Business Risk Management - What Accountants Know

Risk can be defined as the combination of the likelihood of an event and its consequences.

Accountants understand that risk management looks to control both the positive and negative outcomes of risk.

The UK Corporate Governance Code requires directors to confirm in the annual accounts their assessment of emerging and principal risks and an explanation of how these are mitigated.

Levels of risk appetite range from being risk averse to balanced or even active risk-seeking.

Types of Risk

Risk may be systematic and driven by external, market-wide forces (e.g. a change in interest rates) or unsystematic internal factors specific to the company (e.g. clients or contracts).

The main types of risk accountants can assess include:

• Operational risk - how efficiently the business is being run, accuracy of information systems and effectiveness of management and control systems

  
  

• Strategic risk - longer-term factors which include competitor analysis, reputation, regulatory and political change. It also incorporates knowledge management - the ability to retain key staff, intellectual property and production technology

  
  

• Hazard risk - exposure to natural events, actions of employees or consequences of accidents (either internal or external)

  
  

• Financial risk - level of gearing and liquidity, exposure to credit, interest and exchange rates. This type of risk will amplify any inherent business risks at a low level, but may directly contribute to business failure at a higher level

  
  

• Compliance risk - non-compliance with laws or regulations by the company or stakeholders

Accountants also categorise risk in other ways, such as: trading risk, cultural risk, political risk, legal risk, and IT systems risk.

External and internal factors contribute to risk

Risk Analysis

Accountants address risk by analysing the frequency and severity involved:

		Severity
		Low	High
	Low	Accept - cost of risk prevention not worth the benefit	Transfer - outsource or hedge risk
Frequency	High	Reduce - enhance control systems and introduce contingency plans	Avoid - terminate or abandon the activity

Techniques for incorporating risk into decision making include:

• Sensitivity analysis - considering how a change in variables affects the final result

  
  

• Breakeven analysis - making prudent estimates to assess a worst possible outcome

  
  

• Scenario building - assessing the best and worst possible scenarios for a range of results

Relevant cash flow analysis can also help management to determine probable outcomes by considering all opportunity costs and revenues directly associated to the project.

Note: care should be taken to disallow non-relevant cash flows such as sunk costs (money already spent regardless), accounting costs (such as depreciation which has a non-monetary effect).

Risk Strategies

Strategy	Examples	Notes
Diversification	Equity v debt Short v long term Fixed v variable	More applicable to larger entities
Hedging	Offset exposure with a new risk in the opposite direction	May be more important for smaller entities
Sharing	Credit guarantees and swaps
Transfer	Securitisation (insurance)
Internal controls	Credit vetting and limits

Benefits to Effective Risk Management

Key reasons why effective risk management is important include:

• Minimise financial loss

• Opportunity to benefit from potential upsides

• Protects reputation

• Enhanced decision-making

• Ensures employee safety

• Compliance with laws and regulations reduces the threat of fines and penalties

• Increases stakeholder confidence

• Promotes innovation

Ask your accountant how they can help mitigate your business risk in these key areas.

Points to note:

Risk analysis and strategies should be tailored as approaches may not be relevant to particular entities.

Risk is not static and is likely to change and evolve so it is advisable to update risk management at least annually.

This document is a simplified helpsheet and careful research should be completed if you are unsure.

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