This article first appeared in the January/February 2023 issue of Management Accountant-Official Journal, issued by the Institute of Cost and Management Accountants of Pakistan.
The global economy faces many short- term challenges, from continued supply chain disruption to persistent inflation to geopolitical conflict. But even as companies throughout the world grapple with these issues in 2023, they cannot lose sight of the important long- term, systemic issue facing the economy: climate risk. According to a 2021 study, climate change could potentially destroy 18% of the world's GDP by 2050, if global temperatures rise by 3.2°C. Developing countries in warmer climates are especially at risk of economic and humanitarian challenges, meaning that business risk is often greater and more urgent.
What does this mean for businesses – and for finance departments specifically? We discuss the impact of climate change on "economic growth" or "the global economy" in aggregate and as a theoretical concept. We express alarm and concern, but often individual businesses, especially SMEs and regional enterprises that do not operate globally, are not adequately considering the impact of climate change on their own operations or long-term viability, if at all.
A recent survey of global finance professionals by the IMA (Institute of Management Accountants), published in a green paper entitled “Climate Risk and Strategies: Finance Function Readiness to Meet Accelerating Demands” in December 2022, had some concerning findings. About half of the respondents stated that sustainability information, which would include data on climate risk and contribution to climate change, is not used by management for any purpose. Only about 25% of respondents reported coverage of climate and other ESG items as part of their organization's enterprise risk management (ERM) processes. For companies that are addressing sustainable business matters, climate is grouped together with other environmental, social, and governance issues, not as a stand-alone category. This can make locating and analyzing data related solely to climate difficult, especially in organizations with small finance teams.
Regarding ERM, only a smaller number of companies had moved beyond risk identification to actual assessment, mitigation, and management of climate related activities. And a large majority of respondents reported that their organizations are not performing any scenario or sensitivity analyses regarding climate-related risks. All these issues were significantly more pronounced for SMEs and privately owned companies.
What these findings seem to indicate is that companies and finance teams in particular have much work to do in identifying their climate priorities and executing strategies to address them. There are essentially three challenges that the finance function must address:
- Working cross-functionally with other departments along the value chain to measure climate risk and (for public companies) disclose it to investors and regulators.
- Assessing the reliability of these data measurements and creating internal control frameworks to ensure the accuracy of this data (e.g. COSO's Internal Controls Integrated Framework).
- Mitigating exposure of the business to climate risk through proactive ERM and decision analysis.
In all three of these areas, finance will be expected to lead the organization due to its ability to measure what matters, set goals, and gauge progress throughout an organization and its supply chain. And in meeting these challenges, the finance function will have to draw on one indispensable role on the team: the management accountant.
Leveraging Financial Analysis Skills to Address Climate Issues
Management accountants play a crucial role in business in three important ways. First, they are the financial analysis experts. This means they are trained to decipher complex data and not only report on it but also derive what it means for the organization. Management accountants do not stop at documenting costs, losses, and profits. They go “beyond the numbers” to find out the underlying reasons for those outcomes, which entails an intricate knowledge of operations and processes. This is all essential to the reporting and disclosure of important information whether formally to investors for public companies or more informally to stakeholders at private firms.
When it comes to climate issues, this expertise is essential. With IMA's survey showing that many businesses are still in the process of gathering and evaluating key data, the skills associated with financial analysis will have to be quickly and consistently applied to information and patterns related to climate risk. Management accountants can use data analysis to not just determine the relevant facts but also help identify which activities and operations are most at risk or most contribute to carbon emissions, and how the company can shift towards better management and practices. They can, for instance, work with the operations teams to identify areas where extreme weather events will be most likely to impact business, as well as how companies can conserve energy and resources. Public companies also need a familiarity with the emerging reporting landscape on climate such as the efforts of the International Sustainability Standards Board to set a global baseline which regulators may increasingly adopt and what information is relevant and necessary. The management accountant is well-equipped to navigate these rules and guidelines. For private companies, finding the relevant data at all is still a challenge, and the management accountant's skills will be instrumental. When it comes to an organization's climate data, it is important that that data be reliable, and that is where the management accountant's data analytic skills and internal control skills can be leveraged.
Drawing on Cross-Functional (And Cross- Organizational) Insights to Inform Decision Making
Management accountants are typically trained and required by the needs of business to be keenly aware of the operations of all departments across a business.
This comes from the role of the management accountant as overseer of all factors that can impact financial performance, meaning intricate knowledge of the business' value chain. Increasingly, as supply chains have become more global in scope, the needs of ERM have expanded so that management accountants have to pay attention to many financial and non-financial issues throughout the supply chain. This means the management accountant of today is more aware than ever before to what is going on across their own business and that of the (often global) supply chain.
The benefits of this expertise and approach to addressing climate issues are clear. Climate risks and carbon emissions occur across an organization, and a holistic view is necessary to create an accurate picture and make the right decisions. And as regulatory and investor efforts to strengthen reporting requirements highlight, an approach that focuses only on the organization is insufficient when it comes to climate. Increasingly, companies are expected to measure, for instance, not just direct or “Scope 1” emissions but indirect emissions (“Scope 2”) and those caused by third parties in the supply chain (“Scope 3”). Furthermore, the operations might have limited exposure, but a major supplier may be in danger of extreme weather events, or a major consumer market may be tightening regulatory requirements that could impact one's ability to export. Management accountants, with their multifaceted and cross-functional outlook, will be the primary drivers of insights that lead to informed, decisive, and farsighted decision making on climate.
Playing a Leading Role in Strategic Planning Around Climate
The third important function of the management accountant is participating in strategic planning and decision making a fundamental shift in expectations over the past couple decades. As more routine accounting tasks have been automated, the management accountant has been called upon to use the insights they derive from data and their broad knowledge of the organization to be a strategic business partner, earning a seat at the leadership table where the important decisions are made and where goals are aligned with values and strategy.
When it comes to addressing climate issues, the management accountant already has the data-driven insights and cross-functional and supply chain knowledge to inform the conversation around strategic planning and embedding climate risk mitigation and carbon emissions reduction goals into the overall business plan. Transforming an organization to be climate resilient and make a positive impact on the world will require a combination of detailed knowledge and big picture thinking. With the profession engaging in research on best practices in climate and other sustainability issues (see, for instance, IMA's report "Management Accountants Role in Sustainable Business Strategy: A Guide to Reducing a Carbon Footprint” from last year), management accountants are constantly upskilling and enhancing their value to organizations as companies across industries and across the world grapple with this common challenge.
An Ethical Challenge Requires an Ethical Profession
Climate issues should be seen as a challenge to financial viability and profitability, as the disruptions we are likely to face will be immense. But it is important to remember that this is also an ethical matter: companies owe it to their own stakeholders to factor climate into their business analysis, disclosure, and overall strategy. This is another way in which management accountants are ideal for tackling these problems. The U.S. CMA® (Certified Management Accountant) certification, and other professional accounting certifications, including ICMA Pakistan's CMA, mandate the highest ethical standards and require certified professionals to closely follow best practices in ensuring ethical reporting and decision making including emerging ESG issues vital to companies across industries and their shareholders, employees, and customers.
The business world is behind on addressing climate risk, and they need to view it not as an abstract and unfortunate global issue, but as a phenomenon present in their operations and requiring immediate attention. The management accountant can and must be an important voice in the room when it comes to reminding organizations of what they have to do and advising on how to do it.