Metrics
The Environmental Profit and Loss Account (EP&L)

Yorkshire Water develops an environmental profit and loss account ... Businesses need to measure the risks of relying on natural capital whose resources are not infinite – but how?

Burgess COMMENTARY

Peter Burgess

Yorkshire Water develops an environmental profit and loss account ... Businesses need to measure the risks of relying on natural capital whose resources are not infinite – but how?

Chelker Reservoir, Yorkshire Water, North Yorkshire. IMAGE Chelker Reservoir, Yorkshire Water, North Yorkshire. Photograph: Alamy

Most companies are taking a huge risk by treating natural resources as if they are infinite rather than measuring and responding to the business risks created by their dependency on natural capital, according to a new report.

This dependency is still largely hidden from view, meaning that companies could have significant unmanaged risks in their supply chains and material off-balance liabilities, says Accounting for natural capital: the elephant in the boardroom.

The significance is straightforward enough: companies make money from natural capital in one way or another – it includes the raw materials to make products, the ocean on which those products are sailed to new markets and the fuel the ships burn – but, according to the report, they rarely account for the true costs or the associated risks.

This will leave them vulnerable as it becomes more obvious that, contrary to traditional economic and financial thinking, natural resources are not infinite. Companies are already starting to see some of the effects of this in the shape of supply chain disruption and price volatility and some are starting to recognise that paying attention to their environmental impact is not a nice extra for their recruitment posters but a core strand of their long-term business viability, says Lang.

Yorkshire Water, part of the Kelda Group, has recently worked with Trucost to implement an environmental profit and loss account (EP&L) in an effort to integrate sustainability into its core business strategy, billing itself as the first UK water company to take this step.

'We want staff, customers and people in our supply chain to have a clearer understanding of the true cost of water,' says Simon Barnes, Yorkshire Water's programme director. 'It's very new to us, we are in the early days of the journey, but it is a useful tool that we can use to stimulate conversation.'

The test, he says, will be whether Yorkshire Water can inspire others in its supply chain to try something similar. It isn't always easy; it took his team a year to say 'right, let's have a go at this,' he says. 'There are all sorts of reasons why you don't do it – it's not quite the right time, we don't have the right data – but if you keep waiting you will never make a change.'

Investors, particularly large institutional investors such as pension funds, also have a significant role to play in pushing natural capital accounting up the boardroom agenda, says Steve Lang, EY partner and an author of the report. He is not, however, optimistic that natural capital accounting will become widespread any time soon. 'The bleaker side of me says it will take a major catastrophe, a major collapse in crop yield or fish stocks, that really draws attention to it at a broader scale than is currently the case.'

Then there are hurdles to implementation, including the fact that many businesses have outsourced their primary production and do not really know how dependent they are on natural resources, said Richard Mattison, the chief executive of Trucost, an environmental data business.

'The challenge is getting that information back from the companies in your supply chain to provide good information on risk for shareholders and consumers,' he says. 'Then, when you have that data, how do you convert it into meaningful measures of risk and opportunity? That's where natural capital accounting comes in.'

Converting environmental measures into financial metrics makes it possible, for example, to compare the business risk created by generating extra carbon emissions versus that of releasing mercury into a waterway. It also expresses these risks in terms that business leaders are used to using, which makes sense but is not without its difficulties, said Sandra Rapacioli, the head of sustainability research and policy at the Chartered Institute of Management Accountants and another of the report's authors.

'It is the only tool, but it has disadvantages because there is no standard methodology for valuing natural capital, so it is easy to pick it to pieces.' That in turn means that a determined chief executive could usually find reasons to throw the figures out, says Rapacioli.

Barnes, who carries Yorkshire Water's EP&L around with him so he can show it to anyone who is interested, says the numbers themselves are not the entire point. 'I'm sure someone could look at the EP&L I'm using right now and say 'that's not accurate to that decimal point', but it's still helping us to focus on our business strategy and our long-term direction of travel,' he says.

Rapacioli, who suggested using natural capital accounting alongside a variety of other qualitative and quantitative measures, agrees. 'The most important thing is that you look at these risks rather than ignoring them,' she says. After all, if there's any elephant in the boardoom, best deal with it before it runs out of food.

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