A well-crafted capital allocation framework isn't just a roadmap – it's a strategic imperative that aligns financial decisions with corporate goals and stakeholder expectations.
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Effective capital allocation isn't just a financial strategy – it's fundamental to creating sustainable long-term value.
The UK Corporate Governance Code’s May 2022 proposal for “distribution policy statements” aimed to make companies explain their capital allocation strategies but this requirement was eventually withdrawn due to concerns about its reporting burden. Currently, there’s limited guidance on this topic. The Financial Reporting Council (FRC) encourages companies to include capital allocation in their section 172 disclosures, but many still offer only basic and boilerplate statements.
Despite this, investor demand for detailed capital allocation reporting, especially concerning climate initiatives, is growing. Comprehensive and insightful capital allocation reporting is increasingly crucial in today's landscape.
This blog explores the key elements of a robust capital allocation framework, drawing on insights from annual report disclosures and communications with investors.
A well-defined capital allocation framework dictates how a company distributes its financial resources to foster growth and maximise shareholder value. Typically, this includes priorities like:
- Investing in growth: Expanding market presence, developing new products, or entering new markets.
- Returning capital to shareholders: Balancing dividends and share buybacks to reward investors.
- Debt reduction: Strengthening financial health by paying down debt and reducing interest costs.
- Strategic M&A: Acquiring businesses that enhance capabilities or accelerate growth.
To enhance clarity and engagement, consider using an infographic to visually represent these priorities (see Anglo American p.76 and Howdens p.33).
A forward-looking capital allocation policy extends beyond shareholder returns. It provides detailed insights into how capital decisions align with broader corporate strategy, emphasising sustainability and long-term value creation.
Companies should provide the rationale for their decisions, clearly explaining how the capital allocation framework supports the strategy to contextualise and provide a more credible rationale for its purpose (see Phoenix p.38 and Softcat p.90).
Effective communication of capital allocation involves more than numbers – it requires storytelling. Utilising simple design tools like waterfall charts or bar charts to illustrate how capital was deployed during the year can help deliver this in a more effective way (see GSK p.79). Case studies can further highlight successful allocation strategies, offering greater insights into decision-making processes (see Experian p.73).
Responding to evolving investor expectations and regulatory pressures, integrating climate- related considerations into capital allocation is becoming imperative. Companies like Burberry are pioneering this approach (see pp.47, 92 and 93). For instance, Burberry issued its first sustainability bond, linking its capital allocation framework directly to its sustainability initiatives.
It clearly detailed how the capital from this sustainability bond was used, explaining the criteria and oversight against which the investments were considered. The proceeds from this bond were allocated towards projects such as green buildings, pollution prevention and control, and environmentally sustainable management of natural resources and land use, with these allocations externally assured by PwC.
By aligning its capital allocation with its sustainability goals, Burberry demonstrates that its financial decisions support its broader corporate goals and create long-term value for both the company and its stakeholders.
Governance plays an important role in effective capital allocation. Through our observations, we found that some companies highlight capital allocation expertise within the board’s skill matrix, demonstrating its importance in strategic oversight (see Reckitt p.66 and see Mondi p.86). Integrating capital allocation as a key focus within corporate governance disclosures enhances transparency and accountability, aligning with investor expectations.
We also observed governance disclosures which addressed common investor questions, including capital expenditure and policies on returning capital to shareholders (see Croda p.83). This proactive approach in reporting helps to build deeper understanding and trust among investors and provides a more meaningful report with greater insight and depth.
An area the FRC has highlighted as appropriate for capital allocation reporting is the s.172 disclosures. Companies should demonstrate, where applicable, how they made capital allocation decisions during the year, linking these decisions to strategy, identifying impacted stakeholders, and addressing any trade-offs involved in the decision-making process.
We observed some companies effectively incorporating these principles. For instance, Marshalls' s.172 disclosures and case studies (see pp.28–29) highlight key investment decisions, showing how stakeholders were considered and how these decisions aligned with the company's strategy and business model.
By adopting these practices, companies can enhance the clarity and relevance of their capital allocation disclosures, aligning them with regulatory expectations and demonstrating responsible governance.
Conclusion
A well-crafted capital allocation framework isn't just a roadmap – it's a strategic imperative that aligns financial decisions with corporate goals and stakeholder expectations. As investor demand for transparency grows, particularly concerning climate initiatives, companies must move beyond basic and boilerplate statements. By adopting best practices, such as integrating sustainability considerations and enhancing the narrative around capital decisions, companies can effectively communicate their strategies and demonstrate their commitment to long-term value creation.
How we can help
Capital allocation reporting can be challenging, requiring clear and meaningful disclosure to effectively demonstrate your strategy and value. At Design Portfolio we are experts in transforming complex financial information into visually engaging and easily understandable reports.
For tailored guidance and impactful capital allocation reporting, get in touch with one of our specialists today.