Enterprises of all sizes face risk in some form or another. No matter which enterprise risk management (ERM) framework used, most risks will fall within one of the following categories.

  • Regulatory & Compliance
  • Operational
  • Strategic
  • Reputational
  • Financial Risk

Financial risk can include everything from market events to credit and liquidity events. Key to managing those risks is to understand what they are and how they impact the overall enterprise.

Risk and impact

When we hear the word “risk,” we tend to associate it with loss. And because humans are hardwired to fear loss more than to value gain, managing risk is translated at risk avoidance. Company treasurers know, however, that risk does not imply loss; it means uncertainty as to how a financial event may impact the organization. In a financial world that is increasingly becoming more volatile, uncertain, complex, and ambiguous (VUCA), the ability to manage financial uncertainty is a core competency for most finance organizations.

Any type of financial risk management program must start with an understanding of the risk universe, impacts to the organization, and what tools are available to manage risk. Three of the most common risk types for treasury teams are foreign currency risk, reporting risk, and forecasting risk.

Foreign currency risk. As companies grows outside their home countries, they begin to collect payments or pay debts in foreign currencies. They often lend and repatriate capital depending on the needs of subsidiaries and corporate objectives. The translation of those currencies back to U.S. dollars (or another home currency) can impact values on the balance sheet.

Failure to manage foreign exchange (FX) uncertainty can make forecasting and reporting dubious tasks at best and inaccurate at worst. The failure to manage FX is visible for all to see within financial statements through the reporting of month-end currency translational adjustments as part of the regular financial reporting process. FX risk can also be driven by government actions that restrict cross-border remittances or the ability of non-residents to hold local currency accounts. The use of an active transfer pricing process and regional cash pools becomes more relevant when doing business in countries with capital restriction regulations.

Mitigating FX risk can be as simple as setting an FX policy based on an understanding of the unique flows, tax, and cash segmentation needs of your organization and then working with financial tools such as derivatives to hedge currency risk, locking in a currency rate so that it remains the same over a period of time, or simply accepting the risk based on the volume of business or lack of volatility within markets.

Reporting risk. Public surveys have reported  that nearly half of companies that had $10 billion dollars in revenue still used spreadsheets as their primary treasury system. Spreadsheets pose many problems and are inadequate tools for a complex or global treasury function. For example, spreadsheet models are rarely audited for accuracy of logic in formulas or errors in one cell. In addition, users fail to update their assumptions, which can have a ripple effect throughout an entire model, shattering its integrity. Hidden errors may go unnoticed for long periods of time, causing credibility issues with reporting, inaccurate forecasting, a need for excess cash cushions effecting overall company liquidity, and sub-optimal cash investment management, which ultimately lowers total enterprise value.

For companies with multiple legal entities, complex organizational structures (such as a holding company model), and an international footprint, spreadsheets can make it nearly impossible to integrate reporting. For example, spreadsheets may reflect chart-of-accounts and file formats from different systems, causing the need for treasury teams to “clean,” reorganize, and map the data to a common structure, creating reporting lags that can lead to needless activities. Solving the spreadsheet problem could be as simple as investing in an ERP treasury model or migrating to full TMS solution.

Forecasting risk. Cash flow forecasting should provide the precision needed to make sound business decisions. In a recent Kyriba study of several hundred treasury professionals, all of them admitted to having too much inaccuracy in their cash flow forecasting. Nearly half of those surveyed stated that their process was only “somewhat accurate” and nearly 10 percent said that their forecasting was “very inaccurate.”

In order to improve, treasury teams need to know where they stand. This begins with an assessment of the cash flow forecasting process. The assessment should dive into how cash and liquidity information is communicated between business segments and corporate. Many times, department and subsidiaries have different processes for cash flow forecasting. Varying processes may not need to change, as long as they are consistent and transparent to all within the reporting hierarchy.

The objective of any treasury transformation is the creation of a single forecasting methodology for the organization that is well-documented, clear, and transparent. Frequently, companies have key-person risk, where only one or two resources hold the wealth of knowledge. This causes excess operational risk, which can be mitigated through documenting policies and procedures.

Don’t go at it alone

Treasury professionals should understand that wrapping their arms around risk management within treasury is not an easy task. It will require executive buy-in, a careful assessment of a company’s current risks and ERM methodology, and a review of its current and future treasury and cash management needs, payments process, operating cash flow cycle, and security needs.

Oftentimes, treasury personnel aren’t able to take this on in addition to their regular duties. Using an external partner to work in conjunction with an internal designate produces the optimal mix of internal knowledge and external resources to produce tangible results.

If your organization is seeking to understand the risk management landscape better, contact MorganFranklin today the first step in your journey.

By Walter Ward

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