Strengthening the CFO’s Role in Strategic Risk Management

Strengthening the CFO’s role in strategic risk management to lead Capital intensive business in market volatility

Capital Intensive Businesses

Capital-intensive business exists with lower margins. Management is always expecting Return on Capital Employed (ROCE) above the cost of capital. The major businesses are Oil & Gas, Infrastructure, Construction, IT etc.

Market Volatility Challenges

Market volatility, ceaseless pressure on margins and demanding stakeholders increase the difficulties of thriving in an increasingly interconnected, interdependent and unpredictable global economy.

Many organizations have yet to adapt to this new state of the economic landscape. Doing nothing is no longer an option – they need to adjust and take action now.

Many organizations are now transforming their businesses to strengthen their organization to save costs, create more client-centricity, restore stakeholder confidence and/or embed new business models.

For many organizations, long-term success depends on the success of these transformation programs. To make it more challenging, the margin for error continues to be small, and the environment in which transformation needs to happen continues to increase in complexity.

Strategic Risk Management

• It’s a process for identifying, assessing, and managing both internal and external events and risks that could impede the achievement of strategy and strategic objectives.

• The ultimate goal is creating and protecting shareholder and stakeholder value.

• It’s a primary component and necessary foundation of the organization’s overall enterprise risk management process.

• It is a component of Enterprises Risk Management (ERM), it is by definition effected by boards of directors, management, and others.

• It requires a strategic view of risk and consideration of how external and internal events or scenarios will affect the ability of the organization to achieve its objectives.

• It’s a continual process that should be embedded in strategy setting, strategy execution, and strategy management.

Identifying concrete steps for CFOs to increase involvement in risk management for investment decisions

Concrete Steps to Increase the CFO’s Involvement in Risk Management

• Build a tight link between risk management and other Business Process

• Lead a corporate-level discussion of Risk Preference, Focusing on Risk Choice and select optimal mix

• Use Risk Analytics to communicate investment and strategic Decisions

Build a tight link between risk management and other Business Process

• Focus on foresee issues which will emerging in the future instead of current issues.

• On the basis of prioritization a guidelines to be issued for which Business performance metrics would be effected.

• Business Planners conduct adhoc analysis of upside versus risk, focusing most, if not all, of other attention on a single “Center Cut” scenario.

• Highlighting exactly where and how risk will affect the Business Plan

• Incorporating systematic stress testing using macro scenarios which will reflects possible impact on financial planning

• Applying probabilistic “financial at risk” modeling for major investment decision these efforts. (Cash in hand vs cash needs)

Lead a corporate-level discussion of Risk Preference, Focusing on Risk Choice and select optimal mix

• It is critical to have clear answers to the following questions before making decisions:

o What is the company’s competence in the market?

o Are the decision makers familiar with the risks involved including the tail risks and understand their potential impact?

o Is the company capable of surviving extreme events?

• Risk appetite articulates the level of risk a company is prepared to accept to achieve its strategic objectives.

• Risk appetite frameworks help management understand a company’s risk profile, find an optimal balance between risk and return, and nurture a healthy risk culture in the organization. It explains the risk tolerance of the company both qualitatively and quantitatively.

• Qualitative measures specify major business strategies and business goals that set up the direction of the business and outline favourable risks.

• Quantitative measures provide concrete levels of risk tolerance and risk limits, critical in implementing effective risk management.

Use Risk Analytics to communicate investment and strategic Decisions

• CFO plays an important role in financial and strategic aspects of investments and the evaluation of major decision. He leads the discussion and rival proposals and solutions and often hold powerful decision rights.

• Major Projects with value at stake comparable to total risk from current company operations are discussed and decided with qualitative list of major risks.

• The CFO is ensuring by defining right set of core financial and risk analytics to run for each option to ensure this value stake is brought to light and debated.

EXAMINING LEADING PRACTICES APPLICABLE TO CFOS THAT CAN AUGMENT A COMPANY’S FINANCIAL HEALTH

Best Practices applicable for Company’s Financial Health

CFO have several options to compete more effectively in the Risk Management decisions. Improving returns starts with rethinking where to play-and with four strategic steps that many companies often overlook when it comes to improving performance.

Where to play: A more profit-focused portfolio

• The most pressing issue for leadership teams in capital intensive industries is whether to stay in businesses in which margins have been relentlessly driven down. Many companies are choosing to exit low-profit businesses that once were considered to be core. As they rebalance their portfolios, they are migrating up the value-added chain, investing in related sectors where new technologies can provide competitive advantages.

• Profit pool mapping is an important tool for assessing whether and where it makes sense to do business. In heavy industries, management teams often are so focused on volumes and tonnage that they overlook where the biggest profit pools are. By understanding the sources and distribution of profits across their industry, companies can gain an inside edge on improving returns.

• The premium end of the business typically represents a very large proportion of the profit pool. The best opportunities often cluster there for companies competing in capital-intensive industries.

• Picking the right place to play in the value chain is also critical to improving returns-and the most profitable spot varies across industries.

Best Practices applicable for Company’s Financial Health How to win: Four strategic steps to improving returns

Risk Management on Projects

Project Risk Management

How does project risk management differ from any other type of risk management? Well in most regards it doesn’t. However, as this is a project focused activity it helps simplify the overall focus by looking only at the core project fundamentals of scope – which are cost, quality and time. Remember that, I may test you later!

There are a number of good training videos available on YouTube that cover this principal. I’ve added a couple below to help bring home the point of this article. I find watching a presentation often easier to take in than reading some else’s thoughts.

Project Risk Management

So what is project Risk Management is all about? In an earlier article I talk about what risk and risk management are about. If you are still confused about what risks are and what risk management is about then read this article, it should bring you into the picture. On projects we talk about risk as any event that could cause an unplanned change to the projects scope – i.e. impact the project costs, timeline or quality of the deliverables, or any combination of the three.

What isn’t always obvious when talking about project risk management is that we also need to consider the positive impact a risk may have on a project – i.e. reduce costs, decrease the time line or increase the quality of deliverables. In reality it’s not very often that project risks present positive opportunities. Never the less, as project managers we have a responsibility to recognize and act on these risks positive or negative. That’s Project Risk Management.

David Hinde wrote a good article back in 2009 about using the Prince 2 Risk Management technique. Without getting imbedded in any particular methodology, the general approach to project risk management should follow a similar framework and this is as good as any for the purpose of this article:

David talks through a Seven Step process,

Step 1: Having a Risk Management Strategy

This means setting up a process and procedure and getting full buy-in from stake holders in how the organization will manage risk management for the project.

Step 2: Risk Management Identification Techniques

Where do you start in the identification of risks around a project? There are many risk management techniques and David suggests a few which are excellent. However, I like to take a step back and make a list of all the critical elements of a project on the basis of “if this task doesn’t happen will it be a show stopper?”. This helps be build a prioritized list of critical tasks against which I can then consider the risks – what could go wrong to impact this task.

Here’s my thought process on risk identification outlined:

List out critical deliverables
List out, against each deliverable, dependent tasks
List out against all dependent tasks and critical deliverables “any” potential event that could delay or stop the delivery to plan.
Grab a template risk analysis matrix and complete the first pass of assessment – probability v impact for each risk.
Take it to a project meeting and use it as the baseline for brainstorming.

Step 3: Risk Management Early Warning Indicators

Don’t rely on basic performance of the project as an indicator that everything is going well. Status reports showing a steady completion of tasks could be hiding a potential risk.

In risk management a number of other factors need to be on the project managers radar on daily basis. Things that I always look for are delivery dates from vendors – how confirmed are they, is there a movement in delivery dates (you’ll only see this if you regularly ask for confirmation updates from the vendor), resource issues – key individuals taking sick leave or personal leave more often than normal.

Delays in getting certain approvals signed-off by the steering committee or other governance bodies – will this impact orders going out or decisions being made on critical tasks? Getting qualified people in for inspections and certification (new buildings for example require a lot of local regulatory inspections). These are just a few of the daily challenges a Project Manager will face and all can be indicators of trouble to come.

As you gain more experience in risk management you start to instinctively recognize the early warning signs and challenge the culprits earlier in the process. You’ll also finds the a good project manager will build-in mitigation for the common project ailments at the very start, sometimes seeing the tell-tale signs when selecting vendors or suppliers will be enough to select better alternatives and this is what I call dynamic risk management at work.

Risk Management in Accounting Firms: Overview of The New Australian Standards

INTRODUCTION

At its most basic level, risk is defined as the probability of not achieving, or reaching, certain outcomes (goals). Risk is measured in terms of the effect that an event will have on the degree of uncertainty of reaching stated objectives. Risk is commonly thought of in this context as a negative connotation: the risk of an adverse event occurring.

This article discusses the risks faced by accounting firms in Australia, and gives an overview of the new risk management standard (APES 325) issued by the professional standards board.

WHAT IS RISK IN ACCOUNTING FIRMS?

In the context of the professional Accounting Firm, risk is not a new concept for practitioners: it has been attached to the profession for as long as accountants have offered services in a commercial setting. However, as the number and size of legal claims against professional public accountants has increased over the years, so too has the issue of risk and risk management also increased in importance.

Risk management is the system by which the firm seeks to manage its over-arching (and sometimes, conflicting) public-interest obligations combined with managing its business objectives. An effective risk management system will facilitate business continuity, enabling quality and ethical services to be supplied and delivered to clients, in conjunction with ensuring that the reputation and credibility of the firm is protected.

WHY IS A STANDARD REQUIRED?

The Accounting Professional & Ethical Standards Board (APESB) recognised that public interest and business risks had not been adequately covered in existing APES standards, notably APES 320 (Quality Control for Firms). In releasing the standard, the APESB replaces and extends the focus of a range of risk management documents issued by the various accounting bodies. Accordingly, APES 325 (Risk Management for Firms) was released, with mandatory status from 1 January, 2013.

The intention of APES 325 is not to impose onerous obligations on accounting firms who are already complying with existing requirements addressing engagement risks. All professional firms are currently required to document and implement quality control policies and procedures in accordance with APES 320/ASQC 1. Effective quality control systems, tailored to the activities of the firm, will already be designed to deal with most risk issues that arise in professional public accounting firm. However, APES 325 does expect firms to consider the broader risks that impact the business generally, particularly its continuity.

THE NEW REQUIREMENTS

The process of risk management in the Professional Accounting Firm requires a consideration of the risks around governance, business continuity, human resources, technology, and business, financial and regulatory environments. While this is a useful list of risks to consider, it will be risks that are relevant to the operations of the practice that should be given closest attention.

Objectives

The ultimate objective for compliance with the Risk Management standard is the creation of an effective Risk Management Framework which allows a firm to meet its overarching public interest obligations as well as its business goals. This framework will consist of policies directed towards risk management, and the procedures necessary to implement and monitor compliance with those policies. It is expected that the bulk of the Firm’s quality control policies and procedures, (developed in accordance with APES 320) will be embedded within the Risk Management Framework, thus facilitating integration of the requirements of this standard and that of APES 320, and ensuring consistency across all the Firm’s policies and procedures.

A critical component of the Risk Management Framework is the consideration and integration of the Firm’s overall strategic and operational policies and practices, which also needs to take account of the Firm’s Risk appetite in undertaking potentially risky activities.

Whilst the standard allows for the vast majority of situations that are likely to be encountered by the accounting firm, the owners should also consider if there are particular activities or circumstances that require the Firm to establish policies and procedures in addition to those required by the Standard to meet the stated aims.

Establishing & Maintaining

Ultimately, it is the partners (or owners) of the Accounting Firm that will bear the ultimate responsibility for the Firm’s Risk Management Framework. So it is this group (or person if solely owned) that must take the lead in establishing and maintaining a Risk Management Framework, as with periodic evaluation of its design and effectiveness.

Often times, the establishment and maintenance of the Risk Management Framework is delegated to a single person (sometimes not an owner), so the Firm must ensure that any Personnel assigned responsibility for establishing and maintaining its Risk Management Framework in accordance with this Standard have the necessary skills, experience, commitment and (especially), authority.

When designing the framework, the firm requires policies and procedures to be developed that identify, assess and manage the key organisational risks being faced. These risks generally fall into 8 areas:

Governance risks and management of the firm;
Business continuity risks (including succession planning, and disaster recovery (non-technology related);
Business operational risks;
Financial risks;
Regulatory change risks;
Technology risks (including disaster recovery);
Human resources; and
Stakeholder risks.

The nature and extent of the policies and procedures developed will depend on various factors such as the size and operating characteristics of the Firm and whether it is part of a Network. In addition, if there are any risks that happen to be specific to a particular firm – caused by its particular operating characteristics – these also need to be identified and catered for. At all times, a Firms public interest obligation must be considered.

A key factor in any risk management process is the leadership of the firm, as it is the example that is set and maintained by the Firms leadership that sets the tone for the rest of the firm. Consequently, adopting a risk-aware culture by a Firm is dependent on the clear, consistent and frequent actions and messages from and to all levels within the Firm. These messages and actions need to constantly emphasise the Firm’s Risk Management policies and procedures.

Monitoring

An essential component of the Risk Management process is monitoring the system, to enable the Firm overall to have reasonable confidence that the system works. The system works when risks are properly identified and either eliminated, managed, or mitigated. Most risks cannot be entirely eliminated, so the focus of the system needs to be on managing risks down (preventing occurrences as far as practicable), or mitigating the risk (handling the event should it occur).

As part of the system, a process needs to be installed that constantly ensures that the Framework is – and will continue to be – relevant, adequate and operating effectively, and that any instances of non-compliance with the Firm’s Risk Management policies and procedures are detected and dealt with. This includes bringing such instances to the attention of the Firm’s leadership who are required to take appropriate corrective action.

The Framework needs regular monitoring (at least annually), and by someone from within the Firm’s leadership (either a person or persons) with sufficient and appropriate experience, authority and responsibility for ensuring that such regular reviews of the Firm’s Risk Management Framework occurs when necessary.

Documentation

A Risk Management system needs to be properly and adequately documented, so that all the necessary requirements can be complied with, and referred to (if necessary). The form and content of the documentation is a matter of judgment, and depends on a number of factors, including: the number of people in the firm; the number of offices the Firm operates, and; the nature and complexity of the Firm’s practice and the services it provides.

Enterprise Risk Management and the PMBOK

Enterprise Risk Management is a term used to describe a holistic approach to managing the risks and opportunities that the organization must manage intelligently in order to create maximum value for their shareholders. The foundation for the approach is the alignment of the organization’s management of risks and opportunities to their goals and objectives. One of the keys to this alignment is the “Risk Appetite” statement which is a statement encapsulating the direction the Board gives management to guide their risk management methods. The statement should describe in general terms what kinds of risk the organization can tolerate and which it can’t. This statement plus the organization’s goals and objectives guides management in the selection of projects the organization undertakes. The statement also guides management in setting risk tolerance levels and determining which risks are acceptable and which must be mitigated.

This article will attempt to review Enterprise Risk Management (ERM) and relate it to the best project management practices found in the PMBOK® (4th Edition). The source for most of my information about ERM comes from a study published by the Committee of Sponsoring Organizations (COSO) of the Treadway commission published in 2004. The Treadway commission was sponsored by the American Institute of Certified Public Accountants (AICPA) and the COSO consisted of representatives from 5 different accounting oversight groups as well as North Carolina State University, E.I. Dupont, Motorola, American Express, Protective Life Corporation, Community Trust Bancorp, and Brigham Young University. The study was authored by PriceWaterhouseCoopers. The reason for listing the oversight committee and authors is to demonstrate the influence the insurance and financial industries had over the study.

The approach suggested by the study, which is probably the most authoritative source of ERM information, is very similar to approaches taken to managing quality in the organization in that it places emphasis on the responsibility of senior management to support ERM efforts and provide guidance. The difference here is that, while Quality methodologies such as CMM or CMMI place the responsibility on management to formulate and implement quality policies, ERM takes responsibility right to the top: the Board of Directors.

Let’s go through the study recommendations and relate them to the processes recommended in the PMBOK. To refresh your memories, those processes are:

Plan Risk Management
Identify Risks
Perform Qualitative Risk Analysis
Perform Quantitative Risk Analysis
Plan Risk Response
Monitor and Control Risks

ERM begins by segregating goals and objectives into 4 groups: strategic, operations, reporting, and compliance. For the purposes of managing projects, we need not concern ourselves with operational risks. Our projects might support implementation of reports and our projects may be constrained by the need to comply with organizational or governmental guidelines, standards, or policies. Projects in the construction industry will be constrained by the need to comply with the relevant safety laws enforced in their location. Projects in the financial, oil & gas, defense, and pharmaceutical industries will also be required to comply with government laws and standards. Even software development projects may be required to comply with standards adopted by the organization, for example quality standards. Projects are a key means of implementing strategic goals so goals in this group are usually applicable to our projects.