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| Integrating Environmental KPIs with Financial KPIs | |||||||||||||
| 14th May 2007 Until recently, reporting using environmental metrics focused on regulatory compliance and regulated emissions tracking. Companies reported total emissions numbers which were unrelated to their economic performance and to the environmental performance of their competitors. In this article Niki Leahy looks at developments in the use and reporting of environmental performance measurement indicators, and how these can be related to the company's financial performance. It also looks at how Du Pont and Alliance Boots integrate and report their environmental KPIs. Ideally, environmental KPIs should record how the company manages its performance as well as tracks the end results. Despite recent legislative developments, the majority of environmental disclosure still remains voluntary and there are few generally accepted standards that exist to guide companies in the sorting, normalising and reporting of environmental data. However, it is increasingly likely that this situation will not last. Current internal and external reporting efforts will be inadequate to manage the increased regulatory and stakeholder requirements for disclosure of environmental information. Measuring eco-efficiency All measures of eco-efficiency require financial information - for calculating the numerator, as well as physical information about the environment, for calculating the denominator. For eco-efficiency measures to be calculated and for the measures to add value, it's essential that they are integrated within accounting and financial management processes. For accountancy professionals, drivers of environmental performance measurements are costs and accountability, with measurement focus on liabilities and impacts on society. Metrics should combine financial data with output and impact effects. Environmental managers have similar goals – they wish to prove that environmental measures bring tangible value to the company. In an ideal world this would result in the development of dynamic environmental performance indicators that assess and predict not only performance but the value of that performance on the company's bottom line. These environmental metrics are quantative, for example, if measuring solid waste generation, metrics could record annual volume, (tons per year), aligned to annual cost of disposal, (£/yr), annual improvement, (% weight reduction), cost saving, (£/yr), or quantity avoided, i.e. tons of waste recycled per year. Leading and lagging indicators Environmental KPIs can be grouped into two categories, “lagging” and “leading”. Lagging indicators are also known as result indicators, for example air emissions released, environmental costs incurred. These indicators can only be validated retrospectively. In contrast, leading indicators, which are also known as “process” indicators, measure internal practices or efforts that are expected to improve performance. Their purpose is less to measure results, but rather to encourage a focus on product or service performance drivers. There are also two main categories which measure a company's environmental impacts. These are environmental performance indicators and environmental management indicators. Table one below lists some in both categories which can be “normalised” against product output data, or turnover. Environmental KPIs should also be related to input costs, such as actual costs of raw materials and energy as well as output costs, such as emissions and waster disposal charges. |
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| “Normalising” performance measurements relate data in two different dimensions, such as production output or turnover. Normalising environmental KPIs with turnover should take into account the impacts of inflation, exchange rates and changes to profit margins. These factors affect turnover, but do not reflect increased business activity, and do not necessarily impact on the environment. Another common form of normalised measure is one which relates an environmental measure such as emissions, waste or energy and material consumption to production. These are useful for operational management purposes because they focus on critical relationships which can be influenced by individual managers of units. Integrated performance indicators or cross cutting indicators can also relate physical and technical quantities to financial ones, such as total amount of waste generated to the value added. Companies using environmental KPIs also need to consider the importance of measuring levels of actual environmental impacts, as opposed to simply measuring amounts of environmental outputs. For example, by considering type of greenhouse gases, (GHGs) emitted as well as amounts. GHGs should be measured by recording emissions at source, or by estimating the amount emitted using conversion factors. GHGs should be reported in metric tonnes emitted per annum, compared to total turnover of company per annum, tonnes CO2 /£m sales. Cause and effect ratios Financial analysis using cause and effect ratios provides the most valuable contribution to management and assessment of the impact of sustainability issues on shareholder value. Amongst others, the consultancy, SustainAbility, has identified six financial drivers of sustainable value creation, including brand value and reputation, innovation and risk profile. By integrating these drivers into models of shareholder value it is possible to link the environmental management of a company with its ability to create value. This makes it possible to construct a framework that enables a financial analysis of sustainability through cause and effect ratios. Future articles will focus on the development of integrated frameworks for the financial analysis of sustainability. The analysis of ratios such as sales / waste value, costs of emissions to sales etc. can add valuable information to the financial ratio analysis. For example, a high cost of emissions / sales and / or a high environmental fines to sales will be limiting the creation of profit. A low sales to waste value will mean a reduction of the sales / current assets ratio that may offset the high value initially found in the sales / fixed assets ratio. Integrating environmental performance with business performance measures – Du Pont Understanding the cost of waste is often the first step in understanding the link between environmental performance and business performance. Ten years ago, Du Pont began to measure the value of their waste, not only in terms of disposal costs, but also ingredient costs and lost yield. Du Pont measured waste as not only a cost, but as unused product, and as an opportunity to improve yield and profitability. Yield improvement, a business metric, translates into source reduction and pollution prevention. Du Pont was also able to measure how environmental improvement increased market share and generated new business. By analysing the use of chemicals in one product, Du Pont reduced the use of non toxic chemicals which lead to the development of a closed loop recycling system. As a result, customers returned chemicals which were then regenerated and resold. This had a considerable impact on costs of waste disposal, as well as material sourcing, all of which the company measured and reported. Several UK retailers have measured and reported the financial savings generated by targeting supply chain problems and environmental impacts. Such initiatives have reduced transportation distances, reduced packaging usage, and reduced energy consumption. These reductions have been quantified as financial savings as a result of combining information systems and accountability. Alliance Boots Alliance Boots have particular environmental risks, in that they operate at the end of the supply chain, close to customers, with a large portfolio of products and raw material usage to consider. Alliance Boots publish detailed information in their annual CSR report on how the company operates with regard to its environmental impacts, and how these help it to achieve its commercial and strategic objectives [1]. The CSR report details achievements in terms of percentage reductions against previous environmental targets, although the financial value of such achievements does not appear to be revealed. More usefully, Alliance Boots relate their energy efficiency achievements to company turnover, and also report reductions in absolute levels of waste disposal against increasing company turnover. However, no data appears to be provided for the financial savings achieved as a result, and nor are costs of investment to achieve such reductions reported. Absolute figures are given over several years for amounts of transit packaging used per single retail product, and this is useful to illustrate trends in reduced weight of transit packaging. This information could more usefully have been related to financial savings generated as a result – or to a calculation of contribution towards profit. Alliance Boots also report their reduced energy consumption, and their output of carbon emissions, which are compared to increased company turnover over time, but no assessment appears to be provided as to the reduced cost of energy used as a result and no calculation as to the future value of reduced CO2 emissions is given in terms of future liabilities and permit costs. Conclusions Environmental indicators should be used to measure the business value of environmental progress, as well as the environmental performance of business operations. This is particularly important for demonstrating the value of environmental efforts, as well as providing data from which a company may design more efficient processes, that reduce material usage and environmental impacts while at the same time increasing yield and profitability. There remain considerable challenges in selecting and implementing appropriate KPIs at the operational level, and in linking these to enterprise value. A multi-dimensional approach such as a Balanced Scorecard or the use of integrated performance indicators which combine reductions in environmental impacts to financial performance measurement is of most interest and value to investors who have only a rudimentary understanding of the business significance of key environmental issues. Quantifying and communicating the real links between sustainability and corporate performance in terms of opportunities and risks is also fundamental. In Niki Leahy's next article, she will examine the frameworks and accountability systems that enable valuations on corporate sustainability to be made. References |
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