Financial Reporting for the Digital Age

A recent article in the Harvard Business Review discusses the need for financial statements to capture the value of modern tech companies, sharing insights on the subject that were gathered from interviews with several of the sector’s CFOs and analysts.

These include:

  • Financial capital is assumed to be virtually unlimited, while certain types of human capital are in short supply. This runs counter to the more traditional assumption that a firm’s success would be determined by the allocation of limited financial capital. In tech companies, the article says, the CEO’s principal goal is to “allocate precious scientific and human resources to the most promising projects.”
  • Risk is now considered a feature, not a bug. While traditional valuation models view risk as undesirable, digital companies chase risky projects that have what seem like “lottery-like payoffs.”
  • Investors are paying more attention to ideas and options than to earnings. Business students, the article says, are taught to value a company by discounting future cash flow or earnings. “That concept is becoming almost impossible to apply to emerging companies that are run as a portfolio of ideas and projects,” the article argues.
  • Financial reporting requirements won’t change any time soon. Although CFOs realize there are limitations in the current financial reporting model, the article says they are pessimistic about whether it will be repaired any time soon.

The article concludes: “It is clear to us from our research and from these interviews that the time has come for investor bodies and companies to rethink the financial reporting model from scratch.”