Is it time to revisit prior, current, and future commitments to this business model?

Savvy companies that embrace Financial IQ will acknowledge and understand these elements and build them into their decision making. While Sarbanes-Oxley has made it clear about the pound of flesh that will be exacted for abusing investors' trust and confidence, the legislation does not outline the governance changes that will be rewarded by the marketplace.

There is no recipe that details the necessary ingredients. It will be incumbent upon all of us -- business executives and professional service providers -- to learn and embrace the "New Math" and continually challenge the equation and the business processes that will ensure that financial information is transparent, timely, accurate and reliable. Investors are demanding higher quality earnings, and are demanding the removal of risks from the earnings formula -- no more restatements, no more investigations, no more surprises. As business professionals, we need to respond.

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