Climate Risk-Adjusted Financial Metrics: Seven Key Practices for Companies
Understanding financial performance in a climate-constrained world
Companies are increasingly expected to integrate climate risks into their financial analysis. However, traditional financial metrics often fail to reflect the financial impact of climate-related costs, regulations, and transition risks. This is where climate risk-adjusted financial metrics come in. These metrics help companies quantify the potential financial effects of their climate exposure, providing a clearer picture of risk exposure and long-term profitability. Through our research, we have identified seven key practices that companies are adopting to incorporate climate risk into financial decision-making.
1. Adjusting EBITDA for Climate Costs and Risks
Companies are beginning to adjust EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by incorporating the cost of their company's emissions and physical climate risks. This helps stakeholders understand the financial impact of carbon pricing, regulatory changes on profitability and impact of extreme weather events.
For example, a manufacturing company includes internal carbon pricing in its financial reporting to reflect future compliance costs, and assessing immediate and future physical climate risks that can disrupt supply chains and operations.
2. Communicating Climate-Adjusted Financials to Stakeholders
Transparency is key. Companies that report climate risk-adjusted financial metrics in earnings calls, investor presentations, and ESG reports build trust and demonstrate preparedness for climate-related financial risks.
A listed company might include climate-adjusted EBITDA in its financial disclosures, aligning with investor expectations on climate risk reporting.
3. Integrating Climate Risk into Investment Decisions
Asset managers and corporate finance teams are embedding climate risk-adjusted financial metrics into investment analysis. This ensures that capital is allocated to projects that remain financially viable in a low-carbon, climate-resilient economy.
For example, an infrastructure fund adjusts return expectations for projects with high emissions or physical climate risks to reflect long-term exposure.
4. Aligning Financial Projections with Climate Scenarios
Forward-looking companies integrate climate risk scenarios into their financial models, stress-testing profitability under different policy and physical risk scenarios. This helps them assess potential cost increases and adjust strategies accordingly.
An energy company might run financial scenarios based on different global climate policies and carbon price trajectories to evaluate investment risks.
5. Using Environmental Cost Margins for Benchmarking
Companies are benchmarking their Environmental Cost Margin (ECM) against industry peers to assess climate efficiency. A higher ECM signals higher exposure to climate-related costs.
A consumer goods company, for example, compares its climate-adjusted profit margins with competitors to guide operational improvements and investor communication.
6. Assessing Stranded Asset Risks
Industries with high climate exposure, such as fossil fuels, real estate, and manufacturing, are evaluating the risk of stranded assets—investments that may lose value due to regulatory shifts, climate policies, or changing consumer preferences.
A real estate firm might factor in rising carbon costs and extreme weather risks when valuing older buildings with poor energy efficiency.
7. Factoring Climate Risk into Discount Rates
Investors and financial teams are starting to adjust discount rates to account for assets with high climate exposure. This impacts valuations, investment decisions, and capital allocation.
A private equity firm, for instance, applies a higher discount rate to industries vulnerable to climate transition risks, such as fossil fuels and heavy manufacturing.
Why This Matters
Climate risk-adjusted financial metrics are becoming essential for businesses navigating climate regulations, investor scrutiny, and shifting market dynamics. Companies that proactively integrate these metrics will have a competitive edge in capital markets and corporate strategy.
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