Carbon emissions are a global challenge, but the way each company responds to the risks and assesses new opportunities should be highly case specific. While compliance is critical, strategy should matter most of all. CFOs must ensure that their organizations meet customer priorities, adapt to regulatory changes, and develop an informed view of carbon management tools. Too often, companies can have multiple, inconsistent, and ineffective carbon data and analyses across their organizations—or lack meaningful emissions data entirely. The finance function is where carbon should meet numbers. In this article, we’ll discuss how CFOs can help their organizations assess carbon’s importance to strategy, and use emissions data to improve decisions.
The CFO challenge
Across industries, sectors, and company sizes, CFOs not only ensure effective compliance and reporting, but they also play a key role in realizing the organization’s core strategic objectives. Carbon management is no exception.
For some companies, tracking and reporting carbon emissions is mission essential, legally required, or both. In addition, particularly in Europe, regulators mandate that companies not only disclose their emissions but also increase their level of assurances—as they would for financial reports. Moreover, a failure to report emissions accurately can have financial and reputational consequences for companies worldwide.
Yet the optimal setting for carbon management is not necessarily “more is better.” Different markets have different regulations, including with respect to the quality of assurances that must be given. The status of US climate disclosure regulation, for example, is currently unsettled. Nor is the value-creating proposition of carbon management universal. Investing in inapplicable processes and tools, for example, squanders company resources, and forecasting price premiums requires disciplined analyses.
Carbon management is highly context dependent: the challenges that a United States–based software or biotechnology company confront are clearly different from those faced by, for example, a steel, cement, or energy corporation based in Europe, or a media company in an Asian market. For a CFO—who is at the intersection of strategy, reporting, and resource allocation—it’s essential to ensure that the company’s carbon management initiatives are consistent within the company’s strategic and compliance needs—and attuned to the needs of key external stakeholders.
Many essential customers across borders do want to understand a product’s carbon footprint, and are beginning to demand greater transparency into underlying metrics. Businesses that use robust carbon reporting can provide their customers with greater transparency, as well as better inform their own opportunities to identify new, differentiated, green-product offerings. Compelling business cases become even stronger under rigorous regulatory frameworks that have global effects, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM).
Moreover, CFOs can use carbon reporting to help reduce decarbonization costs. Not only can they zero in on their most important emissions drivers, but they can also make decarbonization efforts more cost effective by enforcing uniform metrics within the company and improving accountability organization-wide. Investing in more accurate and more granular data can also help inform discussions with suppliers; in fact, many leading value chain players already require supplier disclosure on production-related emissions, and consistent data makes it easier for suppliers to meet emissions targets. And, critically, many investors will expect rigorous detail to understand a company’s intrinsic value under various carbon pricing scenarios. These analyses are possible only with robust carbon accounting.
Finally, carbon compliance may be more complex than it initially appears. The implications can range beyond reporting emissions data to include carbon taxation, expenses under emissions- trading frameworks or carbon border adjustment mechanisms, and voluntary carbon mitigation costs such as carbon credits. Firms that lack detailed emissions data will need to fall back on generalized emissions factors to estimate emissions across scopes. These estimations tend to rely on generalized industry-level averages that are neither tailored to each company’s specific operations (or those of its value chain partners) nor fully reflect more recent sector improvements. Relying on general frameworks can also be less cost effective. For Scope 3 estimates, rigorous value chain carbon accounting ecosystems such as the Partnership for Carbon Transparency (PACT) of the World Business Council for Sustainable Development can help significantly improve accuracy and reduce the costs of voluntary carbon credit portfolio targets that are in line with the Science Based Targets initiative (SBTi) criteria.
Defining a finance function vision
Today, most companies perform carbon accounting in a rudimentary way, which can limit their ability to keep ahead of regulatory developments and potentially create new value. Core initiatives are often carried out by sustainability teams rather than the finance function. And, critically, carbon management can be driven more by regulations than by strategy.
But consider a finance function in which carbon accounting enables better decision making (exhibit). Finance teams would synchronize carbon accounting with financial accounting, using an enterprise resource planning (ERP) system to produce a carbon or CO2 ledger that mirrors relevant finance accounts and bookkeeping rules. Finance teams would also prepare business-relevant KPIs on carbon budgets, intensities, and target achievement, helping other business functions in their daily decision making. For example, if a company’s customer for aluminum parts wishes to reduce its European CBAM exposure by reducing embedded emissions, the company’s sales team would pass the requirement on to its product development team and work with the finance function to create an integrated business case that ensures a meaningful premium for the specially adapted low-carbon product. Product development would design the product by, for example, reducing materials use and using a low-carbon aluminum grade. The finance function would support the product carbon footprint (PCF) calculation and verification to align with the CO2 ledger. These functions would also support capital expenditure engineering to create sound business cases that reflect both cost and carbon impacts for the newly required equipment. Sourcing teams, for their part, would scout suppliers that offer low-carbon aluminum grades, ensuring that relevant upstream PCF data on parts and raw materials get verified and reflected in the CO2 ledger. Sustainability and finance teams would work together to ensure consistent usage of accounting standards, creating internal and external reporting and disclosure documents that are verified and audited by external parties, and oversee overall P&L and balance sheet impact both for financial and carbon effects. In time, these ledgers would integrate with public carbon markets.
Turning vision into action
Effective CFOs turn vision into action, using clear data to inform their decisions. For carbon-based decision making, our experience suggests that finance functions can obtain much clearer, incisive data and take practical steps now. In particular, they can drive consistency throughout the organization, improve internal processes, evaluate and implement the appropriate ERP system, and help ensure that finance has the capabilities and level of cross-organization coordination it needs.
Improving processes
When it comes to combining internal operations with external reporting, the finance function has a head start over other functions; finance professionals can draw from their experience working with accounting frameworks to help meet current and emerging climate disclosure regimes. In practice, that means leaning into lessons from the traditional financial-accounting playbook, such as establishing yearly processes for emissions target setting, determining carbon compensation targets, and budgeting for decarbonization interventions and carbon credits. The accounting function understands the concept of disaggregating and tracing activities (in this case, as they relate to carbon emissions) down to the transaction level, and in a standardized way (as pioneered by PACT), for all activities predicated on sharing data in the value chain. Moreover, they can provide clear emissions data and analyses organization-wide to help managers draw from carbon information to make critical business decisions.
Implement the appropriate ERP system
While well-designed processes are a necessary element of best-in-class carbon management, companies won’t achieve game-changing impact without an appropriate ERP system. CFOs need sophisticated software solutions to handle the flow of carbon information and synthesize it in order to make the right decisions. As Dominik Asam, the CFO of SAP SE, explains, “To enable better decisions, CFOs need consistent data and metrics that connect directly to company financial reporting. Too often, businesses and functions within an organization produce different reports, use competing standards, and generate data that lack a clear strategic purpose. This misses the point of an ERP system—which is to accelerate company strategy rather than to slow it down.”
Today, many companies are going through ERP upgrades for a wide range of reasons, even if the primary driver is not carbon management. Yet given current regulatory and competitive trends, now is a particularly compelling time to significantly improve carbon management capabilities. ERP systems can be immensely complicated and inflexible, which can complicate making updates and future upgrades. As such, companies are likely best served by approaching carbon ERP implementation with modularity (using APIs, for example) to reduce system dependencies and allow for easier changes in the next few years.
Several new and traditional providers are betting that the rapid growth in carbon accounting needs will lead to a booming market for carbon ERP solutions. Newer players include Persefoni, Watershed, Sinai, Plan A, Emitwise, and Normative, among many others. Emerging software-as-a-service solutions—particularly from earlier-stage companies—tend to offer rapid web-based installation and minimal workload and provide aggregated company information (that is, financial results by service line). These solutions have historically been targeted to chief sustainability officers rather than to CFOs. Their emphasis on speed and simplicity may, however, provide less detail than CFOs and investors are accustomed to.
Since investment decisions (sustainability based or otherwise) almost always involve trade-offs, selecting a solution that provides a basic output from simple tools may indeed be the best option. But for companies seeking to enable much more informed carbon-based decision making, data flows will need to be more thorough, and will likely grow even more detailed in the future. Indeed, in our experience, asking which tool is right today is often the wrong question; instead, the objective should be to ensure the organization has a solution and provider that can meet its needs over the longer term.
Multiple incumbent transaction system and ERP players seek to leverage their accounting expertise, integration of financial and carbon accounting systems, ecosystem synergies, and an installed base of large customers to meet more granular carbon accounting needs. Incumbent ERP providers have an advantage: they already process a large share of the company’s data relevant for a step-up in carbon accounting maturity, such as bills of material, processing assets, and accounting and allocation rules.
What will the winning ERP solution look like? Robust carbon accounting to ensure regulatory compliance will be the minimum. Achieving product-level accounting—crucial for downstream customers—will require a much more rigorous capability for at-scale life cycle assessments, as demonstrated by BASF’s SCOTT tool (see sidebar, “A case study in carbon management: BASF and SCOTT”). A PCF will be accurate only to the degree a tool supports primary data exchange from a company’s supply chain. Yet once established, PCFs can be highly relevant to product sourcing, design, marketing, and pricing. These should be further enhanced by robust decarbonization analytics and tracking. Better carbon market intelligence would reduce compliance and voluntary costs. Ideally, each element of the solution would be automatically integrated into report preparation. An effective CFO will demand company-specific functionality to help create differentiating opportunities, including the ambition of overall carbon strategy, regulatory requirements in countries of operation, better insight into a complex product offering, and cost-effective integration with existing ERP systems.
Move beyond inertia
Shifting from a finance and accounting orientation to one that includes carbon management can sometimes feel uncomfortable for CFOs. Because CFOs are rightly attuned to maximizing long-term economic returns—a mission that clearly connects to financial performance and reporting (though of course, accounting rules should not drive strategy)—it can be hard to prioritize emissions reduction.
As a first step, CFOs should define their company’s carbon accounting aspirations: Why is carbon accounting important to this company? Is the goal to meet regulatory standards, or are there material risks in failing to meet the needs of key stakeholders or falling short of capturing clear growth opportunities? It’s helpful to ensure that voices from beyond a traditional finance and accounting background are in the room, since both the risks and the opportunities may be greater than initially assumed. Among other actions, a CFO should outline what the company intends to achieve with improved carbon flows, assess mandated disclosures and the year by which the company must achieve a reasonable level of assurance, and define and prioritize use cases where carbon accounting could preserve or create value—from designing and measuring the impacts of effective decarbonization initiatives to making product-level claims for customer engagement and pricing to guiding emissions-informed sourcing and procurement.
Second, CFOs should identity key gaps that must be bridged. For example, it’s helpful to map how carbon accounting will build on and fit into existing systems and processes; zero in on competencies, skills, systems, and software that may be missing; and begin identifying and perhaps even selecting providers to support carbon accounting and management, as well as providers of necessary auditing or verification.
Finally, if the strategic rationale is compelling and the gaps can be filled in a value-creating way, CFOs should begin implementation. This typically requires the function to create a road map that specifically spells out the amounts and timing of resources to be allocated to use cases. Nor is allocating capital enough; talented employees need to be trained or brought in-house. Decarbonization efforts that have the greatest impact across scopes should be prioritized and followed through in negotiations of customer and other contractual agreements, to reflect the incremental value of emissions tracking and to inform carbon credit purchases—including, when applicable, for Scope 3 emissions compensation.
Carbon management is at the intersection of strategy, compliance, finance, and technology. It’s a “hard problem,” and one that CFOs are uniquely positioned to help solve. As regulatory standards strengthen, customer demands increase, and new tools emerge, effective CFOs will help their organizations to not only meet reporting requirements but also determine when to integrate carbon management into decision making in order to create value.
