All organizations depend on various forms of capital for their success. These capitals are stores of value that, in one form or another, become inputs to the organization’s business model. They are also increased, decreased, or transformed through the organization’s activities as they are enhanced, consumed, modified, or otherwise affected by those activities. For example, an organization’s financial capital is increased when it makes a profit, and its human capital is increased when employees become better trained.
The International Integrated Reporting Council (IIRC) adopted the concept of multiple capitals and identified financial, manufactured, intellectual, human, social and relationship, and natural capital to represent stores of value that are the basis of an organization’s value creation.
The Integrated Reporting <IR> Framework makes use of the capital model for a broader explanation of performance to make visible a meaningful assessment of the long-term viability of the organization’s business model and strategy.
The capitals are sometimes also referred to as “resources and relationships.” Using the term “capitals” emphasizes the role of the various capitals as stores of value that can be built up or run down over time but must be maintained to continue producing a flow of benefits in the future.
Content Elements of the Prototype Framework
The concept of value focuses on increases and decreases in the capitals.
Reporting on the capitals is embedded in the Content Elements of the Framework.
Organizational overview and operating context includes consideration of the capitals’ availability, quality, and affordability.
Governance includes how the organization’s culture and ethical values are reflected in its use of and effects on the capitals.
Opportunities and risks relate to relevant capital’s continued availability, quality, and affordability.
Strategy and resource allocation includes how the organization’s strategy and resource allocation plans affect key capitals and risk management arrangements related to them.
Business model includes a description of relevant capitals.
Performance and outcomes includes a demonstration of the connectivity of financial performance with performance and outcomes regarding the other capitals.
Future outlook includes the implications for future performance and outcomes of the availability, quality, and affordability of capitals the organization uses and why they are or may be, important to the organization’s ability to create value over time.
Sustainability reporting is considered to be the practice of reporting on an organization’s impacts on the environment, society, and the economy.
The economic aspect of sustainability reporting is intended to reflect an organization’s impact on the economy within which it operates. Traditional financial reporting, in terms of balance sheets and profit and loss statements, reflects the organization’s own financial health.
Manufactured capital are the manufactured physical objects (as distinct from natural objects) that are available to the organization for use in the production of goods or the provision of services, including buildings, equipment, and infrastructure, such as roads, ports, bridges, and waste and water treatment plants.
The most easily identifiable elements in socio-economical endeavors, i.e., production, utilization, or exchange, are the human-created, production-oriented equipment and tools. In an enterprise, the plant and equipment are recognized as tangible capital and the inventory as a short-term asset. The accounting of these items may vary by regulatory requirements regarding valuation, depreciation, and taxation.
<IR> defines it as: Manufactured capital refers to material goods and infrastructure owned, leased, or controlled by an organization that contribute to production or service provision but do not become embodied in its output. Examples include tools, technology, machines, buildings, and all forms of infrastructure, including public road networks available to the organization.
The evaluation criterion for the necessity or benefit of manufactured capital is its efficient use through which the organization can be flexible and responsive to market or societal needs, enabling innovative products and services and faster time-to-market.
The question is, “can it be used efficiently, or how can it be used efficiently; can it, or how can it, enhance sustainable development?”
It is not rare to see abandoned buildings and equipment left to decay to the elements. Flexibility and adaptability is not an inconsequential principle in evolution and in history.
Manufactured capital can embody significant elements of intellectual property (e.g., equipment manufactured using patented technology), a component of intellectual capital.
Manufactured capital is not financial capital. Rather, it depends upon the flow of financial capital to allow resources to be deployed to build it.
Financial capital is the pool of funds available to an organization to produce goods and services obtained (the source) through financing, such as debt, equity or grants, or generated through operations or investments.
This description focuses on the source of funds rather than its application which results in the acquisition of manufactured or other forms of capital.
Financial capital is a medium of exchange that releases its value through conversion into other forms of capital. A significant portion of what is now regarded as financial capital, in fact, relates to derivatives fundamentally based on other forms of capital (e.g., carbon and water).
Natural capital includes all renewable and non-renewable environmental stocks that provide goods and services that support an organization’s current and future prosperity: air, water, land, forests, and minerals; biodiversity and ecosystem health. Natural capital may also be defined as biotic (living/organic) and abiotic (non-living/inorganic). These definitions are often used in preference to renewable and non-renewable for natural capital such as fish which would always be defined as biotic, but dependent upon the stock in consideration at a given point in time, its estimated use and replenishment levels, may fall into renewable or nonrenewable.
Human societies feed on natural capital withdrawal and use different ecosystem services. Natural capital and ecosystem services are the real sources of wealth despite the common belief that only labor and economic capital are such a source. Natural capital is the basis not only of production but of life itself.
Intellectual capital are the organizational, knowledge-based intangibles, including intellectual property, such as patents, copyrights, software, rights and licenses; “organizational capital,” such as tacit knowledge, systems, procedures, and protocols; intangibles associated with the brand and reputation that an organization has developed.
Intellectual capital is primarily about a business’s internal reporting, management, and control. It covers issues that are central to the organization’s future. Statements on intellectual capital help clarify how an organization creates a competitive advantage by providing a narrative that explains value chain positioning and the business model for value creation. It is important to consider how to communicate the value of R&D, innovation, and future prospects and why intellectual capital will result in future success, making identifying, measuring, and reporting on intellectual capital particularly important.
Intellectual property is that part of intellectual capital over which the organization has specific legal rights (such as patents). On the other hand, intellectual capital includes broader knowledge-based intangibles over which specific legal rights may not exist, such as (the knowledge resources of) employee competencies, customer relations, financial relationships, and communications and information technologies.
Human capital are the people’s competencies, capabilities, and experience, and their motivations to innovate, including their alignment with and support for the organization’s governance framework and risk management approach, and ethical values such as recognition of human rights; ability to understand, develop, and implement an organization’s strategy; loyalties and motivations for improving processes, goods, and services, including their ability to lead, manage, and collaborate.
Human capital is understood to be these capacities as they are relevant to the task at hand, as well as the capacity to add to this reservoir.
Human capital lies within the organization’s control through its ability to select, manage, and develop employees.
Competencies are tacit and implicit knowledge and attitudes, including skills acquired through formal education and on-the-job training.
Capabilities are the sum of expertise and capacity (ability to carry out an organizational activity).
Organizational culture per se is not part of human capital (it is included in social and relationship capital) but plays an important role in the ability of an organization to add value through human capital development.
Human capital is dependent on other forms of capital to be fully realized. Intangible assets seldom directly affect financial performance but work through a complex chain of cause and effect.
As individuals “own” their human capital, there must be a desire by the individual, or a certain relationship between the individual and organization, for individuals to invest their human capital in the firm and for an organization to realize the benefit.
Leadership is a key concept in the development of human capital.
Forum for the Future’s Five Capitals Model also includes joy, passion, empathy, and spirituality in its definition of human capital.
Social and relationship capital
The institutions and relationships established within and between each community, group of stakeholders, and other networks (and an ability to share information) to enhance individual and collective wellbeing. It includes shared norms and common values and behaviors; the relationships and the trust and willingness to engage (such as loyalty) that an organization has developed and strives to build and protect with customers, suppliers, business partners, and other stakeholders; an organization’s social license to operate.
The relationship attribute of a network within an organization may overlap with dimensions of intellectual capital, which includes “organizational (or structural) capital.”
To clarify the differences in terms of the carrier of each:
For human capital, the carrier is the person.
For social and relationship capital, the carrier is intra/extra-organizational networks.
For intellectual capital, the carrier is the organization.
Social capital is the ability of people to work together for common purposes in groups and organizations. Social capital inheres in the structure of relations between actors and among actors. It can take the form of the capacity to facilitate action and the potential for information.
Aspects of social and relationship capital in a business context relevant to <IR> include the strength/efficacy of supply chain relationships (e.g., establishing quality expectations, just-in-time delivery systems, and recycling programs), community acceptance, government relations, relationships with competitors (e.g., coming together to develop industry standards), and customer loyalty.
Other intangible capitals frequently rely on social and relationship capital to be realized.
Trust is a common feature of social and relationship capital. Trust lubricates cooperation, and cooperation itself breeds trust. Without trust, no matter how knowledgeable employees are, if they believe they are working in a hostile low-trust environment, they will hoard information, avoid collaboration, and display very low levels of creativity.