In a period of uncertainty, the talents and skills of the world’s finance professionals are tested to the highest degree. Currently, we are in the most challenging economic period any of us have ever faced in our careers — yet it’s also the most invigorating. It is now that management accountants and other financial experts are called upon, not only to drive organisation through the downturn, but to ensure that companies have the right structures in place to ensure sustainable success in the long term.
To highlight some of the key challenges ahead, several professional management and accountancy bodies have produced a number of reports and guidance notes, which are designed to enable businesses to not just survive the downturn, but to thrive. The key themes of these reports cover the areas of strategy, risk, reporting and fraud.
As we know too well, a shrinking economy, poor trading conditions, disrupted markets and uncertain supply chains are all major threats to an organisation’s survival. Taking a structured approach to managing these factors and keeping an eye on the long-term strategy of an organisation are the only ways a business can make it through a recession.
At times of economic upheaval and low availability of finance, there’s a real danger that corporate strategy can be overshadowed by the instinct for survival. But in abandoning strategic thinking, not only do organisations run the risk of undermining their chances of advancing their business when the economy improves, they also endanger their ability to weather the storm.
The answer to this problem is to address strategy in simple, relevant ways that keep management focused on the future success of their company — while delivering clear courses of action to survive turbulent times. Maintaining a strategic approach is critical. Research by Deloitte, compiled before most economies were officially in recession, found that 78% of companies were planning high-priority cost reduction programmes.
While many of these businesses had already factored cuts into existing strategic-change programmes as early as 2007, there is concern that more invasive cost-cutting decisions designed to deliver short-term benefits will harm the long-term competitiveness of the companies concerned.
The key to controlling a strategy that is under stress is discipline. At one level, this means looking clearly at strategic positioning, planning and execution, and then analysing how that long-term strategy can be maintained in a depressed economy. In other words, it’s about not panicking. A management team that is confident in its ability to make reasoned decisions will do a better job of securing the long-term future of their business, as well as their survival.
More immediately, it also means that companies still need to apply the traditional processes and disciplines for formulating and executing strategy in response to the recession. Common strategic failings — such as impulsive reactions to problems, across-the-board cost-cutting, failures of leadership, lack of clarity, misunderstanding of risk and ignorance of consequences — become even more damaging if they emerge in decision-making designed to ensure survival.
It has long been advocated that a clear framework to help boards and management teams to engage with strategy should include the use of the CIMA Strategic Scorecard™.
Whether it’s the organisation’s strategy that is under stress or whether a strategy needs to be formulated for management during the recession, the process embedded in the scorecard is a valuable tool that will instill confidence in the board, and ensure it makes astute decisions under pressure.
The scorecard has four dimensions, which focus on strategic position, strategic options, strategic implementation and strategic risks. By dividing the challenge into sections, directors are prompted to express constructive and searching questions to management. It also helps them to determine key points at which they must make decisions. Further details of how the scorecard can be utilised, including case studies and commentary from leading business figures, can be found in our Strategy under stress report.
Another key factor to reconsider at this time is financial risk management.
This issue has ranked high on the corporate agenda since the early 1990s, yet the large losses experienced in the last couple of years indicate that many firms are still a long way from managing their financial risks effectively.
A Management Accounting Guideline (MAG) highlights the fact that although risk management is primarily concerned with managing downside risk, it’s important to appreciate that risk also has an upside.
This upside involves the exploitation of opportunities that arise in an uncertain world, such as the potential to profit from new markets and new product lines. Risk management is therefore concerned both with conformance (controlling the downside risks that may threaten strategic objectives) and with performance (such as opportunities to increase a business’ overall return).
The MAG offers introductory advice on the nature of financial risk, the key components of a financial risk-management system, and the tools that can be used to make decisions under certain conditions. The advice will need to be fine-tuned to fit different contexts, but the underlying message and risk-management framework will provide a basis for discussion among senior management on the drafting of their organisation’s financial risk-management strategies.
The MAG briefly discusses the different types of financial risk that firms may face (and the benefits of managing them), then outlines the basic elements of a risk-management framework. The core sections of the MAG focus on the interlinked issues of risk assessment (or quantification) and possible tools of control. It also looks at how these tools may be applied for each of the main types of financial risk — namely, market, credit, financing and liquidity.
The guidance is both practical and realistic. Risk-assessment and control tools are suggested for each type of financial risk, and real-world examples are used to illustrate the discussion. A case study of the financial risks and the financial risk-management choice available to a fictitious specialist Italian lumber merchant, Pietrolunga, shows how the suggested methods may be applied in practice.
Evidently, there is a wide diversity in the level of resources dedicated to risk management. At one end of the scale, the risk-management function may be performed by a single risk champion or part-time risk manager. At the other end, there may be an entire risk-management department, headed by a chief risk officer with a seat on the board.
No matter how small or large an organisation’s risk-management function may be, the current view is that everyone in the organisation has some responsibility for managing and controlling the risk to which it is exposed. The board of directors has ultimate responsibility, since it chooses the organisation’s risk-management strategy and is responsible for putting into place the organisation’s risk-management framework. If there is no buy-in from the top, there is little chance of success.
When it comes to reporting, the Financial Reporting Council (FRC) has recognised that the global squeeze on liquidity and its impact on the wider economy has increased the challenges for directors preparing corporate reports this year.
This means that directors and audit committees may need to spend more time planning year-end activities, reviewing key assumptions and models used in financial reporting, and reviewing significant accounting and disclosure judgements.
Responding to these challenges, the FRC has published two reports: an analysis of some of the challenges for audit committees (which provides some suggested questions that audit committees may need to address); and an update for directors of listed companies, relating to reporting ongoing concerns and liquidity risk. They may serve a useful checklist and reduce stress as the corporate year comes to a close.
With all the other demands on directors’ time, the danger of fraud may have disappeared off the radar. One new report, Fraud Risk Management – A guide to good practice — is particularly timely. Research has shown that fraudulent practices can often increase in a downturn when employees are feeling an increased pressure to perform, and businesses may feel compelled to cut corners in order to stay afloat.
Surveys on the scale and cost of fraud regularly remind us how vulnerable businesses are to this kind of activity. It has been estimated that organisations may be losing as much as 7% of their annual turnover as a result of fraud. Financial directors should also note that a high percentage of frauds are committed by senior management and executives, and that fraudsters often work in the finance function.
Despite these worrying factors, many organisations still do not have formal systems and procedures in place to prevent, detect and respond to fraud. While no system is foolproof, there are steps which can be taken to deter fraud and make it much less attractive to commit.
Management accountants are professionally trained to analyse information and systems and can have a significant role to play in the development and implementation of anti-fraud measures within their organisations.
The MAG guide is intended to help management accountants in that role, but will also be useful to others who have an interest in tackling fraud in their organisations.
There is no panacea to the economic challenges that lie ahead. Still, it’s always useful to have an independent checklist to ensure that the corporate engine is as finely tuned as possible. Focusing on possible positive outcomes of the downturn, rather than simply concentrating on damage limitation, can also be a welcome turbo-boost for employees. In this way, the board can ensure that once the economy picks up, their business is poised for full acceleration and a smooth road ahead.
The four cornerstones of strategic implementation require foremost that everyone should be clear on the desired outcome. Stating them clearly is one way to ensure people understand what they’re doing, why and how they are making a contribution.
Secondly, the route should be made obvious, by having a well-articulated set of milestones. Short-term goals are easier to understand than a major ‘strategic vision’, and having a series of milestones building to a final outcome ensures that the organisation will be well coordinated.
Thirdly, these milestones should be defined by time. If a strategic option is designed as a reaction to a change in strategic position — which is highly likely in a recession — then milestone deadlines are a way to ensure an important project does not slip.
Fourthly, each of the milestones and the overall project itself need to meet pre-defined standards for quality, and should meet the budgets set out in the plan. These should be explicit.
Finally, and perhaps most importantly, there is a dire need for strong leadership and accountability, both for the project as a whole and for each milestone.
Key Facts on Fraud:
Corruption is estimated to cost the global economy about $1.5 trillion each year
Only a small percentage of losses from fraud are recovered by organisations
Greed is one of the main motivators for committing fraud
Fraud losses are not restricted to a particular sector or country
The prevalence of fraud is increasing globally
For more information, please visit www.cimaglobal.com
Note: The Management Accounting Guideline (MAG) is issued jointly by the Society of Management Accountants of Canada, the American Institute of Certified Public Accountants and CIMA
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