Mar 13

eXtensible Business Reporting Language (XBRL). Part 1: Why XBRL?

by David Harper, CFA, FRM, CIPM

CFA |

This five-part series will highlight concepts from our screencast called An Introduction to XBRL. The CFA Institute prequalified this screencast for 0.5 credit hours under their excellent Professional Development (PD) program. XBRL will play a big role in the future of equity and credit analysis, so we really wanted make sure you got a healthy introduction!

Why XBRL? 

XBRL will 'disrupt' the existing financial reporting supply chain, eventually. A workable analogy is to the logistical supply chain. The logistical supply chain is chiefly concerned with getting inputs (raw material) from vendors to the company, so inventory can be created and sold to customers. A longstanding 'holy grail' for the supply chain is real-time transparency: the idea that a company can see into its supply chain and its distribution network. Transparency enables shorter production cycles and more efficient distribution. Dell and Wal-mart, with their just-in-time methods, have pioneered supply chain management. They proved that supply chain information (i.e., real-time transparency) can reduce the capital required to create and/or distribute products.

Now consider the analogous financial reporting supply chain, which is concerned with reporting a company's financial condition to its different audiences (or constituents).

Operations generate economic transactions, which are recorded into the company's accounting or ERP system. These systems produce lots of internal reports (for management) and fewer external reports (for investors, creditors, regulators, and the public). An auditor like KPMG will review some reports (e.g., the Quarterly 10Q) and will formally audit others (e.g., the 10K Annual Report).

Transparency in financial reporting, as a holy grail, ought to enable investors to accurately "see into" or "peer into" the company's financial condition. Of course it's just an aspiration. The 'agency problem' will persist. Investor's don't work onsite at the company; instead, they delegate oversight to the Board of Directors, which in turn monitors management. (and to a lesser extent, the Board may proactively guide management). Investors therefore entrust their holdings to agents; financial reports are just one way of coping with this persistent agency problem.

But, at the moment, financial reports suffer as lagging indicators. In fact, to the analyst, they have three problems:

  • They lag in time; e.g., by the time you read the proxy, it may refer to option grants made fourteen months ago
  • They are prone to error; i.e., if an analyst transcribes or copies financial data from a document into his/her spreadsheet, there is a chance that errors will be made
  • The unstructured data in the reports (and much important detail is contained in the "loose-leaf" footnotes) cannot be fully integrated into analytical software or business intelligence systems.

XBRL holds the potential to help with these problems. Specifically,

  • XBRL-enabled reporting ought to reduce the time span from corporate transaction to analyst awareness;
  • XBRL-enabled data will not need to be copied/transcribed into a spreadsheet or database. This will greatly reduce transcription error
  • By structuring financial data, XBRL will allow the analyst to dynamically interpret, reshape, integrate and 'mashup' company data in service of higher analytical purposes. This upshot is that the analyst spends less time in model manipulation and more time in interpretation and insight.

So, in this series, we avoid altogether the debate about whether and when XBRL will transform financial reporting. When you see that XBRL is XML, and understand what's happened with XML as a precursor development, we don't think you'll have any doubts: XBRL is already on the path to transformation!

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