We all know the importance of ESG by now, as previously featured in our blog posts on the “E” (Environmental) and “S” (Social) aspects of ESG. But out of all three letters in the acronym, the “G” is often overlooked, because it is viewed as not “directly” linked to sustainability or often not associated with environmental and social “good deeds.” The “G” component was necessary in order to support the “E” and “S.” Plus, it’s practically mandatory for building up long-term, sustainable value, or even for general business compliance.
What is “G” in ESG?
The “G” in ESG refers to the governance factors of decision-making, from policymaking to the distribution of rights and responsibilities among different participants in corporations, mainly including three key decision-making bodies: shareholders, board of directors, and management. Corporate governance also provides the structure through which the objectives of the company are set, and can be seen as a framework to help organisations achieve long-term success.
To achieve that goal, governance-focused managers focus on accountability, transparency, and corporate responsibility. Given that all companies want to attain their goals, corporate governance is relevant to organisations of all sizes.
What topics and aspects does the “G” in ESG cover? And why is it important?
There is no exact list or limitation to what Governance covers. According to MSCI’s ESG Ratings Key Issue Framework, the Governance aspects can be broken down into:
- Business Ethics
- Tax Transparency
Other topics that might be relevant depending on your industry:
- Risk and crisis management
- Data privacy and security
- Anti-corruption and integrity
Third-party sustainability service providers (such as the reporting standards organisation, SASB, and the sustainability rating organisation, Sustainalytics) break down ESG elements through their ESG frameworks and standards. However, in general, they serve the same purpose which is to act as a guideline that gives an overview of how the various ESG elements have to be taken into consideration in the business context.
How are the “G” aspects applicable to SMEs?
As you’re reading this article, you may be wondering “How are these topics applicable to my business?” and may seem that it is too general and not relatable. But this is simply not the case. To incorporate this into your business, do not do a carbon copy of what was “formally” mentioned as a Governance aspect, but rather modify it to your business’ context and capabilities. To be effective for SMEs, a governance framework must include the additional complexities that are part of their nature.
- Having an organisational structure
If your business is too small to be separated into departments and divisions, it is still important to identify the core business functions that need to be managed, such as finance, HR, marketing, and administration. Assigning responsibility for these functions to team members increases accountability and facilitates clear communication. Developing clear job descriptions with proper documentation is key to evolving your business into a well-defined firm, with clear roles, responsibilities, reporting lines, and authorities.
- Having a working capital and cash flow management
This can be as simple as separating the cash sources and bank accounts of your business from your personal sources and accounts of the founders. Routinely monitoring and analysing cash flow is also needed to effectively plan working capital and financing needs and your business’ investment strategies. Having an objective appreciation for the investment value of the business is an important bargaining tool when approaching potential investors.
- Disclosing business’ financials
Prepare basic financial accounts and use this information consistently for registration, reporting, and other purposes. Consistency in maintaining such financial records is important to potential investors and funding institutions because it allows them to better evaluate the business’s performance and future growth potential.
- Clearly establish role of founder(s) and shareholder(s)
Especially when you run a family business or have a family member(s) as your colleague, defining the role and rights of other family members—and communicating to them as well as to company employees is very important. This will reduce the risk of nepotism, informality, and complexity which will affect your business negatively.
Why should SMEs care about implementing good governance practices?
Even if frequently put in relation only to large companies, the principles of corporate governance are also suitable for small and medium enterprises (SMEs). According to the International Finance Corporation (IFC), an international financial institution, and ACCA, a global professional accounting body, these are some of the benefits you can gain from having good corporate governance in place:
- A strong dedication to positive governance improves the reputation of the brand as a whole and leads to greater employee commitment and customer loyalty.
- Have better access to finance, as your business will appear more attractive and less risky for investors and banks.
- Well-structured management bodies (and later, boards of directors) provide critical stewardship, strategic direction, and business connections for sustainable growth.
- A more effective and quicker decision-making process, as a result of better information and communication management across all business functions.
- Better audit culture, due to higher compliance standards implementation.
- Helps support the management of environmental and social risks that could be present in your business.
Now that you’re reading this, you should be able to understand the importance of implementing well-structured and good governance in your business, however small it is. The E, S, and G aspects of ESG are all equally important and are a complimentary factor for you to be able to conduct your business in a more sustainable way. Stay tuned for our next blogs for more ESG and sustainability topics!
Funding Societies | Modalku strives to strike a balance between economic, environmental, and social factors in both our internal operations and our financing activities. We also want to support and guide SMEs that are making contributions in these areas, regardless of what stage they are in their sustainability journey.