There are many challenges for the CFO in managing shareholder’s money — providing an adequate return on the capital employed and increasing the share price with the least volatility. And, uncertainty of the future is a risk that may thwart his plans in doing so.
Such risk challenges may come from different buckets such as strategy, emerging new risks, changing economic and regulatory environment, changes in the global ecosystem such as crude oil, currency volatility and so on. Therefore, managing uncertainties depend on how robust is the risk management within the organization.
Strategy: The growth of the business is a function of strategic planning for the medium to long-term — on what to sell, how to sell and where to sell. This would require product ideas, its manufacturing, human resources planning, operational enhancement, developing a marketing strategy, and ideas about current and emerging target market.
Furthermore, all the growth parameters require capital deployment to accelerate with the pace of shareholder’s requirement while keeping an eye on changes in different dynamics. If the capital is invested without monitoring the risks, the actual growth may not be in line with expectations.
The risk may come from wrong identification of products or its pricing, keeping stagnant human resources to squeeze expenses, inadequate investment in enhancing operational activities or mismatch between products and target market.
Therefore, before any investment to achieve any strategic goals, the CFO must perform risk identification, its quantification, and plan of action, in case the risk occurs in reality.
It is often observed that because of lack of risk culture, to achieve the strategic goals, capital is employed without looking at the risks, given the past success. Where risk-based capital (RBC) is employed, risk identification and its management action is a must to acquire a return on capital. On the other hand, where RBC is not employed, the volatility of various economic parameters may derail the plan.
Emerging Risks: The CFOs are not only supposed to monitor the existing risks but also the emerging ones. The world is changing fast — from paper to paperless (the digital) world.
The businesses are to invest in the next big development of the digital world, but they should also to be aware of the emerging risks from it. The digital world is providing many pathways to cybercriminals to track the computer system as compared to the previous time where everything was documented on paper and scope for cybercrime used to be limited.
On top of it, the CFOs should be aware that there are technological risks which come from lack of understanding about the system and there will be a dependence on specialist people. This brings not only the technological risk but also people risk, who are the basis of his decisions. There is a need to have specialists in the risk team who can advise on the digital risks.
Unfortunately, such specialists are short in numbers.
CFO is to work closely with the Chief Risk Officer (CRO). This has to be more as a critical friend rather than a policing approach. This relationship will go a long way in helping the company in managing the risks better.Sonjai Kumar Thus it is important to understand that the digital risk is not the same as cybersecurity risk, but a bigger risk. So in the current scenario, the CFO is not only to manage the return on new capital employed for digitalization but also identifying these risks and its management.
Thus, the success in the future will not only depend on investments but also on risk management on the digital front — as the businesses are entering into the digital world of unknown and untested areas.
Economic and Regulatory Environment: The key risks arising from economic and regulatory changes for the company are from macro-economic factors such as changes in the interest rate, price movement, equity market volatility, industrial development and so on.
The risk from a regulatory environment are changes in the regulation brought in by different regulators such as Reserve Bank of India, SEBI, IRDA, PFRDA and so on.
For example: If the company has taken decisions assuming that the interest rate will fall and more customers will purchase the company’s products. Thus, increase in inflation and subsequent rise in interest rate may divert the customer’s money into the savings (deposits). This will have an adverse impact on the company’s new business which will further lead to increase in per unit expense.
In such cases, the CFO is to perform the stress testing where scenarios are tested for, if the assumptions turn out to be opposite. The action plan should be ready in advance if such scenario turns into reality. This will help the company act quickly, rather than getting caught up on the wrong foot.
The regulations around the world are rapidly changing when it comes to cybersecurity, data protection and a protectionist approach to safeguard the country’s interest. While strategizing and executing it, possibility for such local and global regulatory changes should to considered as it may change the course of doing business.
This is especially true for the companies doing the business at a global level. This requires looking at emerging pattern on the global front and taking decisions keeping in mind the changes. One such example is EU GDPR (General Data Protection Regulation), or Brexit. One simple way to assess the impact of such likely changes is to do scenario analysis and stress testing.
Changes in Global Ecosystem: With Indian businesses becoming global in nature, the Indian companies are not insulated from the changes in the global market. The currency volatility, movement in the crude oil price and any adverse global developments need to be considered while taking current and future decisions.
The classic example in the present day context is of the rising crude oil price that has led to an increase in inflation and subsequent rise in the interest rate. Also, the worsening of rupee against the dollar has further precipitated the prices and imports becoming expensive. Those doing the overseas business will take a hit, in such cases.
The CFO may mitigate such risks by purchasing the derivative contract on currency, and such protection will minimize the losses.
The CFOs should be aware that there are technological risks which come from lack of understanding about the system and there will be a dependence on specialist people.Sonjai Kumar
Maturity of Risk Management: It is evident that the risks are present everywhere and any decision on investment must go through the risk management process.
In India, the risk management is in its early stages of development. It is found that there is a lower take-up rate for the adoption of risk management. The 2008 and earlier crises have taught the world the importance of risk management and the western world is evolving it ever since those days.
Barring few stray incidences of fraud in the Indian market, the big jolting event that could impact the entire economy has not happened in India. So, the Indian corporate are not yet fully aware of the value of risk management. Barring at a place where there is a regulatory requirement. In such places, risk management is performed more for compliance purposes.
Therefore, in order to address the risks, the CFO is to work closely with the Chief Risk Officer (CRO). This has to be more as a critical friend rather than a policing approach. This relationship will go a long way in helping the company in managing the risks better.
In such a case reporting of CRO becomes an important factor; in mature countries, CRO is to report to Board and not directly to any other C-level executive to avoid the conflict of interest and getting the best results in favor of company.
In conclusion, modern day CFO is to manage the risk better with close working relationship with the CRO to address the strategic, emerging, economic, regulatory and global risks better. Importantly, those who will manage the digital risk better in future will survive longer as compared to those who lag behind. History is full of evidences — those who tried to follow their own path without the knowledge and not hedging for the uncertainties, have been wiped out of the market.
About the author: Sonjai Kumar is a certified risk management professional from IRM, London working as an independent risk management consultant.
The views expressed are solely of the author and ETCFO.com does not necessarily subscribe to it. ETCFO.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.