As community expectations of transparency and compliance have risen, fueled by situations such as those identified by the Hayne Royal Commission, the role of directors as stewards of the enterprise has been brought into stark relief.
Into this environment, changes to accounting standards that deal with matters such as revenue recognition, financial instruments, loan loss provisioning and lease accounting have added considerable complexity to the preparation and look and feel of financial statements.
Financial literacy encompasses a combination of skills, background and experience. For company directors, financial literacy is largely about the ability to:
- Acquit formal legal and statutory obligations as they relate to financial
matters, such as signing off on the annual financial reports;
- Monitor financial results to assess solvency;
- Balance risk mitigation (financial and otherwise) with the ability to drive
the company’s financial performance by understanding the ‘story’ told by its
financial reports; and
- Know when financial experts are required to assist with the above points.
While these are the four pillars of financial literacy, other factors may shade the depth of financial skills and knowledge needed, such as:
- The company’s business model;
- Business plans and strategy;
- Stage of growth;
- The company’s financial health;
- Risk profile;
- The skills mix around the boardroom table; and
- The economy.
Financial literacy vs financial expert
A board will comprise directors with various skills relevant to the company’s business. In addition, each director should have an appropriate level of financial literacy, and the board should have at least one director, or an adviser, who is a financial expert.
A financial expert can identify and action the most appropriate accounting treatment in a given set of circumstances. A financial reporting expert can choose and apply the correct accounting framework. Accounting frameworks explain when, why, what and how transactions should be described in accounting terms in a financial report. Several different accounting frameworks exist, and the applicable accounting framework will not be the same in all circumstances.
The financially literate director is not expected to have an in-depth knowledge of different accounting frameworks or have the ability to action the required accounting treatment. Instead, a financially literate director should be satisfied that the accounting framework required in the circumstances has been applied. He or she should also be able to understand when financial expertise is needed, and why a particular course of action has been followed.
Financial reporting is a language used to explain business activities in financial terms. Directors should have an in-depth understanding of business activities and must have confidence ‘the story’ portrayed in financial terms in the company’s financial statements is consistent with their understanding. The ability to read and understand this ‘story’ is at the heart of a director’s financial literacy.
Financial governance provides the link between the company’s operations, carried out in accordance with its business model, and reporting performance for both internal and external purposes. An understanding of financial performance provides directors with an insight as to whether or not the business model is capable of achieving the results anticipated.
The primary areas of financial governance are:
- Monitoring; and
Financial governance also includes the company’s responses to key issues and financial risks that arise at each stage of the company’s lifecycle. It will also determine how financial decisions are made on a daily basis, ensuring there is an appropriate level of authorisation and oversight, depending on the extent of risk associated with the nature of the transaction.
It is not necessary for all directors to be financial experts, however they must be sufficiently financially literate to satisfy themselves that they understand the results and financial position of the business and are able to fulfil their statutory obligations. Importantly, they need to know when to ask for expert advice.
A company’s strategies, business activities, risk mitigation and relationships are captured and explained in the financial statements, both in the numbers reported and in the disclosure notes. As each of these factors evolve and change, the ‘story’ told in the financial statements will also evolve and change.
This new edition of the book aims to help directors better understand financial reports and improve their financial literacy. This financial literacy not only helps directors with their governance obligations, but it also helps them better understand their organisation’s financial story, which in turn leads to better risk and strategy decision making.
You can access the latest edition of Financial Fundamentals for Directors on the AICD bookstore.
About the author
S. Dianne Azoor Hughes is an independent consultant in governance, risk and audit. She has 35 years of experience in business, including 18 years in senior executive and board roles.
She is an independent audit committee member for the Victorian Legal Services Board + Commissioner and an independent audit and risk committee member for the Victorian Building Authority. She is also chair of the Monash University Department of Accounting Advisory Committee and a board member of a not-for-profit organisation. She is also a Fellow of Chartered Accountants Australia and New Zealand, and holds a Master of Business Law and a Post Graduate Diploma in Advanced Accounting.