How to win the numbers game

A new book from Company Directors, Financial Fundamentals for Directors, will help improve financial literacy. This is an edited extract from Chapter One.

According to the Corporations Act 2001, company directors are expected to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if he or she held that same position of responsibility. Financial literacy is just one aspect of these duties and encompasses a combination of skills, background and experience. For 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.
• 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.
• The economy.

For instance, a start-up needs very different financial strategies to an established public company. Therefore, directors need to consider whether they have the appropriate skills and expertise to balance risk effectively and drive performance for a company’s particular circumstances.

A smaller, not-for-profit (NFP) board may require directors with an extensive background in NFP fundraising with knowledge of how to balance the cost of this with the returns. NFP directors are likely to require a depth of understanding of different aspects of financial literacy in comparison to those of established public companies. And yet, despite these very different scenarios, all directors should have an appropriate level of financial literacy to meet their legislative responsibilities, understand the company’s financial information needs and recognise when to consult with a financial expert.

If companies operate across borders and if different legal obligations and accounting standards exist, directors will need a new level of financial literacy together with an understanding of the different economic environment. Understanding risk management includes financial literacy as it enables directors to steer organisations through boom and bust cycles.

A lack of compliance with the Corporations Act’s statutory obligations could result in financial and other penalties. For instance, no director – no matter the type of organisation, paid or voluntary – can delegate his or her responsibilities to sign off the company’s statutory financial reports (which are prepared in accordance with Australian Accounting Standards) to other directors, company officers, financial experts or any party.

While director statutory obligations have not changed, several court cases over the past decade have highlighted how vital financial literacy is and how severe the consequences can be when it is lacking. Indeed, the high profile Centro case put the spotlight back on director duties and responsibilities as they relate to financial matters when it concluded in 2011 with significant penalties for several directors.

In 2012, the Financial Reporting Council (FRC) surveyed directors and financial professionals to gauge financial literacy around the boardroom table. It found that both groups agreed directors need more financial knowledge and skills. Financial professionals had a far lower opinion of director financial skills than directors had themselves. Directors nevertheless saw room for considerable growth.

The survey’s findings suggest that the financial literacy of directors as a whole may not be at a level that adequately enables directors to acquit their legal and statutory obligations, balance risk and performance and understand when to seek advice from financial experts. Some survey respondents went further, calling for compulsory accreditation for directors to demonstrate they had achieved a minimum level of financial literacy and continuous professional development to keep up with changes in reporting law, accounting standards and regulatory expectations. This would codify expectations for director financial literacy. However, there are no current regulatory proposals regarding this.

In response to these concerns, Financial Literacy Fundamentals for Directors seeks to help directors develop their financial literacy. However, this book is just one element of a lifetime of learning; other opportunities to develop this skill set should be sought whenever possible.