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

This article was originally published 26 March 2020.

There is a misconception that to be a director, you must have an in-depth understanding of financial reporting, however this is not the case. While all directors must understand financial viability, diversity in director skills, knowledge bases and commercial backgrounds also play an important role for the Board.

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?

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

The Australian Securities and Investments Commission (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 focusing 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 audit partners and specialists in the NFP sector, who regularly attend board meetings, our experts have 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 is two comments our experts recently heard 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’s important to respect each director’s expertise, it’s also vital that every director understands the financial position of a company or organisation and how the financial decisions made will affect it. As highlighted earlier, directors are responsible for ensuring 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.

What can boards and individual directors do to counter this issue?

Our experts have outlined a few simple actions that boards can take to help facilitate active financial discussions and engage all directors regardless of expertise. This includes:

• Encouraging each person to contribute. Never belittle or dismiss someone for asking a question, especially from non-financial experts enquiring about financial topics. In our experience, it’s sometimes the simplest of questions that are sometimes the most revealing
• Providing literacy training based on the entity’s financial information. This may be as a group, or as part of the induction process
• Ensuring 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
• Requesting evidence of when creditors are due to be paid and the company or organisations’ ability to comply with normal terms of trade
• Understanding the current level of bank lending and the ability to access additional funding if required
• Understanding 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, ensuring 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 an 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
• Providing sufficiently detailed and written explanations for variances between planned and actual performance
• Allowing 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
• Being transparent and present both positive and negative news.

Important considerations for boards and directors

Boards and directors need to be aware of current and potential issues and how these will impact the company, organisation or NFP entity. As more companies and organisations are impacted by the current cost of living conditions and an evolving regulatory landscape, it has further highlighted the importance of boards and directors working collaboratively to understand their organisation’s financial position and quickly identify current and potential risks.

In particular, some of the top issues NFPs need to be prepared to manage include solvency, employee and volunteer obligations, payroll compliance, fundraising pressures due to the cost of living increases, environmental, social and governance (ESG) reporting and cyber security.

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.