Its time for risk consultants to be players with the team on the line. Learn how to achieve innovative advantage using the case studies.
Wednesday, April 22, 2009
Your Balance Sheet Is Different
There are very few experts who know how to read a balance sheet and tell you where you are going wrong with your strategy. I am training myself in this art for last 16 years. I have been into Internal Audits and reading balance sheets all through out.
I don't read balance sheets to manage an investment portfolio but to know how a company stands to perform in future and where a little tweaking can help it turnaround and produce breakthrough results for its shareholders.
It's a real fun to read a balance sheet if you connect it with the key decisions taken by the management. You can know how management is performing to create wealth for its shareholders.
Interesting aspect about reading a balance sheet and P&L is when you can spot the concern areas quickly that management doesn't know that it doesn't know.
Once you know that there is something fishy, its time to find answers and reasons. Informed enquiries with management along with knowledge of business and processes, helps you to get to the skin of the issues.
Second task is about communicating what you have read to the management and inspire them to do something about it. That 'something' which you suggest will bring forth new possibilities and higher value addition for the management.
My intense knowledge in Management Audits along with my ability to read financials helps me coach the management for creating higher value.
You talk about better corporate governance, controls, planning, resource utilization, revenue generation, revenue leakage, cost reduction, where you will look first? All involves a closer look into financials. Different people look at financials in a different way.
Auditors look at a balance sheet in a different way. When you do due diligence for M&A, you read balance sheet in a different way. When you read balance sheet from point of view of wealth generation, it's a different ball game. It's strategic and it's innovative.
SMEs can add great value if they get their balance sheet read by an expert. It's important they understand the game of wealth generation. The expert spends few hours with you, visit your facilities, factories, offices and of course your balance sheet and P&L and come out with value adding recommendations that can produce breakthrough results involving turnaround of your business, increased cash generation, increased revenue, reduced cost, reduced losses and introduction to new possibilities of growing.
Reading balance sheet in this economic recession is very important. Read yourself or ask for some help.
If business consultant tells you what you already know then kick him out and invite the one who tells you something that you don't already know.
One of our clients increased their revenue by 200 %. Cost reduction achieved 50%. Asset turnover doubled in just six months.
You may lose your head but may not like to bow it. Risk perceptions have changed so as the returns and the negotiation process. Negotiations are heated and getting quite messy these days. Is it a time to be more diplomatic or appropriate? Recession has its greater impact when people lose faith in the system. Although system has not failed totally; businesses are not able to breathe peaceful transactions for sure.
Capital resources are funneled in safe projects after due negotiation, competition reduces for challenging and more profitable projects. And, where there is no competition opportunities to create blue oceans exist. Let's talk about some risky projects that are unheard in recent times, which can produce a huge return on your investments.
Are you invested hugely in inventories? What do you think your action plan should be to get rid of the pile you gathered all these days? My suggestion to all of you who are stuck with this pile is - not to find root causes as to why inventories got accumulated but to capitalize on it by pushing it to a totally new avenue or market place. You may scrap it or sell it at discount but there are other opportunities which can be experimented with.
Are you facing a good amount of challenge to recover your debts? My suggestion is to know more about your debtors and their businesses. It's a very good opportunity for you to explore your value chain. There are hidden opportunities waiting for you. You may like to re-engineer the industrial value chain and thus create higher value. Returns can be enormous.
Now talk about capacity utilization in your industry. Many times it is not easy to utilize your excess capacity when there is no demand. Now there are opportunities to create demand internally and thus remove bottleneck in your value chain. Many people are not able to deliver where as many find it difficult to utilize their capacity to fullest. Go grab the opportunity.
Are your investments valued below your purchase price? Many think that option is to minimize loses or wait till the arrival of good times. Now you are not realizing that the above options have hidden opportunities as otherwise it is impossible get rid of such investments. Let' take example of real estate. I think there is huge opportunity in real estate. Industry as a whole needs to understand that this is a right time to commoditize the product. Its time to sell volumes and increase supply as you may notice that all the Companies in real estate segment follow more or less the same strategy. It's a time for them to create new market space by following blue ocean strategy.
Recession is not all evil, but brings with it a lot of opportunities too and the one who has proper insight can bank upon these opportunities at the right time and create value for the business. A real entrepreneur takes right advice to plan its resources and assets for creating higher wealth for himself and the society. Breakthrough is possible for sure.
CXOs sound like some kind of phantoms in your organization. These phantoms should have some kind of specialization and leader's role to play. Why CXOs? Mergers, acquisitions and consolidations are transforming virtually every industry, and the impact is global. Industry consolidation and integration are affecting risk management strategies too. The stakes are quite high in global businesses and companies need specialists to manage its portfolio of diverse risk.
I am sure everyone has heard stories of successful CXO who, in the end, could not achieve their targets of growth. They realized that both organic as well as inorganic growth strategies were too risky to execute.
Your risk assessment affects your decision making as well as execution. The priorities are affected the way CXOs see risks and act. Some times leaders step back fearing risks that are mapped in their risk list. They have painful dreams of phantom risks which are mapped in their brains. Leadership is largely how one responds to risk or posed business problems.
Let's check out risk mapping in the brains of these so called leaders. They say if it's not our core competency, outsource the activity to third party. Now, there are stories of outsourcing companies mushrooming and assuming greater control over their clients' critical business processes and thus becoming more embedded in their enterprise. The accountability is enormous on both the sides, and the margin for error is slim. It's a matter of business continuity for both of them.
Solution is not just conducting a thorough quantitative risk assessment that examines all possible scenarios or point of view as nobody can predict or prepare for every scenario. However, one can manage his response to them. Are processes built into the system that permits needed flexibility? Is leadership role and style predefined for the every phase of the business life cycle?
What role a CXO can play in this era of virtual organization and continuous change? And, do companies have CXOs in place with the capabilities of executing no matter what comes their way?
CXO postion is like a head farmer. How a farmer prioritizes his risks and resources and what is most important element according to him for a successful harvest this year viz. Soil, Seed, Fertilizer, Weed, Pest Control, Sun, Rainfall, Credit or Subsidy, Equipment? A well informed farmer might say it depends on crop stage and condition. Focusing only on using bio-engineered seeds can be too risky just like focusing on quarterly MIS reports.
For leaders, as for farmers, some factors are not in their control. Both leaders and farmers can plan for expected natural progression of events, but there are inevitable surprises that require analysis, agility and response.
A farmer cannot repeat same practices in same way in same field. Soil depletion, crop prices, weather patterns and new equipment, techniques, and supplies alter farming practices. Farming, as well as leading requires ongoing judgment and adjustment and mere rote imitation cannot be a success mantra.
And all knows how correct the predictions of the weather department these days are. :)
Today's leaders need ideas on how to respond to risks. They need to map the risks in their brain correctly to change the gears rapidly based on the situation confronted. Do you fear any phantom risk? If answer is in positive, call the exorcist now for Crisis & Risk Response Consulting.
Recently, Risk Head of a fortune 500 company, a top global confectioner, asked me on how to approach monitoring of their accounting shared services function which had been outsourced a year back to a global BPO firm and had not been monitored since then. It came as surprise to me; as they had no prior plans to monitor and manage the risks involved with the new business model.
Nowadays many Companies are looking to implement shared services for driving scale to reduce cost and increase efficiency by combining their common back office functions dispersed across various business units. This could be anything from Human Resource to Quality Assurance and even Finance which could either be in-sourced or outsourced to a BPO firm.
Many difficult decisions are to be made before shared service function may start delivering desired results. Some of these decisions are irreversible in short term and thus risks have to be better understood beforehand.
It's a bad strategy to impose a centralized control function at an operational level in the belief that centralization will straight away provide a stable platform for achieving best value results.
Majority of share service champions both at the client and vendor level have come from an era of proprietary protectionism and therefore are having some difficulty in grasping the new processes that reflect today's technology convergence practices. In essence, they are making decisions based on technological limitations that no longer exist instead of the operational imperatives that are required.
Unfortunately in most of the cases, the people, who are too busy working in a standardized process environment, think that working in it is going to make them better at working on it. It's like they don't identify the destination before they start peddling the bicycle. Many choose shared services as they are too busy doing things and do not have time for improving or streamlining the processes and the functions aren't getting any better to provide them with substantial cost benefit advantage.
When Companies choose a new business model without considering non-confirming information and the associated risks; it is like they leap in their car and take off; knowing that they have a pretty good idea where their destination is, but they haven't timed it. They don't get into the business specifics that are part of the route to get to the goal or destination.
Visualizing as to how risks can be perceived differently is one of the weakest points for anybody getting involved with in a shared service situation. Bear in mind; if you operate out of need, rather than opportunity, you will always make poor decisions.
Let's understand it from two brief stories from NASA.
Scientists at NASA have developed a gun for the purpose of launching dead chickens. It is used to shoot a dead chicken at the windshield of airline jet, military jet, or the space shuttle, at that vehicle's maximum traveling velocity. The idea being, that it would simulate the frequent incidents of collisions with airborne fowl, and therefore determine if the windshields are strong enough to endure high-speed bird strikes.
British engineers, upon hearing of the gun, were eager to test it on the windshields of their new high-speed trains. However, upon firing the gun, the engineers watched in shock as the chicken shattered the windshield, smashed through the control console, snapped the engineer's backrest in two, and embedded itself into the back wall of the cabin. Horrified and puzzled, the engineers sent NASA the results of the experiment, along with the designs of the windshield, and asked the NASA scientists for any suggestions.
The NASA scientists sent back a brief response: "Thaw the chicken."
In another story, when NASA began the launch of astronauts into space, they found out that the pens wouldn't work at zero gravity (ink won't flow down to the writing surface). To solve this problem, it took them one decade and $12 million. They developed a pen that worked at zero gravity, upside down, underwater, in practically any surface including crystal and in a temperature range from below freezing to over 300 degrees C.
And what did the Russians do...?? They used a pencil.
Remember, it is the application and the purpose that drives value.
It is better to expand the context which could reveal win-win options / opportunities of changing business model and would not amount committing to unnecessary and impractical process re-engineering, standardization and benchmarking across the business units.
Thus it is critical to create a community of diverse talent committed to shared results and not so called sharing services merely to reduce cost. It is critical to ensure a shared responsibility among all players that adds uncommon opportunities.
In reality, the adaptive capacity of a new business model reflects a collaborative process in which key stakeholders work toward identifying and achieving a collective, best value outcome. In practical terms, the unique operating strengths of different stakeholders are actually leveraged to achieve both stability of processes and consistency of outcome.
~ it is the application and the purpose that drives value.
Risk management means exploiting opportunities and not just controlling the damaging impact of the risks. Risk management is not about mitigating every risk identified rather it is about achieving the optimum. Innovation can bring the greatest value to the business, but it is probably the least understood risk management option.
Now look at the risk map below for a global confectionery company named balbury's that manufactures chocolate and sells it through its company and franchised outlets around the world. Balbury's mission is to be first thought in minds of people for gifting and celebrating.
The management sees a loss of appetite for its product range to be the major risk to its business success. After that, they see breakdown in quality control at franchises to be a major risk. Balbury's loose product has to be maintained at a set temperature and hygiene is a crucial factor for customer confidence.
After the risk assessment, the companies have various options to manage a particular risk. However, a lot of companies simply think of what they will physically do to manage the risk, or else they allocate it to the risk owner to think it over. Thus, the marketing director of Balbury's might have been told to come back with a strategy for dealing with loss of appetite for the product.
Rather than the marketing director to think it over alone, the choices should be discussed openly in a strategy meeting. Choices can be as follows:
Avoid: get out of the business or get out of a line of business or out of a country. Outsource: transfer the operation to an expert in that field. Accept: live with it and do nothing. Monitor: keep a weather eye on the situation. Measure: work out a key performance indicator to track. Control: put a new or improved control in place. Insure: cover the potential loss with a policy. Hedge: reduce risk by covering several options. Innovate: grab opportunity out of consideration of risk.
One of the high risk issues for Balbury's is quality breakdown in the franchises. If risk realizes, then it could affect its global brand badly. The company could threaten to withdraw the franchise from any operator who does not meet the standards; in addition, it could send inspectors to tour the franchised operations. Or, it might get franchisees to complete regular quality self-assessments.
The other high risk issue is more difficult to address. Loss of appetite for the product initially seems something that the company may be unable to do anything about. Where risks are deemed "uncontrollable" in this or some other fashion, then there is usually scope for the "innovation" option. The simplest form of exercising innovation option is reversal. Instead of "loss of appetite for the product", the risk is restated as objective - "increased appetite for the product". The team then has to come up with a strategy that could make the new objective statement true.
Increased appetite could come from a high level of new product development leading to the launch of new products: they could produce ice-cream versions of their chocolate products, develop "Diwali ki Mithai" concept to support the "celebrate" concept, make chocolates with messages inside etc. The strategy could be articulated then as something like "achieve 25% of sales from new lines" and this could be measured and reported on.
Let us take some more examples of the innovation option of risk management:
The kirana retailers found "fresh stores" a major risk to their future business. Fresh stores came with strategy of rapid expansion offering better services at reduce prices. The solution could have been, to aggressively change the present state of affairs by integrating small kirana businesses or creating stores for readymade or homemade vegetables or food stuffs or coming up with new ways of making delivery etc. Instead of trying to defend against the apparent risk that "fresh stores will take business away from us", the reverse of this could have been proposed like "Fresh Store will bring business to us".
An agro chemical business looked at its risk map to its utter disappointed that the high risk issues were outside of their control as they were related to regulation of the sector they were in. "We are regulated" was then reversed to "we are not regulated" making expansion into unregulated, but related, sectors as their business priority.
A small web 2.0 consulting firm expressed one of its biggest issues as "business people might not take us seriously". This was the biggest risk to their securing greater business. Reversing the issue as "business people take us seriously" led to development of a balanced scorecard to express their strategy, how they would achieve it, and how they would measure it.
Aren't you ready yet to exercise the innovation option of risk management?
Post-Enron era was supposed to be different but just six years after the disaster it feels as though somebody hit rewind.
I read above lines searching for ''Fannie Mae'' this morning. Actually today morning, I was going through my website's tracker report and found that somebody from ''Fannie Mae'' was surfing my website doing an organic search using the keywords ''Risk Consulting Mumbai''.
Fannie Mae explained to its nervous investors about the change in the way it discloses its bad loans and whether the change is masking the mounting losses. However, the chief financial officer and other executives failed to answer some important questions about loan losses and left the investors in doubt about the Company's financial footing.
Fannie Mae changed the method for calculating its credit-loss ratio, an indicator of its bad loan losses as a percentage of its overall loans. Investors have been using the credit ratio to assess the credit quality of Fannie Mae's mortgages. Fannie Mae had announced recently an annualized credit-loss ratio of four basis points for the first nine months of the year that was well within the company forecast but If it had not changed the method, it would have had a credit loss ratio almost twice the four basis points, high enough to start making the investors nervous.
Essentially, the company was able to lower the ratio by excluding a certain type of loss known as SOP 03-3 loss.
Here is how SOP 03-3 losses work: Fannie Mae guarantees mortgages, which have been packaged and sold to investors as bonds. If a house-owner falls significantly behind on his payments, Fannie Mae has to buy back the loan from the bondholder. If the mortgage has an outstanding amount of, say, $100,000 and unpaid interest of $5,000, Fannie Mae would have to pay $105,000, its full value, to make the bondholders whole.
However, the $105,000 loan may actually be worth less on the market. It is Fannie Mae's job to estimate the market value, or fair market value, of the loan and to record that price on its books. So if the fair market value is $80,000, Fannie Mae takes a loss of $25,000 (the difference between $105,000 and $80,000). This loss is considered an SOP 03-3 loss.
Until recently, Fannie Mae included SOP 03-3 losses as part of its credit-loss ratio. But here's the trick: Fannie insists that, based on past trends, it can recover a large part of that $25,000 loss by, for example, helping the borrower renew payments. So it simply decided to stop including SOP 03-3 losses in calculating its credit-loss ratio.
Fannie Mae executives failed to provide numbers showing what proportion of SOP 03-3 losses are recovered, but promised to disclose them in the future. One possible reason why Fannie Mae doesn't want to provide information on recoveries is because it might be using assumptions that are too optimistic, potentially underestimating SOP 03-3 losses.
Now, question remains why somebody at Fannie Mae was looking for Risk Consulting in Mumbai at this time.
An organized retail chain into fresh food retailing recently decided to rollback its expansion plan in few states after aggravated agitation against it by the local vegetable vendors. The business leaders face complex decision making situations too often. When you make right decision no one remembers but when you make a wrong one no one forgets. The saying goes like - don't limit yourself to few alternatives but open your mind to different view points. I want all decision makers to look at different paradigms through this interactive case study.
Assume that you are a farmer and you need to plant one crop over all your land. You have a choice of three kinds of seeds. There will be three possible weather conditions, say good, average, and poor. It is impossible to predict which condition will realize, since each is equally likely to happen. The Profit & Loss for the possible weather conditions are summarized in the following matrix.
Which crop would you plant? Why?
There is no correct or incorrect answer as all options have same probable outcome i.e. 6. All depends on your risk muscle. The buzzword used many times is Risk Appetite but I would like to use the word Risk Muscle.
When you have confronted with a yes-or-no decision or a this-or-that decision take out a coin, assign one alternative to heads, the other to tails, and flip the coin. Look at the coin for the result and immediately ask yourself how you felt. Albert Einstein had suggested this method saying it is useful to incorporate your feeling into your decision making. Only after a choice is made, the risk assessment becomes meaningful.
The business managers are trained to make knowledgeable decisions based on factual and experimental analysis and observations. To validate assumptions, informed enquiries are also made. The biggest of assumptions is more the facts available, better the decision making. In reality the business managers often face Dharam Sankat situation in Decision Making.
Suppose you are a doctor working in an Indian Village, and 600 people have come down with deadly dengue fever. Two possible treatments exist. If you choose treatment A, you will save exactly 200 people. If you choose treatment B, there are 1/3 chances that you will save all 600, and a 2/3 chance that you will save none. Which treatment do you choose?
The majority choose option A.
Imagine again that 600 people have come down with deadly dengue fever. Two possible treatments exist. If you choose treatment C, exactly 400 people will die. If you choose treatment D, there is a 1/3 chance that no one will die, and a 2/3 chance that everyone will die. Which treatment do you choose?
Now the majority choose option D.
Now suppose one of your close friends is suffering from a life threatening disease. When your friend is unconscious, the doctors seek your choice between the available two treatments as you are the only one available at that moment. Treatment P which has 100 % success rate but a side-effect that your friend will lose his eyesight and Treatment Q which has only 20 % success rate. Think about your choice first and then think how your friend would have decided if he were to make the choice. Then, think about his close relatives' possible choice and effect of outcome of your decision on them and your friend.
A timely decision is far superior to a perfect decision that is late. Over optimism can kill whereas keeping near to reality helps.
When you are in a leadership position, you have to consider view points of all the stakeholders and effect of your choice on your environment. Remember prospect of loosing is more profound than the satisfaction of winning. It is not difficult to forgo what is not yours at present but it is difficult to forgo what is yours at present. Remember the funny incident from a bollywood movie where a miser pays off his debt in cash to the person owing in front of dacoits. :)
The point I am making will be more clear from the following anecdote. Perhaps apocryphal, about the man who approached Coca-Cola when the company was in the business of manufacturing Coca-Cola syrup. He took two years before the business leaders at Coca-Cola spared their two minutes to listen to his idea which he gave in just two words: 'Bottle It', the rest is history. It may not be procrastination but surely risk aversion of the decision makers to forgo their valuable two minutes (their current ownership) to listen to the future business idea (their future ownership).
Retail boom in India is a reality. And, every corporate retailer is eyeing a big pie. However, there is a fear among the retailers entering the next phase, a situation that led marketing consultant Geoffrey Moore to term the transition as 'Crossing the Chasm'. The difficulty of crossing the chasm in current context means many corporate retailers who were comfortable in initial years of organized retailing are now finding it difficult to expand to the mainstream of the market. The story line of this case study will throw some light.
First time when I met the king of India retail at a retail summit, he looked very aggressive seeking feedback of his fellow retailers on a recent happening in the industry. Just two days back, the biggest retail firm globally had announced its entry in India with a new tie up.
During the course of the day at the retail summit, I could see exchange of heat between the king of retail and the CEO of the Indian firm which had tied up with the biggest retail chain. The king of Indian retail was stressing on having consumption led growth for the Indian retail and thus preventing hasty market entry of the big conglomerates in the sector. I heard him saying the words 'who knows what matters' when some body asked this future oriented retail king about the success mantra of organized retailing in India in its next phase.
I am sure corporate retailers will see a cut throat competition once the industry moves on the S curve ahead. I am really not sure if Indian corporate retailers would be thinking in terms of Blue Ocean Strategy. Many are waiting for the year 2009 when stores and malls of many corporate retailers will be ready to open. However, it should be understood that 2009 will not be a decisive time for Indian retail as many retailers say but the 'now' when every one in the market are working on ideas of launching innovative retail formats to be started 2009 onwards and which will supposedly satisfy a real consumer need 'then'.
Mind well, in the next phase of Indian retailing, the consumer will be more demanding and corporate retailers have to show strong evidence of value and ethics. First mover advantage will not help alone as red queen effect on competition will be stronger. Moreover, the unorganized sector will be creating barriers to the entry of corporate retailers in the market.
Corporate retailers looked really concerned when strong agitation started against a chain of fresh stores of a corporate retailer recently. Chief of Retailers' Association suggested that there should be no distinction between organized and unorganized retailing and the industry shift towards organized retailing should be looked as a step toward modernization of the industry and the society. Although I am not very clear on this suggestion of his but one thing is very clear that he was not sure of a adaptation strategy for the next phase.
For managing the uncertainty, I suggest all corporate retailers to concentrate on a single niche of the market while making transition to sell to the mainstream of India. Don't spread your resources too thinly across many activities or formats. Cross the Chasm with right strategic positioning in the next phase. Start riding the S curve in small steps with increased market segmentation. Build on success stories. Promote innovation in agriculture, infrastructure and related technologies, Understand aspirations and needs of mainstream again with a new insight. Have a robust resource management and a risk management strategy to avoid waste of efforts, unnecessary expenditures and corporate failure.
Everyone nodded their heads to the idea of Managing Director who wanted to launch a new product within next six weeks. But when he sought views of everyone present at the meeting on worse case scenario of launching the new product in such a short stint, nobody responded fearing consequence of refuting the Managing Director's idea. Some one with a blank face suggested asking the audit committee directly about it. Hearing such a passive answer, the Managing Director moved on to the next agenda saying that he will ponder the idea one more time before it can be talked about at a greater length.
Two days later, the Managing Director received a call from a young colleague of his, who wanted to know more about the idea after knowing about it from the organizational grapevines. He also wanted to share a similar idea of his own with him.
The Managing Director responded to him that the idea needs to go through a reality check and he wants all those, who going to execute the project, to visualize and accept the worst case scenario. He had taken a back as he didn't intend to give the project in hands of those who didn't understand the risks involved. Ideas rigidly adopted can limit thinking and commitment. Focusing on incorrect end results increases chances of failure and encourages non-action. But by changing focus, one can influence performance. More you know about the end results and risks, better you are prepared. More you are prepared, more confident and assured you are. Outcome based thinking and result oriented actions are critical for effective risk management.
The Managing Director revealed that today he has been approached for first time after his announcing six month back, the policy of getting in touch with him directly for discussing any new ideas. He said that his vision is to create an organized decentralized firm which encourages participation. He wants to bring in young people with contagious passion and enthusiasm to inspire change and enter uncharted waters. He thanked the young guy for calling him and requested him to pay a visit next morning to discuss the prospects of his new idea and the new organization.
Is audit committee adding any value or is just for statutory compliance? asked the furious chairman, who had been advised recently about the abnormal functioning of some of the non-financial performance measures. He said I know you all are really independent but, are you performing your oversight function as expected? Although the firm has been certified by the external auditors for effectiveness of its financial accounting controls during the past years, these controls have inherent limitations when looked at in silos. It is high time for the audit committee to look at non-financial performance measures as well.
He further said that the stakeholder expectations are very high nowadays. Not just the financial accounting controls but the entire gamut of management accounting controls needs to be looked at. Those who design and implement controls can also override or bypass these controls. The audit committee members began to wonder how they could have met the expectations better. Audit Committee members while justifying for their current way of functioning emphasized on having, a written code of conduct and its communication at all the levels of management to prevent overriding and bypassing of controls and a hotline programme. Though the chairman considered the importance of these steps, he wanted the audit committee to become more smart and business like. He wanted the audit committee to add value.
The board room conflict was in the open. Surely the members of the board and committee had failed to understand each other's expectations. Another problem was that expectations were not shared and reviewed periodically. The expectation from the audit committee had been changed over time. With their expanded responsibilities, the audit committee members were struggling to fully understand and embrace the scope of their duties, including oversight of risk management and internal controls.
To avoid surprises, the audit committees should understand the importance of defining and agreeing with the board of directors on the scope of their oversight of risk management and internal controls. This scope should be revisited on a periodic basis.
Audit committee members can meet increased expectation by demonstrating the appropriate level of skepticism, asking probing questions, having open discussions with the management and the auditors keeping business perspective in the mind. Audit committee should also target non-financial measures and various key success factors for monitoring. These key success factors for monitoring should be determined with extensive top management involvement.
The conventional financial accounting reports, both internal and external, are much like a scoreboard at a cricket game. The scoreboard tells players whether they are winning or loosing the game, but does not tell one about what is right or wrong about his batting, bowling or fielding. One must watch the ball in order to get a hit rather than just study the scoreboard. Conduct of the management cannot be monitored effectively just looking at the financials alone; one should see the non-financial performance measures too.
Like every year, this year too, the ERM meeting by Chief Risk Officer was not very interactive. The external consultants who were present at this year's meeting with their vibrant presentation even could not engage the senior managers present to contribute to 'to be' Enterprise wide Risk Management System (ERMS). The senior managers at the meeting didn't ask searching questions and they didn't debate but were just sitting passively watching the nicely made power point presentation. The meeting soon got over before the lunch hour and the managers left with no commitments whatsoever.
Two weeks later, when annual budget and operating plan for the next year was on the table of CEO; inherent conflicts of interests were visible. All the line managers had strongly presented their cases for granting excess budgets for their activities. They had confirming information for their decisions which they had already committed of making. All had justified their future action plans without any sort of critical evaluation in light of any disconfirming information.
The Production Head wanted to have full capacity utilization with stable production schedules for bringing major cost saving for the assembly unit whereas Sales Head was pressing for having wide range of products with different sizes so as to increase chances of making a sale. Unlike others, CFO had envisaged lower economic growth ahead and was worried about inventory built-up and additional cash outflow on account of discounts and promotional activities. Many managers have tendency to be over optimistic or unnecessarily pessimistic when their incentives are linked to their specific functional achievements and thus they tend to discount the information that might lead to conclude that their plans were biased and not in synchronization with other functions.
Something was definitely missing. A moaning Risk Management System which critically validates assumptions. If you want to reduce risk in your business, you have to seek both confirming and non-confirming information before you take action. This helps the firm to make intelligent trade-offs based on reality. But most of the time the problem is lack of platform that encourages open debating of the assumptions made by the managers and their by challenging of each assumption by cross functional leaders at granular level with penetrating questions.
Is Chief Risk Officer responsible for seeking disconfirming information or decision makers themselves are to seek such information compulsorily while making any decisions as a process? Who will conduct a meeting for challenging their own assumptions openly? Who will make correct trade-offs? Who will see the entire Elephant of Enterprise wide Risks? Audit Committee!!! I don't think so. Debating in group will only construct and share a comprehensive picture of enterprise wide risks. Only open and guided discussions will encourage commitment to execute with accountability and develop respect for each other.
Yes. Respect and unity within a business team are the missing elements. No one can claim, not even any sort of Committee, of having a vision of the entire Elephant of Enterprise wide Risks. Yes. ERMS too needs integration with the entire body/soul of knowledge system, the biggest of elephant ever known to business kinds.
I was reading an interesting case study recently which seems straight out from the real world wherein CEO and Chairman of Audit Committee were arguing with each other as to how internal auditors should perform their work. CEO was stressing on lack of understanding of internal auditor about responsibilities and authority aspects of controls. He was vary furious about fault finding nature of their reports and he felt need for discussing the report with him before presenting it to the committee. Mr. Chairman at first was more interested in bridging the control gaps found in the report but later on some what convinced with what CEO was saying started instructing the Internal Auditor to pursue more transparency with the auditees henceforth. Not everyone in the meeting was of the view that the internal audit function is adding value to the firm.
Internal control is no longer the exclusive domain of highly trained accountants on the internal auditing staff. Corporate Boards, Committees, CEOs, CFOs and employees at virtually every level are now seen as responsible for designing, implementing and monitoring these controls; few, however, have the training and background needed to fulfill this complex responsibility along with understanding other's point of view of controls within the organization.
Every employee in an organization has a stake in the control process. So there is quite a possibility of conflict situations due to difference in the risk perceptions within the Organisation. Everyone who is made responsible needs to know the control framework in its entirety and how they work together.
Using a collaborative approach for building a culture of effective risk management through extensive employee involvement in identifying and controlling risk factors is essential. And thus, Control Self Assessment is being recognized as a powerful tool by businesses to help auditors, management, and others examine and assess business processes and control effectiveness within their organizations. However, harmonization in understanding the controls from various perspectives is also very essential. Conflict of interests due to varying use of management accounting information by different business managers should not hamper the risk management processes.
I have attached a risk score tool which will prove useful to score risk perspective of various participants and to foster innovative discussion between them to resolve conflicts and improve risk management processes.
Participative and playful discussion on differences of opinion makes the participants learn more about the controls and their own responsibility regarding risk management. They tend to become involved in designing and executing the controls that contribute to meeting the organization's goals and objectives.
There are very few experts who know how to read a balance sheet and tell you where you are going wrong with your strategy. I am training myself in this art for last 16 years. I have been into Internal Audits and reading balance sheets all through out. 
The management sees a loss of appetite for its product range to be the major risk to its business success. After that, they see breakdown in quality control at franchises to be a major risk. Balbury's loose product has to be maintained at a set temperature and hygiene is a crucial factor for customer confidence.
