ICAEW’s guidance for preparing prospective financial information (PFI) such as forecasts and projections was first published in 2003. It assists directors of listed companies in preparing forward-looking financial information in a public market regulatory context – profit forecasts or warnings, working capital statements, merger benefit statements and a range of other financial projections. Since then many developments have taken place in the regulation of capital markets, in financial and corporate reporting, as well as in the wider fundraising context – the financial crisis and the advent of International Accounting Standards, to name but two.
So a more consistent update that reflects changes in the regulatory environment as well as a more volatile business environment makes sense. Robin Stevens, head of capital markets at Crowe Clark Whitehill, says he is in favour of enhancements to reporting of capital market transactions if they bring standardisation and consistency. “Since 2003 there has been an awful lot of change, so it’s no bad thing to see what can be adapted and brought up to date,” he says.
The principles in the 2003 guidance should still be helpful as they aim to produce forecasts that are reliable, relevant, understandable and comparable. But when ICAEW’s Corporate Finance Faculty published a consultation document earlier this year it identified a clear need to update the regulatory context of the guidance. It also consulted members about whether the same guidance might be used voluntarily in a wider context – it is no easy feat to give a credible guide to the future in such an uncertain environment, for example.
ICAEW believes there is a strong public interest in having unified, common standards for the preparation of forecasts. For its new framework, the Institute has suggested defining PFI more widely so it includes all financial information relating to a future period. This will reflect changing trends in capital markets more generally, including investor and lender needs and business accountability.
One of the motivating factors behind its proposal to broaden the scope of the guidance is the increased options companies have to raise new money. Not only is the funding mix greater, but the primacy of capital markets has been challenged. According to a Financial Conduct Authority (FCA) report this year, Review of the Effectiveness of Primary Markets, more companies are staying private for longer. In its 2015 report, Capital Markets for Growing Companies: A review of the European listings regime, TheCityUK stated that across the EU, capital markets play “too small a role” in funding businesses.
“The proposals still cover the core capital markets’ activities,” says Katerina Joannou, ICAEW manager of capital markets policy, who convened the working group that developed the consultation paper. “The first initiative is to address the principles underpinning PFI and produce up-to-date guidance for the quoted company sector aimed at people preparing forecasts and statements. The second initiative reflects a broader landscape of fund-raising activities and extends the PFI approach to forecasts prepared for private finance raising, which could be new or renewed banking facilities and funding from business angels and via crowdfunding platforms,” she says.
A principles-based approach to business forecasts and projections might be useful to private-market fundraising too, and could serve investors or other users. ICAEW’s proposal to bring into scope all financial information with a future date attached might promote a positive role for accountants. For example, the PFI approach to thinking about the future could serve preparers of forward-looking financial information in the contexts of corporate and financial reporting, by bringing robustness to estimates.
A framework for arriving at PFI that can be referred to in relation to IFRS, particularly when looking at areas like impairment, would also be welcome, says Stevens. “IFRS can be a subjective form of accounting when compared to historic costs, so adding more consistency of approach there would be helpful. If everyone uses it, it will bring investors a level of comfort,” he adds.
“We’ve thought about the kinds of application for PFI. It’s about taking the guidance and bringing it to life”
Staying on mission
This wider scope is not without its difficulties, however. “I am concerned that in refreshing its guidance ICAEW avoids ‘mission creep’ and tries to turn the guidance, which has a very clear application, into something for which it is not necessarily fit for purpose,” says Steve Maslin, audit partner at Grant Thornton. “Considering profit forecasts to support fund raising on a public exchange has a clear purpose and audience. Providers of funding in a private environment or crowdsourcing will inevitably have different needs and it would be dangerous to assume applying the same guidance would meet their specific needs,” he says.
That’s one take on it. ICAEW’s idea is to include within the new guidance hypothetical case studies that will enable preparers to formulate their own projections. Diane Craig, head of capital markets at RSM and a member of the ICAEW working group, says these are not intended as benchmarks, more as recognisable scenarios that will help preparers formulate their own projections. “We’ve thought about the kinds of application for PFI. It’s about taking the guidance and bringing it to life,” she says. The four original principles within the 2003 guidance have been the subject of much discussion, adds Craig, and consultees are also being asked about the inclusion of two new principles: namely that any forward-looking information should be aligned with other statements companies make, and that they should not be misleading.
The question of aligning PFI with other corporate statements makes sense, says Joannou, in terms of ensuring preparers consider other strategic documents and reports put out by their company. “There is an opportunity to make forecasts align with financial management information more generally,” she says. “They should be underpinned by the same system. There will always be assumptions within forecasts, but the point about forecasts is that if they are based on these guidelines they will be justifiable and comparable. Otherwise it is difficult to track and support your forecast.”
In proposing the extension of scope, ICAEW’s working group anticipated questions of cost and proportionality and, before publishing the proposals, invited reactions from bodies in the banking, crowdfunding, business angel and private equity sectors. These were broadly positive, assuming that to be useful, forecasts must meet the needs of users.
ICAEW’s revised guidance would remain voluntary and the Institute envisages that, for private fundraising, it would be applied in a proportional way. Still, Stevens sees difficulties when it comes to the question of “what is proportional” and believes there’s potential to add costs and delay. “In terms of the private market, I would tend to leave it to the parties involved to decide on what they expect to see,” he says. “Within the private investment sphere, where you have banks and financial institutions involved I would say you have a situation where the different parties can request the information they need in line with their expectations and that is probably safer than putting in a set of guidelines. The people involved are, by definition, experienced investors and it’s up to them to decide on the information they require.”
It is not ICAEW’s intention to increase the complexity and the cost of preparing forecasts and projections for businesses seeking to raise additional funding, says David Petrie, ICAEW’s head of corporate finance. “That’s why we are consulting so widely on these proposals. The outcome should be an up-to-date framework, which is proportionate and essentially reflects current market practice. It’s also not the intention to displace or preclude the ability of a private finance provider to question a business’s forecasts or challenge the assumptions. That wouldn’t happen quite so often if the information is prepared in a way that everyone expects.”
While ICAEW is to be applauded for championing a consistent approach and providing guidance and illustrative examples to members responsible for producing PFI, there is a danger, suggests Maslin, in arriving at a situation of what he describes as “spurious accuracy”. The thing about projections, he says, is that the reader understands they are likely to prove to be wrong. “What is important about them is to understand the assumptions on which they are based. If you look at a prospectus, it is very rare to have prospective financial information within it. In the context of public transactions, in the case of discussions between investors and brokers for an IPO, for example, you would expect to see working capital projections, but that’s a private report, that would then form the basis of a research note that would in turn enter the public domain that way.”
The Institute has considered this, says Petrie. “We know that businesses rarely hit forecasts exactly, but if information is consistently and diligently prepared (and we hope that our guidelines will help with that process) then at least any variances that do arise are more likely to be due to commercial success, or pressures, as opposed to weaknesses in the basis of preparation.”
Proposed frameworkThe consultation paper explains that the proposed new framework for producing PFI will include general principles for its preparation in any context. Two new principles are proposed, bringing the total to six. In addition there will be up-to-date application notes covering PFI in a regulated capital markets transaction context and on how to apply the principles in a proportionate way. Depending on demand there may also be specific application notes for other types of forecasts and projections.
Those preparing forecasts will understand the importance of the tone of these outlook communications. Learning from a robust and considered preparation process would also enable a business to stand behind its projections, which increases the confidence of users.