Strategic Management Heads List of Hot Spots for Risks

While the global economy is on its way to recovery, there will still be pressing issues that will keep finance executives on their toes throughout the new year.


According to a new study by the Corporate Executive Board, a business-research company, finance executives believe that strategic change management is the top hot spot for risk in 2010.

The report also offers recommendations on what finance executives and internal audit committees can do to mitigate these risks.


The top 10 risk hot spots for 2010 listed by the finance executives are:


1. Strategic change management. The makeup of many companies is changing through M&A, divestitures, product portfolio rationalization, and other strategic developments to ensure growth in the new economy. Together with internal reorganizations to support these shifts in strategy or to simply boost earnings performance, these major business transformations are fundamentally altering the risk and control environment.


2. Capacity. Cost-cutting initiatives and uncertain future demand is causing concern about companies’ ability to increase capacity again when there is an upturn in the economy. Audit departments should evaluate the company’s strength in three key areas—rehiring and developing personnel, matching IT capabilities to new demands, and ensuring preferred access to limited suppliers.


3. Incentive plans. The media, investors, and the general public intensely scrutinize companies for supporting policies that maximize moral hazard. Internal Audit must evaluate compensation structures, particularly paying close attention to bonus potential, to ensure these policies are in line with the company’s risk appetite.


4. Human resources. HR risk remains a focus as significant organizational change continues to affect companies. Staff turnover increases the loss of the “human face” of controls and also creates skill gaps that may not be easily bridged. Audit departments must assess the impact of organizational change on the control environment and evaluate company skill gaps and HR’s action plans to address them.


5. Fraud. The level of structural change organisations are undergoing is increasing the risk of fraud in two ways. First, the number of broken processes and controls is on the rise due to strategic and structural changes. Second, senior management and middle management—the traditional “eyes on the ground”—are focused on executing new mandates and not on potential fraudulent behavior. To address this risk, finance executive must go beyond basic fraud controls to re-create a culture of fraud awareness.


6. Innovation/R&D. Nearly 45% of companies have cut their 2009 R&D budgets by greater than 5%. With fewer resources to properly manage product or service innovation, the potential to make poor investment decisions will increase. Internal audit teams should assess the processes by which companies screen new investment opportunities for differentiation potential and alignment with enterprise objectives.


7. Third-party relationships. TThe worsening global economy and lack of available credit mean that more companies will experience business disruption from customer and supplier insolvency than at any time in the past 50 years. Further exacerbating the situation is the decrease in lead time between awareness of a solvency problem and ultimate receivership or liquidation. Internal Audit should assess both the third-party risk management process for its ability to evaluate the supplier base for vulnerabilities and the current plan for replacing expendable partners and retaining critical partners.


8. Shared services. An urgent need for cost reduction is driving many organizations to increase their use of shared service centers (SSC) and relocate existing facilities. In addition, as SSCs reach a natural point of maturity, executives are looking beyond their traditional scope to identify opportunities to take on higher-order activities. Audit departments should evaluate the decision criteria being used to determine the development or expansion of SSCs, as well as assess the resulting process changes to ensure the maintenance of a strong control structure.


9. Inflation/Deflation. Facing a severe recession, finance leaders cite concerns about their companies’ ability to deal with a high inflationary or deflationary environment. Audit departments must assess the company’s capabilities to monitor triggers that will alert management to the existence of a high inflation/deflation environment, as well as evaluate the company’s preparedness for operation in both of these potential environments.


10. Tax management. As budget deficits rise, governments are determined to extract larger tax revenue from businesses through stricter enforcement of current regulations and the creation of new regulations. In addition, rapid changes to corporate strategy may not align with long-term tax plans already in place. Audit should evaluate the level of vulnerability to aggressive revenue authorities, and review compliance with the applicable regulations. As management works to adapt business practices to operate successfully in the current environment, Internal Audit must also ensure that the consideration of tax strategies and risk is part of the strategic decision-making process.


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