by Nigel Grey, Treasury Manager, De Beers Group
Companies today face a multiplicity of obstacles in their quest to achieve the returns on capital required by stakeholders. The majority of these obstacles can be overcome through active management of the issues by members of the organisation. For example, production processes can be reengineered to overcome quality issues, marketing plans and strategies can be adapted to changing consumer preferences, and staff shortcomings can be addressed by appropriate training and education. All of these actions can have positive impacts on an organisation’s ability to meet its strategic targets through speciﬁc and focused interventions. The areas that expose business managers to ﬁnancial risk where they have little control are those related to currency rates, interest rates and commodity prices. Such ﬁnancial risk can have a material impact (positive and negative) on the ability of business unit managers to meet their ﬁnancial targets. The materiality of the impact is inﬂuenced by the nature of the business and the extent of the risk exposure. For example, an organisation that maintains its cost base in local currency but, because of market norms, prices its product in a foreign currency, is more exposed compared with a company that operates solely in its local market. These risks can lead to potentially incorrect assessments of business unit performance in that factors outside of management inﬂuence can materially impact the ﬁnancial performance of the entity. It is in this area that a considered and structured plan should be introduced to enable business managers to focus on their core competencies while giving them certainty in areas where control is not possible. Such a plan should address:
- understanding of the organisation’s propensity for ﬁnancial risk;
- the mapping and quantiﬁcation of those risks;
- understanding the accounting presentation of ﬁnancial results;
- modelling of risks;
- development of solutions;
- presentation of solutions to key decision makers;
- tactical action plan development and execution;
- management and reporting of the performance of the strategy.
Understanding the propensity for risk
People are constantly assessing a multiplicity of risks and making decisions on actions to mitigate them. Many of these assessments, even though subconscious, are based on a predetermined assessment as to the severity of the particular risk and the preferred course of action. For example, a driver not following the rules of the road may engender different reactions from one person to the next. The same is also true for businesses - after all, businesses are just groupings of people who manage processes in order to generate wealth. Before developing action plans for managing ﬁnancial risks, it is necessary to understand the business owner’s propensity for ﬁnancial risk. This is often easier said than done. In listed entities, where the owners are constituted by a large number of public shareholders, understanding the owners’ overall propensity for risk has its diffculties. One has to rely on the company’s stewards to give some indication of that propensity, in addition to input from those business analysts serving the shareholder community. In this regard, whoever holds the major persuasion high ground will prevail. For example, companies that generate their revenues primarily through the exportation of product but which operate in jurisdictions with currency controls, may find analysts may advising against hedging currency risks as it provides a means for local shareholders to obtain exposure to currency market volatility.
This may not actually be in the organisation’s best interest, but management may well be inﬂuenced to adopt such tactics if the evidence (or perception) of opinion is such that shareholders would penalise the company by disposing of shares if strategies and tactics in managing currency risks did not take these views into account. The impact of not taking cognisance of these views could negatively impact on the organisation’s market capitalisation, which could follow through to the company’s debt- raising capacity. Conversely, where ownership is tightly held, it is easier to interact with the owners in order to establish their various propensities for risk and to identify a common objective in this regard. Whatever the position, the treasurer needs to ensure that an understanding of the owners’ propensity for risk is taken into account in developing strategies and tactics to assist business units to meet their respective ﬁnancial goals.