CIMA knowledge fast forward is a knowledge sharing initiative which strives to improve the conceptual clarity of the business community with regard to a core management/financial accounting or business related knowledge area, describing the concept, and explaining how it applies in practice. Sudarshan Senaratne is a Fellow Member of the Chartered Institute of Management Accountants, [...]

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CIMA knowledge fast forward

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CIMA knowledge fast forward is a knowledge sharing initiative which strives to improve the conceptual clarity of the business community with regard to a core management/financial accounting or business related knowledge area, describing the concept, and explaining how it applies in practice.
Sudarshan Senaratne is a Fellow Member of the Chartered Institute of Management Accountants, UK. He also holds a bachelor’s degree in Science from University of Colombo, and has extensive experience in the financial services sector, having held senior positions at National Development Bank and LOLC groups of companies.

In 2005, Mr. Senaratne ventured into a career in consultancy. Since then, he has completed assignments for several international institutions and donor agencies in Sri Lanka, as well as in other countries in the South Asian region. His consultancy assignments cover several areas such as financial management, strategic planning, conduct of due diligence studies, credit risks management, carbon finance and sustainable development projects, micro finance, etc.

He has attended several international training programmes, addressed several international conferences and contributed articles to various journals in Sri Lanka and abroad.

He was the President of the Chartered Institute of Management Accountants, Sri Lanka Division in 2002/03. Previously, he has been a Council member and the Deputy President of this institution. He was also a Member of the CIMA UK Council, representing Sri Lanka’s membership from 2004 to 2007. He has held several board positions in public and private sector institutions.

A Finance Professional’s Role in Risk Management Risk Management

The commonly known definition of this term is ‘to avoid unfavourable events occurring to a business or to an organisation’. Risks in general can be viewed as an opportunity or a threat, depending largely on the culture and attitude of the management of an organization towards taking risks. For example a risk-averse management would always view risks as a threat, while a management which likes to take risks would consider a high-risk venture an opportunity to earn high rewards.
The level of risk an organisation would like to accept should depend on its resources. Therefore, as a first step, the business needs to decide what level of risk it is willing to take after considering its resources. This is defined as the ‘Risk Appetite’.

How does a risk arise?

A risk arises when an activity does not bring in the expected outcome; for example, in the case of an investment, a business faces a risk if the expected return is not delivered. On the other hand, every investment involves some risk and the success of the investment will depend on how well the risks are managed. Sometimes doing nothing about an important issue could expose an organisation to risks and the impact of such inaction could be very harmful to a business.

Small versus Large businesses

Good risk management practices are essential for a large organisation even if they are privately held, since the impact on the stakeholders and the economy of a country could be severe if they collapse due to improper risk management. In large organisations, especially public quoted companies, generally the risk management systems are fairly well embedded with proper structures. These companies are now compelled to have audit committees and risk management committees to ensure the organisation’s risks are well managed. Today most large organisations have internal audit systems

that h elp idetify and reduce internal operational risks.

On the other hand, the small and medium scale businesses (SMEs) tend to take a complacent view on risk management, since the impact of any failure is mostly limited to the shareholders and possibly to a few stakeholders closely associated with the business.

This problem of not addressing issues relating to risk exposure could be more acute especially in SMEs where the decision making process is highly centralised (owner-driven) and sometimes autocratic. For example, an owner or a major shareholder of a small business might decide to go into a new venture which might require a substantial investment. Sometimes such decisions could be made on emotional grounds rather than being rational. In such instances, the owners of the business may overlook assessing some of the possible risks. This could be due to a lack of expertise or knowledge. In such instances, absence of proper risk assessment systems and effective methods of encouraging dissenting views or concerns, especially by staff – having too many ‘yes men’ – could result in making wrong decisions, which can have disastrous consequences.

Finance Professional’s Role

In the CIMA syllabus, risks are indentified as Operational, Financial, Economic and Reputational. The role of the finance professional is to be mindful of all risks that are associated with the business or the organisation. He /she should always think of possible adverse consequences if the desired outcomes of the decision are not realised.

There are risks associated with every decision we make in a business; for example, a new investment, launch of a new product, diversification into a new market, buying an expensive fixed asset such as a computer system, recruiting staff, moving to a new premises etc. In all such cases, the finance professional needs to assess the impact that decisions would have on the overall business if the intended decision does not bring the expected results. The assessment should consider how the business will cope with a loss and to what extent it will wipe out the company’s resources, especially the net worth. The risk becomes greater when a company is required to borrow funds externally for investments since such borrowings need to be serviced regardless of the outcome of the investment – success or failure.

Conclusion

Organizations are faced with numerous risks and the management of these risks play a vital role in achieving the corporate objectives of the organization. The impact on the stakeholders and on the economy of a country is severe if a large organisation fails. Such failures could be avoided if organizations can adopt good risk management practices such as introducing corporate governance practices, developing risk policies and internal controls systems, proper risks assessment etc. A good finance professional should assist the senior management by educating them about risks, adopting risk-assessing systems and ensuring that exposure is well within the risk appetite of the company.




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