Article:

Why financial understanding is critical when you’re a non-financial director

26 March 2020

Anthony Whyte , National Leader, Not-For-Profit
Partner, Audit & Assurance
|
Leah Russell , Partner, Audit & Assurance |

There is a misconception that to be a director, you must have an in-depth understanding of financial reporting; this is not the case. While all directors must understand financial viability – especially in this time of particular uncertainty – diversity in director skills, knowledge bases and, commercial backgrounds also play an important role for the Board. For example, as more companies and not-for-profits experience uncertainty as a result of COVID-19, expertise and experience in crisis management and response become significantly valuable.

As the role of boards and directors continues to evolve, how is this impacting financial reporting and decision making and what can non-financial directors do to take a more active role in financial reporting discussions?

So what is the role of a director today and how is it changing?

ASIC clearly states that a general duty of a director is to ‘exercise powers and duties with the care and diligence that a reasonable person would have which includes taking steps to ensure you are properly informed about the financial position of the company and ensuring the company doesn’t trade if it is insolvent’. The role of a director, therefore, must be one of strategic oversight. 

As such, more boards today are focussing on expanding director skills-sets, as well as taking steps to grow board diversity. However, one of the effects of this is that we are now starting to see fewer directors on boards with advanced financial skills. Non-financial experts, therefore, are relying heavily on the board members who are considered ‘financial experts’ to challenge management and ask those often pointed financial questions.

As an audit partner who regularly attends board meetings, I’ve started to see this worrying trend. At meetings where financial matters are discussed, non-financial directors can often be quick to agree with the position or decisions proposed by financial directors under the assumption that the ‘expert’ knows best. An example of this, are two comments I heard recently at meetings: “given the Chair of the Audit Committee is happy, so am I” and “that’s not my area of focus, happy with what the consensus is”.

While it is important to respect each director’s expertise, it is also vital that every director understands the financial position of a company or organisation and how financial decisions made will affect it. As highlighted earlier, directors are responsible for ensuring that the company is solvent and running well financially. There are severe penalties for cases of oversight. This means that all directors regardless of their expertise must raise any questions or concerns they may have when it comes to financial decisions and reporting.

So what can boards and individual directors do to counter this issue?

Below, I’ve outlined a few simple actions that boards can take to help facilitate active financial discussions that engage all directors regardless of expertise.

  • Encourage each person to contribute. Never belittle or dismiss someone for asking a question, especially from non-financial experts enquiring on financial topics. In our experience, it is sometimes the simplest of questions that are sometimes the most revealing.
  • Provide literacy training based on the entities financial information. This may be as a group, or as part of the induction process.
  • Ensure that senior management provides clear and regular financial updates in both numerical and written form. These updates should include the current status compared to the prior year, budget and forecast.
  • Request evidence of when creditors are due to be paid and the company or organisations’ ability to comply with normal terms of trade.
  • Understand the current level of bank lending and the ability to access additional funding if required.
  • Understand whether there is a risk of grant and other funding not being provided because key milestones may not be met.
  • When not in day-to-day management, ensure that systems are in place, to enable accurate information can be provided.

Management can also assist boards and directors by:

  • Providing regular financial information in a format that allows for ease of reading. A straight balance sheet, profit and loss, and budget can be brought alive in easily digestible fashion through graphs and colour. We need to remember that people are a mix of visual and numerical readers and therefore should cater to both.
  • Provide sufficiently detailed and written explanations for variances between planned and actual performance.
  • Allow plenty of time for questions and answers. This is especially important in scenarios where there are significant variances or financial issues facing the company or organisation. The provision of position papers outlining how decisions are made and accounted will also assist directors’ understanding and comfort.
  • Always be transparent and present both positive and negative news.

Important considerations for boards and directors responding to COVID-19

As more companies and organisations are impacted by the growing Coronavirus (COVID-19) pandemic, it has further highlighted the importance of boards and directors working collaboratively to quickly identify potential risks. Boards and directors need to be aware of current and potential issues and how these will impact the company, organisation or entity.

In particular, some of the top issues companies and charitable organisations need to be prepared to manage include, solvency, employee and volunteer obligations, supply contracts and logistics, health and safety (hygiene and virus prevention) and cybersecurity. (For more information on these issues please see our COVID-19 page.)

Regarding solvency and the financial stability of the company or organisation, it’s critical that directors:

  • Immediately take positive steps to confirm the company or organisation’s financial position and realistically assess the options available to deal with the company or organisation’s financial situation. This would include forecasting what a worst-case scenario may look like.
  • Obtain appropriate advice from professionals and experts. This is even more pressing if you currently do not have a crisis management plan in place.
  • Consider and act appropriately on any advice received in a timely manner.
  • Communicate any decisions – especially largescale announcements affecting staff- clearly and transparently. Many people will be experiencing stress at this time so it is important to ensure that your people are well informed.  

How can we help?

At BDO we have a wealth of experience in assisting with financial literacy and can provide example templates for reporting financial information to the board and insolvency assessments.

For boards and directors of companies and charitable organisations concerned about the impact of COVID-19, we have provided a range of resources on our COVID-19 page including checklists, webinars, technical updates and more. For assistance with developing a crisis management plan, conducting risk management assessments or accessing federal and state stimulus please contact us here.
 

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