Impact of Sustainable Development on the Financial Management of Czech Enterprises

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1 Impact of Sustainable Development on the Financial Management of Czech MICHAELA KRECHOVSKÁ Department of Finance and Accounting Faculty of Economics University of West Bohemia Husova 11, Plzeň CZECH REPUBLIC Abstract: Sustainability and sustainable development have recently been frequently discussed topics in various fields. The knowledge-based society and the sustainable development concept are a phenomenon of the 21st century. Adoption of the concept of sustainability and implementation of sustainable activities are becoming one of the prerequisites for the economic success of businesses in the future. Sustainability has become a way to improve business performance and to provide an increase in the shareholder s value. This paper is focused on the integration of sustainability into the system of business management with an emphasis on financial management and decision making in Czech enterprises. The level of integration of sustainability into financial management and its aspects was examined by two author s empirical research carried out in recent years. In order to collect data, a questionnaire research tool was applied among Czech small, medium-sized and large enterprises across various branches of business branches. The aim of this survey was to identify the approach of Czech enterprises to sustainability and to find out their symptoms in the area of financial management and accounting. The sustainability should be reflected through the whole process of business management. The sustainable performance management requires the inclusion of social and environmental aspects in the evaluation process. It would be advisable to create the integrated system of financial management that would reflect all effects of business sustainable business initiatives. Key-Words: Sustainable development, sustainability, financial management, corporate performance, stakeholders 1 Introduction In 1987, sustainable development was defined by World Commission on Environment and Development as development that meets the needs of the present without compromising the ability of future generations to meet their own need [22]. Transferring this to the corporate level, corporate sustainability can be characterized as meeting the need of a firm s direct and indirect stakeholders (such as shareholders, customers, employees, communities etc.) without compromising its ability to meet the needs of future stakeholders [2]. In order to achieve this goal, all three dimensions of sustainable development have to be satisfied, i.e. economic, environmental and social dimension (a well-known approach called triple bottom line introduced by Elkington and others [3]). Integration of all three dimensions of sustainability is a prerequisite for achieving long-term corporate sustainability. Recent trends within society support the development of the corporate sustainability concept and its implications in business management. Sustainability is becoming a phenomenon. Not only academics conducting research on this topic, but also enterprises are interested in sustainable development. Here, we meet with various problems in its application on both theoretical and practical levels. If we look only at the definition of sustainability at a business level, a number of definitions arise with the development of this concept. However, the definition proves to be problematic for various reasons. The term corporate sustainability is often defined very widely or vaguely [18], [12]. Such s defined framework can then be difficult for enterprises if they decide to adopt corporate sustainability. Then there is no differentiation between corporate social responsibility (CSR) and corporate sustainability (CS); they are regarded as synonyms in many cases. Therefore, resulting definitions of corporate ISBN:

2 sustainability were further analysed and often criticized in academic literature. Differences between CSR and CS have been examined, for example, by Marrewijk [12] or Montiel [13]. Dahlsrud [1] developed five dimension of CSR through an analysis of existing CSR definitions. Marrewijk [12] derives differences on the basis of historical perspectives, philosophical analyses and impacts of changing trends and relationships between corporations, governments and society. He proposed definitions of five levels of corporate sustainability related to the development level of organizations. The enterprises should understand how corporate sustainability is constructed in a specific context and how the concept of sustainable development can be applied to the business level and what enterprises should do when they want to became sustainable [2]. Individual levels of sustainability should be defined and the enterprises should know which activities are specific for individual levels. The questions of how to correctly perceive the concept of sustainability and how to implement it in corporate management in accordance with corporate strategy are widely dealt with; see [4], [17]. The growing importance of the issue of sustainable development in enterprises is confirmed by various surveys that submitted evidence of the current state of this issue in terms of enterprises: 1. The survey Six Growing Trends in Corporate Sustainability conducted by Ernst & Young and GreenBiz Group [5] determined an increasing focus by executives on corporate sustainability in the last years. The executives of companies are aware of the impact of sustainability on achieving business goals. The mentioned survey was carried out in late 2011 and included 272 sustainability executives from 24 industry sectors who are employed by companies generating revenue greater than $1 billion. According to these survey results, 80% of respondents see opportunities to increase revenues through sustainability programs and sustainability initiatives, while the primary initiative, on which most businesses are focused within their sustainability program, is the reduction of costs (74% of respondents). Most companies focus on the environmental aspect of their activities, as evidenced by the growing number of public reports regarding mostly greenhouse gas emissions or water usage. This focus on environmental impacts is based on awareness among businesses of natural resource shortages. Scarcity of natural resources will affect the achievement of business objectives in coming years, particularly in some sectors. The company management also met with an increase in sustainability related inquiries from shareholders and investors (confirmed by 66% of respondents) [5]. 2. According to the survey carried out by GfK Czech Agency for Henkel CR [7], companies most focus on reduction of energy consumption (77%), waste reduction (70%), emphasizing the relationship of sustainability to the company and its products (59%) together with the emphasis on sustainability in relation to customers and suppliers (59 %) in the question of sustainability. Increased activity corresponds to the increasing amount of funding for this area. 58% of Czech companies have expanded their investment in sustainable development projects in the past three years. Future outlook is similar, 55% of companies are planning to increase funding [7]. 2 Problem Formulation There are changes in society and enterprises should correspond to society s expectations. If customers are looking for environmentally friendly products and social responsibility in purchasing decisions, companies have the opportunity to implement sustainable development activities to remain competitive and to be constantly attractive to customers. The main factors that influence the behaviour of the organization in terms of sustainable development include: Maintaining or increasing competitiveness, Profit growth and value creation, Pressure from stakeholders, Exhaustibility and increasing price of raw materials, Responsibility towards future generations and the environment. Corporate goals are changing, leading to changes in business, hence financial management. The success of enterprises depends more and more often on factors which cannot be measured by the means of financial metrics. The financial system of measuring efficiency in such conditions is no longer ISBN:

3 efficient, and indeed prevents monitoring of the implementation of the strategy [15], [16]. To create value for corporate stakeholders, performance should be achieved in all three areas of the sustainable development concept (economic, environmental, and social performance). Therefore performance measuring in the context of sustainability activities is more complicated because the range of possible used metrics is very broad. There is no consistent approach for selection of indicators and metrics, or for integrated performance measurement and management system. Every company is unique and has to choose just the metrics that will be able to assess its performance [19], [10]. Therefore, there is a large discrepancy in what and how enterprises measure and report their sustainability performance [19]. Social and environment performance is unique for each company as well, and it is often very difficult to quantify. Environmental performance is generally related to the amount of resources that a company uses (energy, water, land) and the by-products of its activities (waste, emissions, etc.). Social performance generally refers to the impact a company has on the communities in which it works [8]. This article aims to determine the approach of Czech enterprises to sustainability and to find out their symptoms in the area of financial management with emphasis on performance measurement. 3 Problem Solution 3.1 Research Method The level of integration of sustainability into financial management in Czech enterprises was examined by the author s conducted empirical research. First research entitled The business approach to sustainable development and its impact on financial management and accounting was realized in the year For this research, a questionnaire method was used among Czech small, medium-sized and large enterprises in various branches of business. The aim of this survey was to identify the approach of the enterprises in the Czech Republic to corporate responsibility and sustainability and find out their symptoms in the area of financial management and accounting. The questionnaire contained three groups of questions, namely demographic questions, introductory questions and main questions. The demographic questions were included to gather information about respondents such as legal form of business, branches and region which a company operates in, and size by number of employees and the turnover. Introductory questions were designed to determine whether the companies were familiar with the sustainability concept and how is it significant for them in terms of achieving corporate goals. The main questions were focused, for example, on integration of sustainability into business performance measurement and management and used methods in Czech enterprises. Sample and Data Collection 300 Czech enterprises were contacted and feedback came from 193 respondents. Because different results depending on the size of the company were expected, respondents were categorized into small, medium-sized and large enterprises. The categorization was made based on the Directive of European Commission No. 70/2001. As regards the representation of enterprises in sectors, 68.2% of respondents were from the industry sector, 16.6% from the service sector and 15.2% from the trade sector. Most of the companies were from the Pilsen Region, Karlovy Vary Region and South Bohemian Region, but companies from all regions of the Czech Republic were represented. Table 1: Respondents categorization Number of respondents by size Small 65 Medium-sized 80 Large 48 Total Results and Discussion Performance Measurement and Management Most Czech enterprises have already established measurement and management system of their business performance - almost all large enterprises, more than three-quarters of medium-sized enterprises and more than sixty percent of small enterprises, as Table 2 shows. Some of the most common reasons for performance management system implementation include: strategic management and strategic planning, controlling and remuneration system. ISBN:

4 Table 2: Introduction of performance measurement system Do you have a system of Mediumsized Small performance measurement and management in your company? Large Total Yes No Total It was also tested whether the introduction of performance measurement system depends on the size of the enterprise: H 0 : The introduction of performance measurement system does not depend on the size of the enterprise. H 1 : The introduction of performance measurement system depends on the size of the enterprise. It is possible to calculate the expected frequency as: ni. n. j mi, j = (1) n For i = 1, 2,, r and j = 1, 2,, s. Where: n i., and n. j = marginal lines and columns totals, n = the number of elements on the n scope. Calculating the test-statistic [6]: Where: = observed frequency. (2) The value of (test statistic) is compared with the critical value of - distribution of degrees of freedom on the chosen level of significance (α = 5%), where is the number of lines and the number of columns. The calculated is higher ( ) than critical value of distribution (5.9918). H 0 is rejected and the relation between the two variables was proved. Furthermore, it is possible to measure the intensity of the relation in the contingency table using the Cramer coefficient (V) [14]: (3) Where: q = min The Cramer coefficient is , which proves the weaker dependency. Whether Czech enterprises have established a performance measurement system or not is dependent on the size of the enterprise, but this dependence is weak. It means that companies have made progress in performance measurement, and even small companies already have introduced some measurement systems. All surveyed respondents evaluate their corporate performance mostly based on economic variables and indicators. The most frequently used metrics are the basic indicator of financial analysis (return on equity, return on assets, return on sales etc.). In the Czech Republic, the classical approach dominates in the assessment of corporate performance, as confirmed for example Kocmanová [9] The Inclusion of Sustainability into Corporate Performance Measurement Most Czech enterprises understand sustainability as a way to improve competitive advantage, as can be seen in Figure 1. On the other hand, none of the enterprises that participated in the survey include the concept of sustainability in performance measurement and management. were also asked whether the effect of sustainable activities should be included or not (see Table 3). Further dependence of sustainability inclusion according to company size was again examined: H 0 : The inclusion of sustainability into corporate performance measurement does not depend on the size of the enterprise. H 1 : The inclusion of sustainable activities in the measurement of corporate performance depends on the size of the enterprise. ISBN:

5 Fig. 1: Can sustainability bring a competitive advantage to your company? Table 3: Inclusion of sustainability into corporate performance measurement Do you include the effect of sustainable development activities, if you measure your corporate performance? Small Mediumsized Large Total No, but we believe that should be included No, the influence of sustainable development should not be included Total The calculated is lower ( ) than critical value of - distribution (5.9918). H 0 is not rejected and we can assume independence. The fact whether the effect of sustainable activities should be included or not does not depend on company size Pressure from Stakeholders Respondents also met with an increase in sustainability-related inquiries from stakeholders, for example on corporate reporting. Pressure created by various stakeholders (investors, banks, public etc.) was reported by 37% of small and mediumsized enterprises and 45% of large enterprises. Independence of pressure from stakeholders on company size was confirmed using test statistic Communication is an important part of every organization; it is an indispensable element in achieving corporate goals. This means communication with both external and internal entities. Business entities place great emphasis on communication with their customers and they utilise different tools of communication. Attention of enterprises is primarily focused on business customers, leading subsequently to low levels of informing the employees [20]. should not forget that not only customers but also employees are a key stakeholder group for their sustainability programs and activities. Employees ISBN:

6 are usually ranked under customers, but as some studies showed, for example [5], companies realize that they are a primary driver of sustainability efforts. In order to verify the relationship between economically successful companies and companies acting in accordance with the principles of sustainable development, it is necessary to increase the quality of these reports to bring relevant data that include all the financial, social and environmental activities of the company. There are many data and possible forms for measuring and assessing these impacts. An internal audit can make recommendations in terms of improving the level of business non-financial reporting [11] Further Research Further empirical research among Czech enterprises was conducted at the beginning of It was an additional questionnaire survey which already dealt with individual areas of sustainable initiatives and sustainable performance in more detail. Companies activities were investigated in relation to the economic, social and environmental factors. The next area of interest was also non-financial reporting of Czech enterprises. One hundred respondents participated in this survey. They were divided into categories of small, mediumsized and large enterprises as in the previous survey. At the moment, the results of this survey are still being processed. 4 Conclusion Must all enterprises adopt concept of sustainability? And is it beneficial for them? Of course, it is not an obligation. However, it is up to them to decide whether they want to act sustainably and fulfill the assumptions of this concept. Even though some companies do not want to and their representatives are opponents of this concept, the trends indicate that they will probably be forced to accept the concept of sustainability in the future. Thus, we can observe a growing interest in sustainability, as well as in reporting on sustainable activities, but as shown by the studies, these tools are still developing [5]. constantly try to increase performance and optimize their use of resources. A significant change is that enterprises have begun to pay more attention to cost management and economic effectiveness and efficiency of business processes in previous years. Some of these enterprises were forced to do so by external conditions during the economic crisis. Czech enterprises have made significant progress in performance measurement and management, but they still have a classical approach to assessment of corporate performance. They focus only on economic performance, for which traditional indicators of financial analysis are most often used in its measurement. Most Czech enterprises consider sustainability as a way to improve competitive advantage, but they do not include the effects of sustainable development activities into corporate performance measurement regardless of the enterprise s size. In order to achieve long-term corporate sustainability, all three dimensions of sustainable development should be integrated. Sustainable performance management requires the inclusion of social and environmental performance as well. It is necessary to create the integrated system of performance management that would reflect all effects of corporate sustainability initiatives. This paper was created within the project SGS Paradigm of Development in the 21st Century and its Impact on the Behavior of Economic Entities. References: [1] Dahlsrud, Alexander. How corporate social responsibility is defined: an analysis of 37 definitions. Corporate social responsibility and environmental management, 2008, Vol. 15, No. 1, pp [2] Dyllick, Thomas, Hockerts, Kai, Beyond the business case for corporate sustainability, Business Strategy and the Environment, 2002, Vol. 11, No. 2, pp [3] Elkington, John, Cannibals with Forks: the Triple Bottom Line of 21st Century Business, Capstone: Oxford, [4] Epstein, J. Marc, Roy, Marie- Josée, Sustainability in Action: Identifying and Measuring the Key Performance Drivers. Longe Range Planning, 2001, Vol. 34, No. 5, pp [5] Ernst & Young and GreenBiz Group, Six Growing Trends in Corporate Sustainability, 2012 Download from: x_growing/$file/sixtrends.pdf [6] Hendl, Jan, Přehled statistických metod, Praha: Portál, ISBN:

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