What is impact accounting?

When profit is no longer enough:
Understanding Impact Accounting.

Against the backdrop of the climate crisis and growing social inequity, the traditional markers of business success—namely ‘growth’ and ‘profit’—no longer suffice. In response, a profound shift is underway in the realm of financial reporting. Enter Impact Accounting—a paradigm that integrates a business’ traditional financial data with its externalities, providing a more comprehensive understanding of ‘value’ and long-term success. Join us in this article as we explore the origins, key principles, benefits, challenges, and the future implications of Impact Accounting.

What is Impact Accounting?

Impact accounting is an approach to financial reporting that aims to incorporate the environmental, social, and governance (ESG) impacts of a business into its financial statements.

Traditional financial reporting focuses solely on financial metrics like revenue, expenses, and profits, where impact accounting provides a more holistic view of performance by quantifying an organisation’s non-financial impacts (also known as ‘externalities’) and including these on their balance sheet.

These non-financial impacts can include things like carbon emissions, water usage, employee well-being, community engagement, and diversity and inclusion efforts. 

By assigning monetary values to these impacts, we more accurately reflect the true costs and benefits associated with a business and its operations.

Impact accounting helps investors, stakeholders, and the public better understand the broader implications of a business’ activities, beyond just its financial bottom line.

Transparent reporting on impact can also incentivise organisations to improve their ESG performance and align corporate goals with community goals.

Key Principles of Impact Accounting.

Triple Bottom Line (TBL) Approach

Impact accounting is guided by the principle of the triple bottom line, which considers three dimensions of performance: social, environmental, and financial. By evaluating performance across these three pillars, organisations can achieve sustainable outcomes that balance profit with people and the planet.

Materiality

Impact accounting focuses on identifying and prioritising the most significant social and environmental issues relevant to the organisation and its stakeholders. This ensures that resources are allocated to areas where the greatest impact can be achieved, leading to more effective initiatives.

Measurement and Reporting

Impact accounting involves collecting relevant data and setting metrics to measure the organisation’s performance against its social and environmental goals. This data is then used to produce impact reports, which transparently communicate the organisation’s progress, challenges, and achievements to stakeholders.

Integration into Decision-Making

Impact accounting is not just about reporting on past performance; it also informs future decision-making. By considering social and environmental factors alongside financial considerations, organisations can make more informed decisions that drive long-term value and help them mitigate risks.

Benefits of Impact Accounting.

Impact accounting harnesses existing global standards of financial reporting and translates ESG impacts into the shared language of currency. 

As the IFVI puts it: “By monetizing environmental and social impact, we can readily analyze and act upon information using the same management systems that are already well understood by firms, investors, and regulators.”

It improves the fact-base that informs decision-making, and takes traditional ‘risk / return’ models and expands them so that risk, return and impact are considered concurrently.

Transparency and impact reporting also helps organisations to identify and mitigate negative impacts on their community, reputation, operations, and financial performance. Proactively managing risk is not only protective, however. It also reveals opportunities for innovation, differentiation and long-term competitive advantage.

Accounting for impact also helps organisations to prepare and adapt to changing market and global dynamics, regulatory requirements, and stakeholder expectations. And further, by investing in social and environmental initiatives, businesses help to build resilience – both in their organisation and their wider community – thereby improving their chances of long-term survival and success.

Challenges and Limitations of Impact Accounting.

While impact accounting offers numerous benefits, it also presents challenges and limitations that organisations must navigate.

Collecting accurate and reliable data on social and environmental impacts can be costly and challenging, particularly for complex supply chains and when tracking indirect (think third- and fourth-party downstream) impacts. So organisations will likely need to invest in systems and processes to improve data collection and management. It will also require investment in staff training, technology, and reporting systems.

Perhaps most daunting, there is currently no universally accepted framework for impact accounting. 

Whilst Harvard Business School’s Impact-Weight Accounts Project (now, IFVI), has made incredible headway, there is still no globally-accepted standard for reporting practices across industries and regions. Efforts to develop common language and metrics are ongoing but will take time to achieve widespread adoption.

And until then, the task of quantifying social and environmental impacts will be complex and subjective based on individual perspectives on what constitutes a positive or negative impact or outcome.

Global Need for Impact Accounting Framework.

Despite these limitations, the need for a standardised impact framework persists. 

We are at an inflection point where “nearly two thirds of investors globally want information that describes a company’s impact on the environment and society,” and “of those investors who want impact information, 66% want to see companies disclose the monetary value of that impact,” according to a recent PwC survey.

Consumers, investors, shareholders and staff are clearly saying no longer is reporting profit enough. And they’re beginning to vote with their feet.

Profit No Longer Enough.

For proof that EBITDA (total profit) in isolation just isn’t a sufficient gauge of value, you need to look no further than research from Harvard’s Impact-Weight Accounts Project.

Several years back, researchers analysed and monetised the environmental impact of 1,800 leading companies. 

Their findings revealed that of the 1,694 companies with positive EBITDA “252 firms (15%) would see their profit more than wiped out by the environmental damage they caused, while 543 firms (32%) would see their EBITDA reduced by 25% or more.”

Furthermore, their data reveal entire industries (e.g. airlines, paper products, construction materials, containers and packaging) where nearly all companies would lose over a quarter of their profits if they included their environmental impact on their balance sheets.

That’s all to say, Harvard’s research shows that to fully understand profitability and the true value of a company or investment, impact must be systematically considered. An impact lens reveals many seemingly ‘profitable’ companies and investments that are actually racking up social and environmental costs that far exceed their total earnings.

Moreover, if we acknowledge the likelihood that these current ‘hidden’ non-financial costs will eventually surface, it becomes evident that impact is also a crucial indicator of risk and long-term value.

Society Pays When Businesses Do Not.

The rise of Impact Accounting signals a critical shift in how we measure business success. 

It reveals that financial results in isolation – no matter how high the profits appear – are simply no longer a sufficient indicator of true value, risk, or enduring relevance.

Impact Accounting’s focus on integrating ESG impacts into financial reporting offers a more comprehensive view, revealing hidden risks and opportunities. And whilst challenges persist, the global demand for impact information underscores its importance. In this new era, Impact Accounting not only enhances transparency and accountability but also guides informed decision-making for sustainable growth.

The hard truth is that someone always pays for impact. And when business does not account for their environmental and social costs, we all end up footing their bill.