In July 2017, ICAEW published a consultation paper on prospective financial information (PFI). Developed by a working group set up by the Institute’s Corporate Finance Faculty, the consultation paper set out the case for updating 2003 guidance. The 2017 consultation included proposals to update the 2003 guidance for regulatory changes and market developments and to review the PFI preparation principles; to extend the scope of the updated framework to all PFI and to develop guidance for applying it; and to introduce two new attributes of useful PFI.
In December 2018, an exposure draft of the new guidance was published for consultation. Katerina Joannou, manager, capital markets policy at ICAEW, says the thinking is that those receiving PFI from companies not in the listed sector should enjoy the same level of confidence.
“Listed companies are required to provide information in a certain way because investors don’t have the opportunity to probe and challenge the business,” she explains. “With a private business, a bank manager – for example – could dig into assumptions and forecasts to understand how robust they are and what they are based on.”
The recipients of PFI are looking for information that increases their confidence in the person or business in front of them. If this is prepared according to a set of principles designed to increase the confidence of the user, that can only be a useful development.
Broadening the scope
“The guidance could certainly be helpful when preparing prospective financial information for a wider range of situations,” says EY capital markets partner, Sean Callaghan. “It contains specific application notes for preparing prospective financial information for capital markets transactions, while the exposure draft contains overall principles as well as general application guidance.”
Recent events in the audit and assurance industry have led to increased scrutiny of financial information placed within the public domain, regardless of whether or not the publisher is quoted. This increased level of scrutiny – and therefore increased interrogation of quality – gives rise to an expectation gap between the inherent pitfalls and inaccuracies that are present within, and the public’s intended reliance on such information.
That is the view of Andrew Moyser, partner at MHA MacIntyre Hudson, who also makes the point that prospective financial information is not limited to that which is published for public consumption, but also that which is prepared for internal use.
“Such internal information, prepared by management for the purposes of strategic planning and forecasting, may in turn be relied upon by auditors when forming an assessment of key issues such as going concern,” he adds.
Asked to assess the value of extending the guidance, Stuart Brown, associate director at Duncan & Toplis, refers to a comment made by David Petrie, head of corporate finance at ICAEW, on the launch of the consultation paper.
Petrie stated: “The proposed new guidance is of relevance to anyone preparing, reviewing or advising on financial forecasts or projections, of virtually any kind and for almost all purposes – from formal finance raising documents to business planning in a private company.”
Whereas the 2003 guidance had been specifically focused on providing guidance for certain PFI in a capital markets transaction context, the updated guidance will assist businesses of all sizes in the preparation of this type of information, including budgets and forecasts, explains Brown.
“The preparation of prospective financial information is a vital component of the work of chartered accountants,” he continues. “Clients seek assistance in the preparation of prospective financial information, be it for internal or external purposes. If that information is prepared on a consistent basis (for example, following the guidance provided by ICAEW) then the users of that information are more likely to find it of value.”
No format favoured
Companies report prospective financial information in differing forms and for a variety of purposes. So how does this affect the forecasts produced and will it be reflected in the guidance? The guidance offers general principles on preparing information and specific application notes, which relate to information prepared by listed companies. However, observes Joannou, the general principles are format agnostic it is more about making sure forecasts are based on available information and estimates.
Any extension to the application of the guidance would be on a voluntary basis. However, if market participants felt the principles would be useful then it would become the expected reference for ICAEW members unless they had reason to believe there was a more appropriate way of publishing forward-looking information.
Since prospective financial information is not prepared on the basis of a statutory format, it is bound to vary depending on the motivation for its preparation. “Some prospective financial information may report from a more optimistic perspective, for instance,” explains Brown. “ICAEW’s guidance should make clear that whatever format the information takes the supporting narrative must clearly explain to the user the basis on which it has been prepared. On this basis, the user would fully understand the message of the information.”
ICAEW’s guidance advocates a principles-based approach, applied on a proportionate basis, adds Brown. “This should enable users to clearly understand the information presented to them. The guidance advises that where it has been followed, this fact should be disclosed.”
Moyser observes that the revisions to the guidance aim to identify and segment the key elements based on the nature and intended use of the PFI. “This is useful in some respects as it is clearly stated that there is an expectation for the ‘core’ principles and techniques (parts I and II specifically) to be applied on a more proportion - ate basis depending on the nature of the information to be prepared and issued,” he says. “However, there is always room to improve guidance with practical examples of when such principles may not be relevant or practicable.”
“People are increasingly running their businesses based on forward-looking financial information,” adds Joannou. “There is no suggestion that demand for this type of information has reached its peak. The use of technology to increase the amount of data that can be processed is already affecting how businesses run their models.” Callaghan agrees that the drive for improved performance reporting is set to continue, with forward-looking information increasingly used to help influence decision making.
“The four principles set out in the exposure draft – relevance, reliability, understandability and comparability – are exactly what users are looking for,” he adds. “These ensure that the prospective financial information has predictive value and can inspire the confidence and trust of its users.”
Increased availability of information on a much wider scale increases the expectations of users, who may assume that more information equals better quality and greater reliability – although this is not always the case.
“It is clear that there is appetite for improved reliability,” says Moyser. “This, combined with an effort to make financial reporting in general more useful and relevant to its users, is likely to continue the drive and demand for an increased level of forward-looking information to be available and used. One element of this is evident in the introduction of IFRS 9, which requires a more future-conscious approach to the impairment of financial assets.”
Brown is also in no doubt that more companies will seek this type of information. “There are numerous factors in play here,” he says. “For example, with audit thresholds increasing in recent years there has been a need for prospective financial information to be provided to banks and other lenders to help secure finance for smaller entities.”
Additionally, in the wake of the Kingman inquiry into the FRC and the ongoing review into the expectation gap of the statutory audit process, there will be a greater focus on high quality prospective information. “The exposure draft of ISA 570 (going concern), for example, places a greater emphasis on the quality of management budgets and forecasts,” says Brown. “We believe that this is the first of many changes in focus from the retrospective to the prospective.”