The question posed is quite reasonable in the current environment. Let me put it in context – it is based on over a decade dealing with companies in this area and what I see as an alarming lack of risk awareness in the current environment.
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| When chaos strikes! |
Firstly, there is the old saying that to cure a drink problem you must first recognise that you have one. Risk management is the same – risk will only be managed when companies recognise that they have risk. This may appear to be a statement of the obvious but a lot of companies are “flying blind” out there. Listed below are some examples of where risk could exist and cause difficulties without proper management.
Has your business underlying risks that need to be identified e.g. are you invoiced in euro from a non-eurozone country? If so to what extent is the change in the underlying FX rate impacting on your euro price? Increasing interest rates coming from a low interest rate environment have a disproportionate effect. With the double-whammy of higher markets rates being added to higher lending margins, interest bills could rise by 50% to100% over a 12-18 month period very soon.
The effect of rising interest rates on banking covenants could result in a covenant trigger. Assuming that interest cover covenants exist for most medium and large companies, the market norm covenant would be around three times. Therefore every €100,000 increase in interest costs will require €300,000 in extra profits just to “stand still”. The cost of poor debt management is suddenly amplified through an inability to understand the interrelationships.
Have you run a risk assessment of your bank’s ability to provide you with the risk management tools and techniques that you require? We are seeing diversity in this area both between banks and, in one case recently, within a bank (one section of the bank would not allow the borrower to hedge its debt while a different section was insisting on hedging for a separate loan!)
Have you really looked at your cash management and working capital processes in order to identify costs savings?
Finally, the piece that has surprised me the most and is generally well below international standards: how do you report risk? Conventional financial/management reporting (variance analysis) doesn’t work. FX and interest are usually below the operating profit line and, hence, below the radar from a reporting perspective. When one considers the above shortcomings apply to the two fastest moving price categories of the business (as FX and money prices change every second of every day), the existence of poor risk management becomes obvious.
The conclusion? The need to challenge - challenge yourself to improve it if already addressing it, challenge yourself to address it if you are ignoring it and challenge your board to recognise that what they are presented with is something that could bring them down if ignored but something of competitive advantage if addressed (for example, as FX losses flow to the bottom line, ascertain the increase in sales required to generate profits to negate the FX losses). And based on recent experience, challenge your bank to provide you with the appropriate tools. Risk management is one of the few areas where banks and corporates are in a “win-win” situation. Neither party should ignore it.
Penned by John Finn, Managing Director, Treasury Solutions Ltd
