Accurate risk reporting needs to be improved in the business rescue profession

The regulatory pressures for improved risk assessment and reporting on internal control have increased around the world.

The reason corporate accounting failures, frauds, internal control breaches, and governance failures have been seen in companies and countries that thought they were immune to these events.

Although risk assessment processes generally have improved, inadequate risk reporting in some organizations has led to a failure to fully integrate identified risks into strategic and operational decisions.

This is a challenge that all BRPs and turnaround professionals need to manage.

Informed financial decisions are at stake
Financial professionals want to provide a clear understanding of the risks and fair disclosure to both internal and external decision-makers without causing unnecessary alarm.

What is the role of the BRP when it comes to this kind of reporting? As we continue to build the narrative of companies becoming more attractive to investors, accurate reporting to creditors and lenders – those who make the final decision when it comes to PCF – helps them to appreciate the risks that the company faces. They can then make an informed funding decision.

The demand for disclosing risk externally is also growing. Investors, financial analysts, and other external stakeholders are increasingly aware of the critical role of proper risk management.

They want better information on the various risk’s organizations confront, and how to address them, and are interested in organizational risks far beyond the traditional scope of financial risks. They want concrete assurance that a sound system and process is in place to identify, assess, and manage risks, so that they can better evaluate corporate performance and make more informed decisions.

Increased measurement and reporting of this broader set of risks is necessary, not only to meet the new regulatory requirements but also to improve managerial performance and stakeholder confidence. Senior corporate managers need to develop ways to effectively communicate organizational risks and risk management processes both internally and externally. They face decisions on what to report to each audience, and the form of risk reports, including how much detail to include.

Senior management therefore needs to clearly understand the risks and promote disclosure to both internal and external decision-makers without causing unnecessary alarm or increasing reporting and compliance risks. A more effective organizational risk reporting system can provide internal and external stakeholders with information they need to:

• craft strategy;
• make investment and other
• business and personal decisions; and (simultaneously)
• inspire confidence in the organization’s financial reporting and disclosure.

This increased focus on risk can turn risk management and risk reporting into an opportunity and reward.

The importance of organizational risk reporting
Improved internal decision-making is facilitated when managers apply various analytical approaches to their decisions, and also incorporate numerous variables into capital investment and operating decisions. ROI is calculated, using projections of revenues and costs based on the best available data. Unfortunately, the decision models of many organizations are incomplete, since they do not explicitly incorporate evaluations of potential risks, which has often led to poor decision making.

Organizations can improve decision making by attempting to formally integrate estimates of a broader set of organizational risk related costs and benefits into their decisions.

These risks include the risks of:

• technological obsolescence of product assembly (or the product or service itself);
• financial risks;
• potential breakdowns in the supply chain;
• risks inherent in new product or service development (and in R&D investments generally); and
• other risks. As a reliable and timely risk reporting process provides credible information on organizational risks, employees also can make better decisions and accelerate continuous and breakthrough organizational improvements.

Appropriate external disclosure of organizational risks and risk management initiatives allows shareholders and financial analysts to more properly value company shares. Improved disclosures make capital allocation more efficient, and reduce the average cost of capital. Voluntary disclosure also decreases price volatility and narrows bid-ask spreads, enhancing securities liquidity. Customer loyalty may also increase, and fair and favourable media publicity may result.

Profiling The Risk Report Audience
Reporting organizational risks should operate on multiple levels to address the needs of diverse audiences, each with their own specific needs, requirements, expectations, agendas, and levels of expertise.

Although internal risk reports aim exclusively at internal audiences, from a broader perspective external risk reporting, including corporate annual reports, may include both external users and interested internal groups both internal and external audiences can be further divided into two subgroups. On one hand, some audiences (audit committees, internal control steering committees, boards of directors, and senior management among internal audiences, and registered auditors, regulators, shareholders, and creditors among external audiences) must or should be informed about the organizational risks and risk management processes because of regulation or recommendations in standard setter guidance. Voluntary disclosure to other internal audiences (managers, employees, and integrated business partners), and external stakeholders (financial analysts, customers, suppliers, community, and media), is recommended because of anticipated benefits to improved decision-making.

For years, reporting has often been based on mistrust, as senior management questioned the willingness of outsiders to handle corporate information responsibly. Today, the premise is not just that senior management should base the risk reporting communication policy on trust to be more accountable; organizations can also expect tangible benefits from fair and broad disclosure of organizational risk management. With respect to external stakeholders, owners of the organization were typically considered the principal external audience for external risk reporting. However, with increased recognition of the role of customers, suppliers, creditors, and communities in successful achievement of organizational goals, external risk reporting should not be fragmented but unitary.

Creditors have a particular vested interest in complete and timely disclosure of organizational risks, to assess credit risks and potential joint liability for loans secured by, for example, contaminated properties. They may be interested in strategic risks as well.

The foundation stone of trust
A lot has been written in the past about the growing level of mistrust in the industry. Particularly between shareholders (creditors and lenders) and BRPs. On the one hand, shareholders are not confident that certain BRPs are qualified to do their jobs. Of the 400 + BRPs that are currently in the industry, shareholders feel that only 30 have the requisite skills set (knowledge and experience) to execute their duties with confidence. While there are some BRPs who accurately fit this description, how much of this crisis of confidence is based off the fact that distressed companies provide BRPs with inaccurate information trying to hide the level of distress? As one BRP recently put it: sometimes, this (the provision of untruthful information to BRPs) is quite intentional.

Equally, a lot has been written about environmental and social governance (ESG) and the role that it plays in complicating or alleviating financial distress. Accurate reporting of risks is at the heart of ESG.

As we move forward and further interrogate the crisis of trust that is building in the industry, it is becoming apparent that there needs to be a meeting of minds to come up with best practice principles when it comes to risk reporting. Getting more companies out of financial distress improves the industry success rate which is another red flag which has been highlighted by creditors and lenders. Think about the recent rescues that you have made, and those that have been reported on extensively in the media and ask yourself these questions:

• was accurate information about the extent of the company’s financial distress provided at the early stages of the rescue? and
• if different information was presented to creditors and lenders during the PCF stage, would a different funding decision have been made?

Unfortunately this does come back to the skills and experience of a BRP. Even if inaccurate (false) information was provided to the BRP to try and hide the extent of distress, Experienced and Senior Business Rescue Professionals should be savvy enough to spot this and flag it to companies and shareholders. If they cant, then they need more experience with cases where this is a challenge. But how can we give BRPs chances to gain this experience if shareholders are reluctant to work with the 370 BRPs who they feel are not qualified to successfully do their job.