How capital mapping and strategic themes can improve decision-making

Recognition of the importance of intellectual capital in organisational value management has increased over recent decades.

The Value Reporting Foundation (VRF), now consolidated into the IFRS Foundation, has advanced integrated reporting focused on a broad base of financial and intellectual capitals and is driving the use of its Integrated Reporting Framework as the norm for external corporate reporting.

Expanded reporting highlights interdependencies between multiple capitals and the consequent effects on creation, preservation, or erosion of value over the short, medium, and long term.

However, understanding interdependencies goes beyond external reporting. Behind these reports, organisations must fundamentally change to ensure they are also managing their capital on an integrated basis. This requires developing an appropriate organisational culture, which will only happen when dynamic information feeds into management reporting and decision-making. Finance must adopt new skills to expand and improve information gathering as an effective business partner guiding change.

Transitioning to integrated reporting and management requires an understanding of the various types of capitals and their interdependencies, the development of strategic themes, and ultimately, generating insights that enable value-adding strategic decision-making.

Types of capital and their evolution

Traditional accounting focuses mainly on financial and manufactured capital with some recognition of intellectual capital gained through acquisitions. Kaplan and Norton introduced two major tools to enable this approach: the balanced business scorecard and strategy mapping.

Over the last couple of decades the range of capital forms under consideration has extended further. There is now increased acknowledgement of the interests of a wider group of stakeholders including employees, suppliers, business partners, local communities, legislators, regulators, policy makers, and customers. Therefore, the Integrated Reporting Framework now includes social and relationship and natural capital — in addition to financial, manufactured, intellectual, and human capital.

Tangible financial and manufactured capital often have a stand-alone value regardless of their ownership, and this can be relatively straightforward to determine.

Other forms of capital have attributes that make valuation far more complex. Primarily, the value of these capitals is often realised through indirect relationships to any ultimate financial outcomes. Value is also dependent on the contextual environment: What is valued by one organisation may not be by another. A time dimension is also relevant, as value is derived from the future potential financial outcomes that may be realised from that capital. Finally, value is normally only realised through a combination of capitals rather than from one that stands alone.

Whilst it can be complex, significant synergies can be created with the right set of capitals combined under a coherent strategy.

From capital types to mapping

Kaplan and Norton proposed building strategy maps to define cause-and-effect relationships through a set of interconnecting perspectives: financial, customer, internal, and learning and growth. These, in effect, represented the various forms of capital. Developing strategy maps based on only a few perspectives has the risk of inadequately considering other forms of capital. Instead, explicitly mapping out the various forms of capital can be better for identifying the key cause-and-effect relationships between them (see the table below).

From mapping to strategy

A strategic financial forecast that is not justified by specific actions to effect changes in underlying drivers will fail to deliver the predicted levels of performance. Using a capital map can help ensure that desired strategic outcomes are supported by causal factors. You can develop logical and justified strategic themes by tracking cause-and-effect relationships through to financial outcomes. Mapping these strategic themes can highlight the benefits to be gained by linking capitals that are managed in different functional silos (see the chart "Example Strategic Theme" below).

Example strategic theme

This example strategic theme shows how improvements in intellectual capital can be separated causally and temporally from the resultant financial outcomes.

Strategic themes can both guide investments to develop an organisation's capabilities and unlock the potential that is stored in existing or acquired capabilities. This potential is realised by directing the use of capitals towards completing integrated activities that have the highest predicted value creation benefit.

Combining capital maps and specific strategic themes forms an extremely powerful communication tool to get organisational buy-in by clarifying what the strategy is, how it will be achieved, and staff members' personal objectives and their contribution towards strategic success.

From strategy to insight-based decision-making

The next step is to define objectives, measures, targets, and initiatives against each capital and the inter-connections represented in the strategic themes. The objective is to achieve a thorough understanding of historic performance derived from an integrated view of financial and nonfinancial measures. This can lead to an integrated approach to predictive modelling of future performance over the short, medium, and long term.

Determining and quantifying measures for the interdependent relationships between capitals can be very challenging. For example, if employees attend a course to improve organisational efficiency, you can measure training course attendance and improvements in efficiency. However, determining and measuring whether course attendance directly influences efficiency is also necessary. Measurement of course attendance and operational efficiency will be at one point in time and relatively straightforward, but due to the temporal offset between cause and effect, it is far more difficult to formulate an algorithm to mathematically describe the influence that course attendance has on efficiency.

The purpose of mapping capital interdependencies and creating strategic themes is not just measurement as an end in itself. The goal should be to enable data-driven decision-making for financial, operational, and strategic management and success. By establishing and monitoring the correct set of nonfinancial measures it is possible to indirectly measure progress towards achieving positive financial outcomes and ultimately value creation.

— Paul Ashworth, FCMA, CGMA, is a Jersey, British Isles-based practising management accountant, providing strategic insight and enabling business intelligence systems in financial and business services and public sector organisations. To comment on this article or to suggest an idea for another article, contact Oliver Rowe at Oliver.Rowe@aicpa-cima.com.