Ecosystem accounting might become integral to every business
Natural resources are becoming scarce, and businesses must account for their depletion
TLDR: Traditional accounting focuses on a business and all its activities, but it rarely takes outside partners into account beyond the value they supply. One such partner, nature, might no longer be able to supply the value that it used to. This is a problem because nature is crucial for almost every business in some way. Ecosystem accounting helps understand any losses and help drive measures to preserve and improve the services that natural ecosystems provide to businesses and surrounding communities. In a similar vein, social accounting helps understand the impact of a business on its communities and what it can do to improve them. Such extra-financial dependencies have financial consequences and should thus be disclosed by businesses and used by financial institutions. Post originally published on January 30, 20024.
Accounting is creating knowledge. Far from its boring stereotype, without accounting many businesses would not stay afloat or ahead of their competition. Without this data, businesses would lack the data that helps them understand what to do next.
Most accounting frameworks, however, solely focus on the business itself, and do not care much about its surroundings. Key partners, such as suppliers, investors, clients, and regulators only find a mention when they financially interact with the business.
This is a problem because some of these partners are vital for a business, yet they do not interact with it in a financial way. This notably includes natural ecosystems, and social communities in- or outside the business itself. The main focus of this article is on natural ecosystems; much of the key logic can, however, be applied to social aspects as well.
It is worth pointing out that ecosystem accounting is different from ESG reporting. The latter deals with environmental, social, and governance risks and opportunities that a business might choose to disclose. That being said, most of the mandatory ESG reporting these days is focused on environmental risks, i.e., threats that nature or the climate might pose to a business.
Ecosystem accounting, on the other hand, puts natural ecosystems front and center. It aims to understand the value of natural assets, their benefits, and how businesses might profit from it. This helps monitor their health and uncover hidden opportunities that ecosystems might provide.
ESG reporting data might give clues about the health of an ecosystem because it might contain information about the health of a business that depends on it. That being said, it is in the self-interest of many businesses and their financiers to invest into dedicated accounting systems for the ecosystems they most depend on.
Drawing the right conclusions about nature
Accounts are a system of structured tables with some internal logic. In traditional accounting, these tables are used to store key information about business transactions. These almost always involve a form of financial flow and are usually registered with monetary units.
Accounting as a process means filling all accounts from different data sources, and using them to draw key conclusions about a business. Such conclusions might range from basic remarks about its financial health to strategic decisions about targeting new markets, restructuring departments, or redesigning a product.
Conclusions might also be reached about key partners: If a supplier is starting to charge more money for its services, or starts delivering less supplies, this will be seen in the corresponding account. Such a supplier may be in bad shape themselves. And if the business depends strongly on them, it will suffer too.
One key partner for many businesses is nature. At the end of the day, almost everything we consume has been mined or harvested from a natural ecosystem by one or several businesses.
The only problem is that nature is in increasingly bad shape. This varies locally, so one cannot apply a global nature-related metric to all businesses and call it a day. Natural ecosystems do not understand money, hence a key dependency of a business is being omitted from business accounts.
Ecological risk assessments, as they are done for ESG reporting, can help understand this peril. They do not, however, directly quantify the value of a natural ecosystem itself and cannot uncover hidden opportunities that they might pose.
Ecosystem accounting does this by building accounting frameworks that are mostly non-monetary and by focusing on an understanding of the ecosystem itself. Similar frameworks exist for social accounting, often connected with corporate social responsibility (CSR) initiatives.
Five accounts, many conclusions
A dedicated system has been developed by the System of Environmental-Economic Accounting (SEEA) and was subsequently adopted by the UN Statistical Commission.
Because the SEEA system follows a similar accounting structure to the System of National Accounts (SNA), it is quite interoperable and can be used to draw important conclusions. It is flexible in the sense that it can be adjusted to the individual priorities of countries and corporations, while at the same time providing a common framework, concepts, terms and definitions.
Ecosystem accounting according to SEEA starts with measuring the extent of various ecosystems in a given territory. Such ecosystems might be forests, river basins, wetlands, and more. By monitoring their extent over time, one can keep track of any changes.
The first account keeps track of the size of each ecosystem. For a forest, this might be the number of tree-covered hectares.
The second account keeps track of the quality of an ecosystem. Soil depth might be a good proxy for the health of a forest.
The third account refers to ecosystem services. A forest might provide water filtration due to the fact that vegetation in a healthy forest collects and filters rainfall before it reaches rivers and streams.
The fourth account refers to monetary assets of an ecosystem. This refers to the benefits and risks of an ecosystem on its surroundings, and thus is expressed in dollars or another monetary currency. For example, benefits generated by the forest’s water filtration service take the form of cleaner water and reduced water treatment, which can be expressed in dollars.
Finally, thematic accounts are the fifth step. This is a group of accounts specific to policy-relevant themes like the aforementioned forests, biodiversity, ocean, carbon, protected areas, wetlands, or urban areas.
The underlying data sources for these accounts are varied: Land use and land cover is collected from satellites, aerial photos, maps, surveys, and cadasters. Data linked to the quality of an ecosystem is collected through soil sampling, species data, monitoring of the level of public protection (a protected area is more likely to stay in good health), and monitoring of the level of pressure (increased fertilizer use might indicate signs of soil depletion). Data linked to ecosystem services is collected from agricultural and forestry production records, sources about natural risks, and records on recreational activities.
The public sector is already starting to gather this data. By putting it together with their own financial accounts and potential ESG reporting data, businesses and their financiers can gain a deeper understanding of the business and its dependencies.
Ecosystem accounting might be lucrative
Although the public sector has started gathering and evaluating ecosystem data, the implementation remains tricky due to the strong technical demands that a regulation of this sort poses. Grants have been given to various projects doing ecosystem accounting, for example by the EU and the Australian government.
Furthermore, ecosystem accounting might help to identify interesting investment opportunities. A study by the city Calgary focusing on ecosystem accounting of natural infrastructure concluded that their insights might reduce their reliance on costly built infrastructure and might even mitigate some effects of climate change.
Many of the most recent efforts have come from the public sector. To some extent this is normal because many natural assets are managed by the public sector. Nevertheless, the cornerstones for it originally emerged from the private sector. In particular, the Natural Capital Protocol (NCP) aids businesses in assessing their impacts and dependencies on natural ecosystems. According to the UN, there has been growing convergence and increasing opportunities for and interest in collaboration between the NCP and SEEA communities.
Profiting sustainably from nature
By taking natural ecosystems into account, businesses can build a better understanding of their opportunities and risks.
To some extent, such accounting procedures might even circumvent the Tragedy of the Commons that natural assets so often fall prey to. Fueled by a deep understanding of its benefits from nature, a business might decide to invest in a the restoration of a nearby forest instead of building a dam around its production site. A healthy forest might be able to mitigate a sudden flood as well as a dam because excess water can drain through thick layers of soil. A forest might also cost a lot less to build and maintain than a dam.
Had the business only thought about the risks posed by rainfall, it might have resorted to a dam for mitigation and called it a day. Through ecosystem accounting of a nearby forest, it could connect the dots and understand that this natural asset would give it the service of flood protection almost for free.
In addition to this, other parties like nearby communities might also appreciate a lower flooding risk and all the other benefits that a healthy forest brings. This might be of additional benefit to the business in the long run, because a positive public image might boost their revenue, help with talent retention, and drive down their cost of capital.
At Wangari, we aim to include findings from ecosystem accounting and social accounting into our financial models wherever that is possible. This will help financial institutions get an even better picture of where they might want to deploy their capital.
Accounting is far from boring or all about taxes. It can provide crucial insights that, coupled with smart investment decisions, might help keep communities wealthy, healthy and well for decades to come.
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