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Painting the Whole Picture – Highlighting the Importance of Non-Financial Performance Indicators

It has become common place to evaluate an organisation based on its ability to generate soaring revenues, profits and shareholder dividends. In today’s free market era, the language of capital accumulation has become synonymous with that of success and progress. It should, therefore, come as no surprise that financial performance indicators have historically been given priority by investors in ascertaining the value of an organisation. However, when one takes cognisance of recent financial crashes and the rise of alternative political movements, definitions of “value” are beginning to span beyond the confines of static financial information.  

The Limitation of Financial Performance Indicators

Financial performance indicators provide a snapshot of an organisation’s immediate financial position. Metrics such as market capitalisation, headline earnings and operating profit are often devoid of any historical reflection, or future outlook. As an organisation exists in an environment that is a product of its past and a pre-cursor to its future, the short-termism of financial performance indicators becomes problematic. For example, in the context of managerial remuneration, linking short-term incentives and rewards to immediate financial performance may inadvertently result in managers making decisions that  improve short-term financial performance but have a negative impact on an organisation’s environmental, social and governance outcomes, which will begin to hamper financial performance in the long-term.

Broadening the Language of Performance

The way value is articulated requires a level of nuance that is congruent with the complexities that exist in the world today. A growing trend, especially in the financial reporting sphere, is the disclosure of non-financial performance indicators. These indicators are gaining more use as information becomes proliferated to a wider audience of investors and stakeholders. In many instances, non-financial performance indicators can be better indicators of future financial performance. For example, an organisation disclosing how it is progressing in pursuit of its strategic objectives, can offer some useful insight into the potential value an organisation can create in future. One study examined the ability of non-financial indicators of “intangible assets” to explain the differences in the stock market values of large US companies [1]. The study found that indicators that related to innovation, management capacity, employee, reputation and brand value explained a significant proportion of an organisation’s value. These kinds of indicators, however, have some detractors. It is argued that non-financial performance indicators lack comparability – as most of these indicators are organisation-specific and can’t be compared with peers. It would, perhaps, be more useful for organisations to use a blended approach, inclusive of both financial and non-financial indicators, in reporting their performance and ultimately value created.

A Blended Approach

As the world changes, there is a new cohort of discerning stakeholders and shareholder activists that have wider criterion to measure the performance of an organisation. While traditional financial indicators have the closest linkages to financial returns and profitability, non-financial indicators often offer the tacit knowledge that contextualises an organisation’s financial performance. In a world that is becoming increasingly cognisant of the tangible and intangible dimensions of value, financial and non-financial information should be given the same level of salience when companies speak the language of “good performance”.

 

References

[1] – http://knowledge.wharton.upenn.edu/article/non-financial-performance-measures-what-works-and-what-doesnt/