How Financial Transparency Ranking will improve Annual Report Contents

Source Capital and BusinessDAY have come out with an innovative way to improve the level of financial disclosure and transparency in published annual reports. The introduction of a ranking of quoted companies based on the level of financial disclosure and transparency in their published annual reports will improve the contents of annual reports in Nigeria.  

There is no such ranking in the country currently and most companies basically follow the minimum regulatory guidelines in the contents of their annual reports. An evaluation of these contents by analysts who need this information to make an informed investment decision has been largely considered inadequate.  Usually the information in most annual reports are generic, full of platitudes with no in depth explanation of the rational of the business, the risks faced by the business, the strategies put in place to navigate identified risks and forward looking analysis of the company's position.

Where detailed information is provided, non financial information, that cannot be deduced from the annual report are usually absent. Employee turnover, manufacturing capacity, market share, liquidity position, working capital needs and projections are all information that managers often do not disclose in annual reports. It is to ensure a more detailed disclosure in annual reports, which is the most accessible document, available to all stakeholder interested in a quoted company for their different reason that Source Capital and BusinessDAY have introduced the ranking.

Currently, the FTRA has separate indices for banks and non banks with a separate index for ranking the insurance sector still being worked out.  For banks, the FTRA will cover governance and risk management disclosure in their financial statements.

 The governance section covers disclosures concerning; Board Matters, Remuneration Matters, Accountability and Audit matters. The Risk Management section will analyze the disclosure of banks concerning their Credit Risk, Market Risk, Operational risks, Other risk (Strategy, IT, Legal and Reputational risks) practices.

 Over 100 indices for each area of disclosure have been developed. The sum of points scored by each bank will be covered to percentage scores. The higher the score, the higher the level of disclosure and transparency in the published annual reports analyzed.

The percentage scores will further be converted to an index on a scale of 10 which will be called the Financial Transparency Index (FTI). This index will be attached to the company's or bank's listed name on the stock exchange. This will be the indication of the level of financial disclosure by the company or bank, for example if XYZ Bank Plc has an FTI score of 6.5 and ABC bank has a FTI Score 2.5 then any external party looking at this information should easily be able to interpret this to mean that XYZ Bank Plc has a high level of disclosure and transparency in its financial statements than that of ABC Bank Plc.

For none banks, the FTRA will be ranking companies based on the level of their governance disclosures and that of the quality of their Management, Discussion and Analysis (MD&A). The quality of the MD and A indices have been fashioned based on the exposure draft of the International Accounting Standards Board (IASB) which is in the process of becoming a non binding accounting standard for companies soon. It is quite detailed and ensures that management convinces all stakeholders that they understand the business they are running.  

In future, there are plans to extend this ranking to the public sector to cover state and local governments.

Usefulness of the FTI

Several studies have shown that companies showing a higher level of financial disclosure and transparency in their annual reports are better managed and financially stronger than companies that have low levels of disclosure and financial transparency.

For investors the Financial Transparency Index will thus serve as a good guide of where to put their money. Companies with higher FTI scores will naturally be a better investment choice than companies that have low FTI scores. The FTI greatly simplifies the investor's decision making process as he or she no longer needs to go through several pages of different annual reports to see companies that are well managed and that deserve his or her earned money. The FTI will greatly simplify the process of investment choices for investors

How it benefits regulators and other stakeholders;

For regulators, the FTI will be an invaluable tool. At a glance, regulators will be able to easily identify companies/banks that pose high risk to the system and increase their supervision and regulatory activities on these companies or banks. Banks/companies with a low FTI score will naturally have a higher risk level than banks with a high FTI score.

Other Stakeholders

Depositors: The FTI will be a good indication of which bank to place their monies as higher FTI scores will indicate a strong bank or company.

Tax Authorities: A higher FTI score will definitely mean that the bank or company is making correct tax returns while a lower FTRA will mean that the bank or company's tax returns bear further scrutiny  

Suppliers/Creditors: A high FTI score means a company that is in position to pay its suppliers without much difficulty while a low FTI score will mean that company will likely delay payments to its suppliers and may not be in position to even pay its debts.

A credible advisory board has been formed to administer the FTRA.