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