Last month we discussed the impact of the Turnbull report in the UK and the guidelines as recommended via the Institute of Chartered Accountants for implementation.  Beyond that how can we create a pathway for change to happen?  There is the potential for many answers to this question but one suggestion could be to integrate financial management with risk management.

 

Risk is moving up the corporate agenda because of compliance issues, business risk is a matter of judgment and perspective, different stakeholders in a business see the approach to risk and its management differently.  Risk and its management must be seen as a positive for a business as well as a potential negative. Too often we tend to dwell on the negatives and at times therefore missed opportunities abound.

 

What are the components of business risk?

 

1. Strategic - the risk of planning failure:Poor marketing strategyPoor acquisition strategyUnexpected changes in consumer behaviourPolitical and regulatory change

 

2. Financial - the risk of financial controls failing:Treasury risksLack of counterparty and credit assessmentFraud and its controlSystemic failurePoor receivables and inventory management

 

3. Operational - risk of human error, either willful or by omissionSystem mistakesUnsafe practicesEmployee routinesWillful destruction

 

4. Commercial - risk of business interruptionLoss of key personnelSupplier failureLegal issues and compliance

 

5. Technical - risk of physical assets failingEquipment failureInfrastructure breakdownFire and physical impactExplosion and/or sabotagePollution Natural events

 

In this scenario financial risk is seen as a component of business risk and not business risk management.  How can the above points be overlaid in such a way as to add value to the finance function of the firm?  We are very well drilled as a business community in the risk and return scenario if we pay attention to the above aspects we can develop another "R", i.e. regret.

 

a. Risk - the level of acceptable exposure in order to create shareholder value.

b. Return - the level of shareholder value created in line with the level of risk accepted.

 

A and B above are the traditional measures of value creation and can be graphically illustrated in dollar and percentage terms readily by todays' computer environment.  However C - Regret, is the additional level of analysis required to link business risk analysis with financial risk measurement.

 

c. Regret - the level to which a decision for a given return will be regretted in the future if the worst- case scenario comes to pass.

 

This level of regret can fundamentally change the way in which a financial decision of risk and return is implemented within the firm.

 

Capital is a scarce resource and the business community is looking for smarter ways in which to invest those resources.  Regret as a decision tool, along with integrated risk management in my opinion will over time fundamentally change the approach to the definition of share holder/stakeholder value.