The CFO and Managing Risk

Surprises.?That is what good risk management is meant to avoid.??

The Silicon Valley Bank collapse was a surprise.?

At CFO.University we teach governance and internal controls as the cornerstone of solid risk management.??As companies grow,?especially when they take on third party debt or investors,?the risk management function is elevated to a competency all its own.??(Read about Risk Management, the third competency under our Treasury Pillar.)

Here are some concepts about risk we can learn (or relearn) from these recent events.??

First, risk is frequently defined in the darkest sense as the possibility of loss or injury.???I prefer a more neutral definition, such as the one used by ISO Guide 73, the effect of uncertainty on objectives.?The broader definition incents leadership to understand the nature of ‘positive’ outcomes in addition to ‘negative’ ones in terms of risk.

Does your leadership team have a common definition of risk?

Second, once a common or similar definition of risk is shared between the leaders, the identification of significant risks is a key responsibility of management.?For CFOs, it makes sense to start this process?with the balance sheet and income statement in mind.?

Here are some questions to get finance leaders started:

• What assets on our balance sheet are insured and how comprehensive is the insurance – including business interruption ??
• What significant assets on our balance sheet are not insured and does our risk management plan address them?
• Do third parties control or have access to our assets??If the FDIC didn’t step in, this is where the failure of SVB would have done the most damage to depositors.???
• What events would cause liabilities to be due prior to the expected maturity??
• Do shareholders have payment rights they can exercise against the company?
• Are margins locked in at the time of sale or does the procurement of goods and/or services take place at a different time than the sale? (Note. Setting prices and making a sale or purchase may occur at different times, creating another set of risks to manage)
• Is our cost structure stable and predictable or unstable and erratic.?
• Are there significant contingencies within the business, for example, pending lawsuits, product warranties, defined benefit plans, etc. that contain risk.???

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Risk Management I: Introduction to Risk Management

Much like the baton exchange described between Accounting and Finance, Governance and Risk Management are deeply connected with the actions of one having an impact on the other. This introductory course will frame Risk Management in a manner that will enhance your ability manage and communicate it effectively.

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Is the leadership team properly managing the risks presented via your financial statements?

Third, a key part of defining risk is your approach to those you do business with, your counterparties.??How do you measure the exposure and how much exposure are you comfortable taking with each counterparty.??Normally, customers receive the most attention in this area. Our exposure to them stands out as a receivable on the balance sheet.?But counterparty risk goes well beyond simply getting paid.?I’ll share my thoughts below.??Use them to kick off a counterparty risk management discussion with your team.?If the start ups banking with SVB would have had this discussion, I bet some (many?)?would have attempted to diversify their deposits.??

Counterparty risk includes the exposure we face for nonperformance on an obligation by a counterparty.?

• The supply chain issues manufacturers faced over the past 24 months are an excellent example of counterparty risk.?Supply chains are normally bloated with counterparty risk.?
• I am a big fan of mark to market valuation of assets and liabilities in part to help business leaders understand counterparty risk.?A contract for future delivery doesn’t show up on the balance sheet but the equity in terms of margin and mark to market should be a known quantity.?Financial traders are familiar with this concept but it’s not a prevalent practice in manufacturing or service industries.??It should be.

Here are some questions to get you started with managing the risk you are taking with your counterparties.

• Do you keep a centralized data base of all your counterparties?
• Is counterparty risk considered in your written contracts?
• Does the team agree on the definition of ‘exposure’ to different types of counterparties?
• Do you formally set limits on the exposure you are prepared to take with each significant counterparty?
• Do you have a system to monitor the exposure you have to each significant counterparty?
• Do you know the contract exposure (including mark to market) you have with all your significant counterparties???(if you answered "Yes" to this question, please follow up with me, you qualify as CFO.University's poster CFO of the month)

Fourth is compiling a list of ‘Other” key risks facing the business.?Example items include cyber security, plant shutdowns, workforce constraints, natural disasters,?supply chain hiccups, a reputation threat; even a pandemic or banking system collapse.??Don’t shortchange this list.??By making it extensive you will improve the way the team identifies risk.??

Resources, in both time and money, will be a significant constraint in step 4 so step 4a is prioritizing which of these risks should be actively managed.?

Five is formalizing your risk management process.?This could include:

• ?Forming a risk management committee (often this is part of the audit committee’s mandate in smaller companies)
• Codifying a Risk Charter to capture learning and create a process to formally manage risk
• Adding Risk as an agenda item to periodic management and board meetings

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John Thackeray,?Chief Risk & Compliance Policy Writer, RiskInk

Visit John’s library on CFO.University for leading edge risk management ideas, policies and processes.???

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Risk and opportunity are two sides of the same coin.?They should be addressed simultaneously when any significant new business activity is being contemplated.??Many times downside risks identified early can be mitigated, preventing a future crisis, while not putting the breaks on a good idea.

Other resources to help you manage risk:??

Don’t be Vulnerable - Properly Assess the Risks in Your Business

Risk Management Assessment

In a Volatile Economy, Purchasing Practices Need to Change

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