The Strategic Report has been with us since 30 September 2013, and is a required part of the annual reporting for medium and large companies.
The intention of the report is to provide context for the financial statements, and to provide insight to a company’s business model, objectives and strategy to shareholders and other users of the accounts. Despite these important considerations, it can often be regarded more as a compliance requirement and another ‘box to tick’ by preparers of accounts.
Companies which are subject to statutory audit will notice a greater focus on the content of their Strategic Report from their auditors for periods ending on or after 30 June 2017. This arises from a change in requirements of the auditor’s report from this date, in which auditors must now assert that the Strategic Report has been prepared in accordance with applicable legal requirements.
Given this increased scrutiny, it may be a good time to look again at the required content of the Strategic Report. The main components include:
A fair review of the business
This section is where management should describe the financial performance in the period, together with factors that have influenced performance. The review should also describe how the business has changed and developed during the year.
Where consolidated accounts are prepared, the report should cover both the performance of the parent company and of the group.
The reference to a ‘fair review’ means the description should be consistent with what is seen in the financial statements themselves, and cover the challenges during the period as well as the positive developments.
Principal risks and uncertainties
These should include the main business risks that the business is subject to. This is in addition to the exposure to financial risks (e.g. interest rate risk, liquidity risk, currency risk), which can either be covered in the Strategic Report or in the notes to the financial statements.
Business risks are often specific to a particular sector, or to the entity itself. They could include for example the risk of product obsolescence, political risks in a key overseas market, legal and regulatory risks, or availability of supply chain components.
This section should also include the measures the business has taken to mitigate these risks.
Financial and non-financial key performance indicators
Disclosure should comprise measures that are actually used by management in assessing performance of the business, i.e. those highlighted in management accounts or discussed at board meetings.
Financial key performance indicators will include measures that can be sourced or derived from the accounts or financial summaries. These may be common items such as revenue growth, or gross profit margin. They could also be more specific to a particular business or sector. Financial KPIs should be defined where necessary, and their method of calculation explained, together with key assumptions made.
Non-financial KPIs will be the measures that management are concerned with that do not relate directly to financial performance, but are still key to the business performing successfully. These could include fleet utilisation, employee chargeable hours, levels of customer satisfaction, lost time due to injury, or many others. There is an exemption from providing details of non-financial KPIs for medium-sized companies, though where such items are the most appropriate to understanding the business, the Financing Reporting Council recommends that they should still be disclosed.
As can be seen from the requirements above, a Strategic Report requires careful thought and preparation in order to produce a document that is informative to users and meets the statutory requirements.
The Strategic Report must be prepared by management, as they will have knowledge of the underlying reasons for financial performance and the KPIs that the business actually uses.
Auditors cannot prepare the Strategic Report on behalf of a company, but will be able to outline the statutory requirements for the report to cover, and can comment on the draft report provided by management where it does not fully meet them.
All information contained in the report must be factual, and management must be able to provide support for any statements they have made, e.g. in reference to the performance of their market sector.
The Strategic Report should address the following points:
- Provide shareholders of the company with information that will enable them to assess how the directors have performed their duty to promote the success of the company.
- Be fair, balanced and understandable.
- Information in the Strategic Report should complement the financial statements. In complementing the financial statements, the Strategic Report should provide information about the business and its development, performance or position that is not reported in the financial statements but which might be relevant to the shareholders' evaluation of past results and assessment of future prospects.
- The Strategic Report should provide additional explanations of amounts recognised in the financial statements and explain the conditions and events that shaped the information contained in the financial statements.
- The Strategic Report has three main content-related objectives:
- to provide insight into the entity’s business model and its main strategy and objectives;
- to describe the principal risks the entity faces and how they might affect its future prospects; and
- to provide an analysis of the entity’s past performance.
- The Strategic Report should address the positive and negative aspects of the development, performance, position and future prospects of the entity openly and without bias. The directors should seek to ensure that shareholders are not misled as a result of the presentation of, or emphasis given to, information in the Strategic Report, or by the omission of material information from it.
- The Strategic Report should be comprehensive but concise.