This article was first published in the January 2016 international edition of Accounting and Business magazine.

As companies prepare their annual reports for 2015, they may feel caught between two conflicting demands. The first is for a long-term growth story, which entails risk-taking, and the second is for reassurance about long-term viability, including a focus on threats to their existence. While the chorus is growing louder for the former, it is the latter that has led to a new requirement.

The UK Corporate Governance Code calls on directors to state the period over which they have assessed the company’s prospects, and whether they have a ‘reasonable expectation’ that it will continue to operate and meet its liabilities. The origins of this lie in the financial crisis and the 2012 Sharman inquiry, which recommended a discussion of viability looking well beyond the 12 months prescribed for the going concern basis of accounting. The issues include combining business planning with risk management; assessing the resilience of a company in stressed conditions; and frank disclosure to investors of the ‘what ifs…’ that could destroy value.

A few companies have had an early go at producing these statements. Derwent London, the commercial property company, blazed a trail in its 2014 annual report. It chose a five-year period, derived from both its strategic review and the typical length of time from planning permission to letting a property. It said that financial metrics with particular relevance to viability, such as cashflow and dividend cover, were subject to sensitivity analysis, but it gave no detail on the assumptions.

Fast-forward to the 2015 report of Grainger, another property company in the private rented sector, and we get a longer statement with some fascinating detail on its stress tests. One scenario modelled a house price crash of nearly 30% over two years, with a slow return to growth; another fed in a long-term price decline of 2% a year. The directors determined these upsets could be weathered over their four-year assessment period. Mitigating action would include selling more properties and ceasing to buy them. ‘Only an unprecedented and long-term lack of liquidity in UK residential property markets would cause any threat to the group.’

The lessons are that boards should:

  • relate the viability assessment period to business planning, not just as a practical matter but as a disciplinary check on any big ambitions
  • consider where the company lies in its business cycle
    be specific about the key assumptions and how they have been flexed
  • give some explanation of how financial stress would be dealt with, and
  • describe any extraordinary circumstances that could see the company off at any time.

These statements cannot do all the work for investors, however. Can you imagine the following statements from the two UK banks whose failure prompted the Sharman report?

HBOS: ‘We are focused on gaining market share and rapid asset growth, even though that means lowering lending standards. If those assets plummet in value, our balance sheet is not strong enough to take the losses.’

RBS: ‘If we buy ABN Amro and it turns out to have a pile of bad assets rather than just being poorly managed, the resulting losses will threaten our existence.’

Viability statements – what is not said as much as what is said – will provide useful evidence of boardroom rigour. But investors will have to exercise their own judgment on management character and the sustainability of the business model.

Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council