Why natural capital should be on your board’s agenda

Natural capital depletion is set to become a major challenge for businesses in the 21st century as population growth and climate change exacerbate the demands on the earth’s resources.

Businesses cannot continue to take natural assets for granted, and an urgent change in mindset is needed, according to a new CGMA briefing.

Until now, corporate accounting and business models have failed to account for the natural resources that form a crucial part of each company’s supply chain, with these factors being considered infinite and free. However, the depletion of natural capital (which includes geology, soil, air, water, and plants) poses a major strategic risk with the potential to impact financial performance through loss of revenue, reduced profitability, and constrained cash flow.

Businesses risk facing water shortages and scarcity of key raw materials, which would disrupt the supply chain and make them vulnerable to price volatility. Failure to adequately manage risk related to environmental concerns may also lead to fines from regulators as legislation develops.

There are reputational risks, too, as consumers and investors begin to place greater emphasis on these issues. For example, the Swiss National Bank in January announced its intention to divest shares in companies that do not meet its ethical and environmental standards.

Given the severity of the risk, natural capital should be addressed at the board level and valued and managed in the same way as financial capital.

The CGMA briefing, Rethinking the Value Chain: Accounting for Natural Capital Throughout the Value Chain, encourages businesses to consider their dependencies and impacts on critical natural resources and ecosystems with a view to managing or mitigating these impacts.

Undertaking this analysis is of particular relevance to multinational companies with extensive supply chains in emerging markets, especially in regions already facing water shortages, air pollution issues, etc. Environmental impact “hotspots” often lie outside of a company’s direct operations, falling under the control of suppliers or, further down the value chain, the end consumer instead.

Unilever discovered that a significant part of its environmental impact is generated in the way consumers use its products: laundry, skin-cleansing, and hair-washing processes that require water as well as energy to heat the water, which contributes to greenhouse gas (GHG) emissions. In fact, two-thirds of Unilever’s value chain GHG impacts are in consumer use, according to the company. Unilever has therefore prioritised this as an area for improvement and is exploring ways of reformulating products so that less water and energy are required in their use (making laundry detergents equally effective in lower temperature washes, for example) and educating consumers to use lower temperature settings on their washing machines.

Natural capital accounting not only helps mitigate risk, but embedding sustainability considerations into decisions and strategy also helps promote the long-term resilience of the business. Furthermore, it can lead to product and process innovation, open new revenue streams and market opportunities, and provide brand differentiation.

Methodologies used by pioneering companies in the field to account for natural capital, as well as the innovations and opportunities that have come about as a result of this focus, are explored in the briefing.

—Sandra Rapacioli is head of sustainability research and policy at CIMA. Samantha White (swhite@aicpa.org) is a CGMA Magazine senior editor.