The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently published new guidance on how companies can promote “risk appetite” as part of decision-making. It’s especially relevant in today’s uncertain marketplace.
Digesting the new guidance
The COSO guidance, “Risk Appetite — Critical to Success: Using Risk Appetite to Thrive in a Changing Word,” explains that management must learn how to anticipate and understand their risk when change happens. It defines risk appetite as, “The types and amount of risk, on a broad level, an organization is willing to accept in pursuit of value.”
This definition is intentionally broad to apply across an organization. The risk appetite may differ within various parts of your organization to remain relevant in changing business conditions. When establishing your risk appetite, the goal is to enhance long-term growth and innovation.
“Risk appetite is a fundamental part of setting strategy and objectives, providing context as the organization pursues a given level of performance,” said COSO Chairman Paul Sobel. He stressed the importance of recognizing that the choice of strategies and objectives requires an understanding of the appetite for risk.
In volatile times — like during the COVID-19 pandemic or when facing regulatory uncertainty from a contentious upcoming election — a business may need to alter its risk appetite to take advantage of growth opportunities as market conditions evolve.
Combining the ingredients
COSO lists six things to remember:
- Risk appetite is not a separate framework.
- Risk appetite and risk tolerance are different.
- Risk appetite applies to more than the financial services industry.
- Risk appetite is at the heart of decision-making.
- Risk appetite is much more than a metric.
- Risk appetite helps increase transparency.
Risk appetite applies through development of strategy and objective-setting. It focuses on overall goals of the business. Risk tolerance, on the other hand, applies to the execution of strategy and focuses on objectives and variation from plan.
To be effective, your company’s risk appetite should permeate its culture. To get the message out across the organization, management should consider creating an appetite statement that includes measurable benchmarks. For example, you might say, “ABC Co. isn’t comfortable accepting more than a 10% probability that it will incur losses of more than $200,000 in pursuit of emerging market opportunities.”
The choice of language and length of an appetite statement will vary by organization. Some statements require several sentences to balance brevity with clarity.
Recipe for success
Taking risks is essential to growing your business. However, risks can’t go unchecked. Setting and understanding risk appetite is an important element of corporate governance, strategic planning and decision-making. We can help you better understand and apply this concept, communicate your risk appetite to stakeholders and monitor progress.
Thanks to affordable technology, more and more companies have been allowing employees to work remotely in recent years. It’s become feasible to procure laptops, set up security protocols, use cloud servers and rely on employees’ home Wi-Fi connections to create functional virtual workspaces. In turn, many of these businesses have lowered overhead costs such as office rent and utilities.
Of course, with the onset of the coronavirus (COVID-19) pandemic, many companies have had to mandate that any employees who can work from home do so. As a result, virtual team building has become more important than ever.
Ensure consistency of processes and expectations
When employees work from home, many of the processes they use to complete tasks and fulfill duties may change slightly — or even drastically — to fit the technology used to execute them. This can cause confusion and lead to mistakes or conflicts that affect employee morale.
Make sure every virtual team develops and follows processes that produce results consistent with those generated on your physical premises. Doing so may require a concerted effort that slows productivity temporarily while everyone gets on the same page.
Meanwhile, reinforce with workers that your expectations of them are the same whether they work on-site or remotely. They shouldn’t feel as if they must work extra hard from home to “prove themselves,” but they do need to demonstrate that they’re getting things done.
Hold regular meetings — and “irregular” ones
Among the biggest challenges for work-from-home employees is feeling disconnected from their fellow team members. Brief, regularly scheduled Web-based meetings are a good way to address this dilemma. These gatherings allow everyone to see or hear one another (or both) and provide employees with the opportunity to voice concerns and contribute ideas.
If a given team is relatively new at working remotely, or you just want to bring any group of employees closer together, you could also hold special meetings specifically geared toward team building. There’s a wide variety of icebreakers, games and activities that teams can use to learn more about each other and to gain comfort in communicating.
For example, you can invite participants to share stories and photos of their pets, hold trivia contests or even sing karaoke. Just be sure to tailor such team-building efforts to your company’s culture and be wary of pushing remote workers too far out of their comfort zones.
Find a way
Whether your business has had employees working remotely for years or just recently had to ask workers to stay home because of COVID-19, there are plenty of ways to help them communicate better and enhance their performance as a team.
Timely, relevant financial data is critical to managing a business in today’s unprecedented conditions. Similar to the control panel in a vehicle or machine, dashboard reports provide a real-time snapshot of how your business is performing.
Why you need a dashboard report
Everything in a dashboard report can typically be found elsewhere in the company’s financial reporting systems, just in a less user-friendly format. Rather than report new information, a dashboard report captures the most critical data, based on the nature of the business. It can provide an early warning system for potential problems, allowing you to pivot as needed to minimize losses and jump on emerging opportunities in the marketplace.
To maximize the effectiveness of dashboard reports, make them accessible to managers across your organization via the company’s internal website or weekly email blasts. Widespread, easy access will allow your management team to quickly identify trends that require immediate attention. Additionally, businesses that are struggling during a reorganization or debt restructuring sometimes share these reports with their lenders as a condition of their continued support.
Metrics that matter
When deciding which information to target, look at your company’s loan covenants — lenders usually have a good sense of which metrics are worth monitoring. Then conduct your own risk assessment. What’s relevant varies depending on your industry, general economic conditions and the nature of your business operations.
In addition to tracking cash balances and receipts, most dashboard reports include the following ratios:
- Gross margin [(revenue – cost of sales) / revenue],
- Current ratio (current assets / current liabilities), and
- Interest coverage ratio (earnings before interest and taxes / interest expense).
From here, consider adding a handful of company- or industry-specific performance metrics. For example, a warehouse might report daily shipments and inventory turnover. A hotel that’s struggling to reopen might provide a schedule of net operating income, average room rates and vacancy rates compared to the previous week or month. A law firm might report each partner’s realization rate.
A diagnostic test
Comprehensive financial statements are the best source of information about your company’s long-term stability and profitability — especially for external stakeholders. But dashboard reporting is critical for internal purposes, too. These reports can help assess a sudden change in market conditions, interim performance or potential downward trend in your financial performance. Contact us to help you compile a meaningful dashboard reporting process for your organization.
A widely circulated article about the COVID-19 pandemic, written by author Tomas Pueyo in March, described efforts to cope with the crisis as “the hammer and the dance.” The hammer was the abrupt shutdown of most businesses and institutions; the dance is the slow reopening of them — figuratively tiptoeing out to see whether day-to-day life can return to some semblance of normality without a dangerous uptick in infections.
Many business owners are now engaged in the dance. “Reopening” a company, even if it was never completely closed, involves grappling with a variety of concepts. This is a new kind of strategic planning that will test your patience and savvy but may also lead to a safer, leaner and better-informed business.
When to move forward
The first question, of course, is when. That is, what are the circumstances and criteria that will determine when you can safely reopen or further reopen your business. Most experts agree that you should base this decision on scientific data and official guidance from agencies such as the U.S. Department of Health and Human Services and Centers for Disease Control and Prevention (CDC).
But don’t stop there. Although the pandemic is, by definition, a worldwide issue, the specific situation on the ground in your locality should drive your decision-making. Keep tabs on state, county and municipal news, rules and guidance. Plug into your industry’s experts as well. Establish strategies for expanding operations or, if necessary, contracting them, based on the latest information.
Testing and working safely
Running a company in today’s environment entails refocusing on people. If employees are unsafe, your business will likely suffer at some point soon. Every company that must or chooses to have workers on-site (as opposed to working remotely) needs to consider the concept of COVID-19 testing.
Employers are generally allowed to test employees, but there are dangers in violating privacy laws or inadvertently exposing the company to discrimination claims. The CDC has said that routine testing will likely pass muster “if these goals are consistent with employer-based occupational medical surveillance programs” and “have a reasonable likelihood of benefitting workers.” Consult your attorney, however, before implementing any testing initiative.
There’s also the matter of working safely. If you haven’t already, look closely at the layout of your offices or facilities to determine the feasibility of social distancing. Re-evaluate sanitation procedures and ventilation infrastructure, too. You may need to invest, or continue investing, in additional personal protective equipment and items such as plastic screens to separate workers from customers or each other. It might also be necessary or advisable to procure or upgrade the technology that enables employees to work remotely.
Move forward cautiously
No one wanted to do this dance, but business owners must continue moving forward as cautiously and prudently as possible. While you do so, don’t overlook the opportunity to identify long-term strategies to run your company more efficiently and profitably. We can help you make well-informed decisions based on sound financial analyses.
During the COVID-19 pandemic, many small businesses are strapped for cash. They may find it beneficial to barter for goods and services instead of paying cash for them. If your business gets involved in bartering, remember that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.
For example, if a computer consultant agrees to exchange services with an advertising agency, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there is contrary evidence.
In addition, if services are exchanged for property, income is realized. For example, if a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory. Another example: If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.
Joining a club
Many businesses join barter clubs that facilitate barter exchanges. In general, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.
Bartering is generally taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,000 credit units one year, and that each unit is redeemable for $1 in goods and services. In that year, you’ll have $2,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.
If you join a barter club, you’ll be asked to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income at a 24% rate.
Forms to file
By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.
By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. Contact us if you need assistance or would like more information.