While the saying that the only constant is change may be 2,500-plus years old – Heraclitus, a Greek philosopher who lived about 500 BCE is credited with first uttering something along these lines – it appears to resonate with 21st century finance professionals. More than 90 percent of respondents to a risk management survey recently released by the Association for Financial Professionals (AFP) and Oliver Wyman expect greater earnings uncertainty over the next five years. Among the top factors driving their view that uncertainty is, well, certain, are financial and macro-economic risks, the survey found. "Uncertainty is here to stay," says Jim Kaitz, AFP president and CEO.
Among the different types of risks to which their businesses were exposed, financial risks, including liquidity, credit and FX risks, topped financial execs' list of concerns; it was mentioned by nearly three-quarters of respondents. Some 38 percent identified macroeconomic risks, such as inflation and GDP growth (or lack of it) as a source of concern. Right behind this were such business risks as supply chain or production disruptions, along with litigation and labor issues.
How are organizations responding to the anticipated prevalence of risk? According to the survey, they're taking a variety of measures. Just under half of respondents have boosted their investments in IT. About one-third have increased their earnings growth targets and/or enhanced their hedging programs. A similar number have increased their use of contractual risk transfer arrangements – typically insurance.
About 30 percent of respondents have taken a conservative approach, slowing investments in expansion, and/or capital expenditures. More than one-third have cut staffing.
While earnings volatility appears to be a widespread concern, an effective risk management program can reduce it, according to a 2010 study by insurer FM Global. In fact, researchers found that companies with strong practices in managing their property risks produced earnings that were 40 percent less volatile than those at companies with less advanced risk management practices. Earnings volatility averaged 18 percent at companies with strong risk management practices, versus 31 percent at companies with weak practices. To determine this, researchers analyzed earnings volatility at 520 companies with revenue of more than $1 billion, and compared this against proprietary data on the companies' risk management practices.
To be sure, FM Global, as an insurer, has an interest in promoting sound risk management practices. However, the findings make sense. The average total cost of a loss at companies with weak physical risk management practices topped $3 million; that compares with $620,000 for companies with more effective risk management programs, the study found.
"One way organizations can take control of rising uncertainty in their earnings is by adopting a new mindset and making more risk-adjusted decisions," Kaitz says. "The ones that do this effectively will have a competitive advantage."