Finance lives at the heart of the business. It’s the one place that collects, aggregates and analyzes data from every corner: from operations to sales to cash management. Finance combines views of the past, present, and future so that the best, most informed, decisions can be made in the day to day running of the company, and in strategic planning for the future.
The problem with the future is that it is uncertain. Finance organizations understand this, which is why they plan, and in doing so, they separate the things they control (e.g. expenses) from the things they do not (e.g. interest rates). Finance organizations that have invested in technology and data infrastructure to support advanced financial modeling are able to explore different scenarios in their planning processes, to be better prepared for uncontrollable eventualities.
Accounting for Non-Financial Risk Factors
But what about the non-financial factors that a company doesn’t control, but can still have a significant financial impact? For example:
- Severe weather events affecting facilities or operations
- Demographic shifts in key markets
- Raw material scarcity due to political unrest or biodiversity loss
Companies that incorporate material non-financial factors into their strategic planning models will be better positioned to anticipate and manage financial risk, while setting up to have first-mover advantage for any opportunities that emerge. These are all topics addressed by sustainability (or Environmental Social & Governance) reporting standards.
Consider this:
Sustainability Reporting is a Tool for Long-term Success
The point of the regulation is to provide companies with the tools to do a comprehensive examination of their businesses, and to learn – and benefit – from that exercise.
Any strategic CFO would do well to consider the implications:
- Sustainability has become part of financial reporting, and sustainability expertise and experience are now table-stakes for global businesses.
- Embracing the process, and the data that comes with it, will either confirm the long-term viability of an existing business and operations model, or it will unearth potential areas of concern. As with all risk, early detection buys time for effective mitigation not to mention a leg up on pursuing any new opportunities that may be identified.
- Conversely, ignoring the process while global competitors embrace it increases risk of being late to the game, especially if there is competition for scarce resources.
- Technology and business process infrastructure investments will be needed to support integrated sustainability and financial reporting. Starting early, especially on data strategy and governance, will allow time for a business to figure out the best approach for them. This is a new concept for everyone, so some trial and error should be expected.
- As more companies incorporate sustainability risks into their financial reports, investor and lender expectations will shift, impacting availability and cost of capital.
United States SEC Climate Disclosure Rule
Notably on a separate path is the United States (US) where the Securities and Exchange Commission (SEC) released new climate-disclosure requirements in March 2024. While similar in spirit the SEC rules are narrowly focused on climate and by excluding Scope 3 emissions as a requirement, puts less focus on value-chain analysis. In essence this means that the process will not require companies to look closely at (upstream) supply chain or (downstream) market risk.
While this ostensibly reduces the immediate compliance burden on US companies that only report in the US, there are some potential downsides:
- US companies will discount the momentum behind sustainability and choose to delay action – until they suddenly need to scramble to catch up because it is clear these regulations are going to expand over time.
- Meanwhile they will miss out on insights they might have accrued from following the broader process that other companies are already learning from and using to future-proof their strategies.
- Any US companies with global reporting requirements will need to prepare separate reports in different formats for the US vs the rest of the world.
- Note that some US states (e.g. California) have adopted standards that are more in line with the EU and global standards.
- A lack of awareness may lead to being less prepared to apply for government funding (e.g. from the Inflation Reduction Act of 2023) that can help them transition to cleaner, more efficient and lower cost facilities and processes.
Sustainability Activities Correlate with Financial Performance
Recent survey data (e.g. 2023 Gartner CFO Survey, PWC Pulse Survey) indicate that most CFOs in the US do not see much connection between sustainability and their top priorities of cost-cutting and growth, despite mounting evidence that tracking sustainability (or ESG) metrics correlates with better financial performance. One such study by Bain & Company + EcoVadis compared the ESG and financial performance of 100,000 companies around the world from 2019-2021, and found that ESG activities are associated with encouraging revenue growth and EBITDA margins.
Forward-looking CFOs are taking note, including in the US.
Look beyond Compliance to Better Data and Smarter Decisions
Sustainability reporting does not automatically lead to business success, any more than financial reporting does. But in a world where more data is available than ever before, companies that make the effort to harvest and harness data that is meaningful to their business in a useful way will be able to make better decisions in the long run.
While this sounds dauntingly open-ended, the sustainability reporting standards defined by organizations such as GRI and IFRS (and embedded in many regulatory requirements) provide “recipe books” for how to identify and organize business-useful data points.
Every finance leader and aspiring CFO should take note and be aware that fluency in sustainability matters is now part of the job description.