FP&A teams are actively involved in strategic decision-making and an ongoing dialogue with senior management. They play a part in ensuring the right tools and infrastructures are in place to manage risks.
Risk v/s Opportunities.
Risk is potential for a loss while an opportunity is potential for a gain. They are two sides of the same coin. Risk taking is one of the key factors to a company’s success. Risk is often thought of as something negative. Although taking risk can result in significant upside opportunities. This can be in the form of innovation, competitive advantage etc.
Risk is something unplanned that might happen that could have a negative impact on the organization. An opportunity is something unplanned that might happen that could result in a positive impact on the organization.
These can come from any unknown source, or direction and are not always internal. It can be external, macroeconomic, customer, technology etc.
How do Finance and FP&A think about risk and opportunity?
Most organizations do their annual operating plans and budgets once a year.
They budget with the best available information at the point in time. Later, every quarter they reflect on what has happened (actual vs budget).
Not everything goes as it was planned. This is where quarterly forecasting becomes important. It helps to quantify and manage the gap between the original budget and the reality: where the company is truly headed, according to the latest insights.
Risk and Opportunity (R&O) matrix is a helpful tool to monitor and quantify material deviations from the budget (or previous forecasts)
This is like a ‘journal’ where we document all the unexpected items an organization is aware of that could result in significant deviations from original assumptions. This journal should be continuously maintained, and reviewed regularly. Based on the updates or the new intelligence we could decide to update the next quarterly forecast to include, exclude, or significantly alter existing revenues or costs.
Here is an example of an Risk and Opportunity (R&O) matrix:
1. Item: This is a short description of the event in consideration.
2. Cost Center(s): This item may or may not impact the entire organization. If it impacts specific departments, then tracking the Cost Center is important.
3. Description: This is a detailed description of the event. We should have possible reasons as to why the given item is considered a risk or an opportunity.
4. Category: This is the Income Statement or the account line item expected to be impacted by the event.
5. New / Change: Is this the first time or a new event (no impact of this event considered in the forecast earlier), or is this a change? (already included in the previous forecast, but there have been changes from what it was previously estimated).
6. Probability %: This is the estimated probability of occurrence. This should be continuously monitored as better insight is gained it moves towards 100%, or 0%.
7. Include / Exclude: Should the item be included in the next forecast – meaning should we adjust our forecast. As a general practice, this is Yes for high probability items. Alternatively, we could consider a weighted dollar amount.
8. Current Year $ Impact: This quantifies the $ impact of this item.
Many organizations tend to include risks and leave out the opportunities for upside surprises. This is not good practice, especially for listed companies as the upside EPS misses can also be painful like a downside miss.
Using an R&O matrix along with quarterly forecasting and budgeting, and scenario planning can help an organization to be prepared to react and course correct on the fly.