FinPod

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you know, with all these interest rate hikes, it seems like, and all the supply chain issues and the credit market tidying up, it's no wonder everyone's thinking about risk management. It's certainly top of mind for a lot of businesses these days. So we figured let's equip our listeners with the strategies they need to not just survive, but thrive in this kind of environment. Yeah. And we've got some really interesting case studies to draw from for this deep dive. Yeah. You sent over some fascinating material. Yeah. And then how Southwest Airlines navigated all that crazy oil price volatility with their fuel hedging. Oh yeah. Fascinating. And we'll contrast that with Lehman Brothers. Oh boy. Infamous collapse. Yeah. Due to their failure to manage credit risk. And then of course we've got Apple and their massive cash reserves. Oh yeah. Is that really a strength or is that a missed opportunity? Well, that's a great question and it kind of highlights a key point, right? That risk management is not just about hunkering down and playing defense. Right. It's about understanding how these different strategies work and when to apply them. Okay. So let's take a step back before we get into the specific strategies and just look at the types of financial risk that companies face because you sent over materials about market risk, credit risk, operational risk, liquidity risk. Right. It's overwhelming. Yeah. There's a lot. It's like the four horsemen of the apocalypse. That's a vivid analogy and it's an apt one. Yeah. Because if you ignore these risks, the impact can be pretty catastrophic.

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Okay. So let's break them down then. Horsemen number one. Okay. Market risk. It seems like every day there's a new headline about interest rates or commodity prices going crazy. Exactly. Market risk is all about those external factors. Yeah. Things that are really outside of your control that can throw a wrench in your plans. Right. So fluctuations in interest rates, exchange rates, commodity prices, those are the big ones. Okay. And the research shows that companies that actively manage their exposure to those things tend to outperform doing times of market turbulence. So instead of just hoping for the best, we got to have a plan. Okay. What about credit risk? That's the one that keeps me up at night. Yeah. Credit risk is a big one. It's the possibility that your customers or your partners aren't going to be able to pay their debts. Right. And we saw with Lehman Brothers, the ripple effects of poorly managed credit risk can be catastrophic. Yeah. Not just for a single company, but for the entire financial system. Okay. And then that brings us to operational risk. What kind of internal disasters fall under that category? So think about things like fraud, cyber attacks, supply chain disruptions, even simple human error. Oh, God. Remember the JP Morgan London whale incident? Vaguely, yeah. So series of internal control failures resulted in billions of dollars in losses. Wow. That's operational risk in action. Wow. And it just demonstrates how crucial it is to have really robust internal controls and losses. It's a good reminder that the risk isn't always external. Sometimes it's internal. Absolutely. Okay. Last but certainly not least, we've got liquidity risk. Yeah. This is the risk that you're not going to be able to meet your short term financial obligations. Oh, good. So it's about having enough cash on hand or access to credit lines to keep the lights on. Okay. Even when things get tough. It makes me think about the contrast between Apple with their mountains of cash and a company like WeWork. Oh, yeah. That really struggled with liquidity. It seems like they're kind of opposite ends of the spectrum when it comes to preparedness. Yeah, they do. And it really highlights how important it is to find that right balance. Okay. Because while Apple's huge cash pile provides a significant buffer, some people would argue they could be to place that more aggressively for growth. Interesting. And on the other hand, WeWork's rapid expansion without adequate financial controls led to a severe liquidity crunch. Yeah, that's not good. So there's a sweet spot in there somewhere. And it's different for every company. And that's what risk management is all about, right? Yeah, finding that sweet spot. Okay, so we've labeled the four horsemen, but I'm guessing it's not as simple as just knowing their names. You're absolutely right. Just being aware of these risks isn't enough. We need to understand how to actually mitigate them. So that's what we're going to dive into in the next part, though. Exactly. We'll get into the nitty gritty. All right. I'm excited to talk about hedging. It sounds like financial wizardry to me. I want to understand how that actually works in practice. We'll break it down. Okay, great. Make it easy to understand and really actionable for our listeners. All right, awesome. I'm looking forward to it. All right, me too. All right, so we've identified our four horsemen of financial risk. Right. Now let's talk about how companies can actually wrangle these things. You mentioned hedging before. And that sounds like some kind of financial wizardry to me. Yeah, a lot of people think that. So how does this actually work in practice? Well think of it like this. It's a way to kind of transfer risk. It's almost like taking out an insurance policy to protect yourself against a specific event. Okay. Let's say you're a manufacturer and you rely heavily on a specific raw material like, I don't know, copper, let's say. Well, in your notes, it looks like aluminum prices are going crazy right now. Yeah, exactly. So that must be tough to deal with. It can be. Yeah, if the price of aluminum just skyrockets, it could really get into your profit margins. Right. So hedging can help you mitigate that risk. Okay. The way to do that is through a futures contract. Okay. Which essentially allows you to lock in a specific price for aluminum at some future date. Regardless of what the market does. Exactly. Regardless of what happens to that market price. So even if it goes way up. Even if it goes through the roof, you're protected. He's got that. You already locked it in. Okay. Now, of course, on the flip side, if the market price plummets, you would miss out on potential savings there. Right. So there's a trade-off. There's always a trade-off.

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You're sacrificing potential upside to protect yourself from that downside risk. It's like an insurance policy. You hope you never have to use it, but you're sure glad you have it when disaster strikes. Exactly. Okay. So are there other hedging techniques besides futures? Absolutely. Option swaps forwards.

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These are all tools in the hedging toolkit. Okay. Each one has its own nuances, and it's really suited for managing particular types of risk. Okay. So for example, a company might use currency swaps to manage their exposure to fluctuations in foreign exchange rates. It sounds like you need to really understand which tool is the right tool for the job. Yeah. You really got to know what you're doing. You need a deep understanding of both the specific risks you're facing and how these instruments actually work. So it's not a do-it-yourself kind of thing. It's definitely not something to just jump into without doing your homework. Okay. So we've talked about hedging. Let's talk about diversification. We touched on it earlier, but how can companies really practically spread their risk? So diversification is all about not putting all your eggs in one basket. Okay. It could involve expanding into new markets. Okay. Developing new product lines. Right. Maybe even diversifying your supply chain. Right. Think about a company that generates all of its revenue from a single product. Okay. If demand for that product suddenly dries up. They're in trouble. They're in big trouble. Yeah, that's not good. So having multiple revenue streams can really provide a cushion during those tough times. Makes sense. Another example is geographic diversification. Okay. So if a company only operates in one country, they're exposed to all the economic and political risks of that specific region. Right. But if they expand into new markets. Then they're spreading that risk. Exactly. Yeah. And they can also tap into new growth opportunities. So if one market's not doing well. Another market might be booming. Yeah. Okay. So they can kind of balance each other out. That's the goal. Yeah. Now, of course, diversification needs to be done strategically. Right. You don't want to just blindly expand into new markets without doing your research. Right. Because that could actually increase your risk if you don't know what you're getting into. Absolutely. It's about finding that right balance. Right. Between growth and mitigating risk. Exactly. Okay. Speaking of finding balance.

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Let's move on to scenario planning.

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We talked about what if scenarios before. But I'm still a little fuzzy on how this actually works in practice. Sure. That is a structured way to explore different possibilities. Okay. So let's say you're a financial institution and you're concerned about a potential recession. Okay. Everyone's talking about that. Right. So you might develop three different scenarios. A best case scenario where the economy keeps humming along a base case scenario where growth flows down a bit. And then a worst case scenario where we actually have a significant contraction. Okay. So you're creating these different potential outcomes. And then what do you do with that information? So each scenario would include different assumptions about key economic factors. Okay. Things like interest rates, inflation, consumer spending. And you'd use those scenarios to stress test your portfolio. So you'd see how your investments would perform under each of those conditions. Exactly. And this would highlight potential vulnerabilities. Okay. And help you develop contingency plans. Okay. So for example. For example, you might decide to reduce your exposure to certain high risk assets if that worst case recession scenario starts to look more likely. Okay. So it's like you're gaming out the different possibilities. Exactly. That makes a lot of sense. But I can also imagine it being pretty time consuming to develop these elaborate scenarios. How do busy FP&A teams find the time to do this effectively?

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It's a valid concern. But fortunately there are tools and technologies that can help streamline the process. Okay. And remember, scenario planning doesn't have to be this overly complex exercise. Okay. Even simple what if discussions can be incredibly valuable. So you don't have to build some complicated financial model. Not necessarily. Sometimes it's just about getting the right people on a room. Okay. And having a frank discussion about potential risks and opportunities. So for example, a manufacturing company might bring together their operations, finance, and sales teams to brainstorm potential supply chain disruptions. There they are. And figure out how to mitigate those risks. That's a great example. The key is to make scenario planning a regular part of your decision making process. Not just a one off exercise. So you're constantly reevaluating. Constantly reevaluating and adapting to the changing environment. Makes sense. Okay. So we've covered hedging diversification scenario planning. What about our last line of defense liquidity buffers? It seems like having enough cash on hand is so critical, especially in uncertain times. It's absolutely critical. Liquidity is the lifeblood of any business. It's what allows you to weather those unexpected storms and seize opportunities when they arise. Remember we work. Yeah. Their lack of liquidity really hampered their ability to deal with the tough market. Exactly. So building a strong liquidity buffer should be a top priority for any company, especially today. But how do companies actually go about doing that? Is it just hoarding as much cash as possible? It's a bit more nuanced than that. There's a balance between holding enough cash to meet your short term obligations, but also deploying that cash for growth opportunities. Right. So you don't want too much cash sitting idle. Exactly. But you also don't want to be caught short. You got to find that sweet spot. So what are some practical things that companies can do? Well, accurate cash flow forecasting is crucial. Okay. You need to really understand your cash inflows and outflows, both in the short term and the long term. So you can anticipate potential shortfalls. Exactly. And take action to address them. So it's all about visibility, knowing when the money's coming in and when it needs to go out. Absolutely. You can also explore things like negotiating favorable payment terms with your suppliers, maybe accelerating the collection of receivables from your customers. Okay. Even strategically delaying certain payments. So it's about being proactive with your cash. Exactly. Proactively managing your working capital. Makes sense. And don't forget credit lines. Oh, that's a good point. Having access to credit can provide a safety net during tough times. Right. So you can bridge those temporary gaps. Exactly. It's like having a financial backup plan. I like that.

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So we've explored all these techniques to tackle the four horsemen of risk, but I'm sensing there's more to it than just having the right tools in your toolbox. You're right. It's not just about techniques and strategies. It's about fostering a culture of risk awareness throughout your organization. So it's got to be part of the company's DNA. Exactly. Not just something that's handled by a separate department. Something needs to be thinking about it. Everyone from the CEO to the frontline employees. So it's about creating a culture where people feel comfortable saying, hey, have we considered the potential downsides of this decision? Precisely. And it's about having a process for capturing those concerns and actually incorporating them into the decision making. Okay. So before we move on to the next part, I want to get your perspective on what are some of the biggest risk management challenges that companies face today? What are some of the blind spots that they should be aware of? That's a great question.

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I think one of the biggest challenges is just the increasing complexity of the global business environment. Right. Things like geopolitical instability, climate change, rapid technological advancements. The world is changing so fast. It really is. And it's creating all these new and unpredictable risks that are difficult to model and manage. It's hard to know what's coming next. It really is. Yeah. Another challenge is the interconnectedness of global markets. Right. What happens in one part of the world can quickly cascade and impact businesses across the globe. So a supply chain disruption in one country could lead to shortages and price heists in another. Exactly. And this really highlights the need for global collaboration and information sharing. Okay. Companies need to work together to identify and mitigate those systemic risks that could impact entire industries. So it's like risk management is becoming a team sport. It really is a global team sport. Are there any other blind spots that we should be thinking about? Yeah. I think there's a tendency to rely too heavily on historical data when we assess risk. Okay. While past data can be informative. Right. It's not always a reliable predictor in the future, especially in today's rapidly evolving world. Right. It's like they say past performance is not indicative of future results. Exactly. Yeah. So companies need to develop these more forward looking risk management frameworks. Okay.

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So instead of looking in the rear view mirror, you got to be scanning the horizon for potential hazards. That's a great analogy. Yeah. It's about shifting from a reactive mindset to a proactive one. So anticipating risks before they happen instead of just reacting to them after the fact? Exactly. And it's about building a culture of resilience. Okay. Where companies are able to adapt and thrive even in the face of adversity. So it seems like risk management is not going to become a real problem. thrive even in the face of adversity. So it seems like risk management is becoming less about avoiding risk altogether and more about embracing it as a natural part of doing business. Absolutely. It's about understanding that risk and reward are two sides of the same coin. Companies that can effectively manage risk are much better positioned to capitalize on opportunities and achieve long-term success. So it's almost like risk management is evolving from a specialized function to a core competency for any successful business. I think that's a great way to put it. Okay, so before we wrap up this part, I want to bring it back to our listener and their specific needs. We want to make sure these insights are actionable for their day-to-day work. So for you listening, think about the risk management challenges specific to your industry. Yeah, what keeps you up at night? What are some of the potential blind spots that your company might be overlooking? We're going to explore that further in part three, where we'll delve into how to actually integrate risk management into the daily work of finance professionals. Okay, so we talked about the four horsemen. We've explored a whole bunch of strategies to tackle them. And we've even touched on some of the broader challenges that companies are facing in this kind of crazy environment. But now let's bring it all home and focus on how you as a finance professional can really own risk management in your day-to-day work. Yeah, let's make it practical. Exactly. You know, actionable, not just theoretical. So let's say you're sitting down to work on your financial forecast. Right. Or you're evaluating a potential investment opportunity. Yeah.

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How do you actually weave risk management into those tasks? Well, it starts with a shift in perspective. Yeah. I think instead of treating risk management as this separate chore or a checkbox to tick off, try to see it as a lens through which you view all financial decisions. Okay, so less about adding another item to your to-do list, more about changing how you approach your work in general. That's it. And it starts with asking yourself the right questions from the very beginning. Like what? What are the potential pitfalls of this project? Okay. What are the underlying assumptions driving our projections? Okay. What could go wrong and how would it impact our bottom line? So it's almost like having a healthy dose of skepticism, even when everyone's excited about a new project. Yeah, don't be afraid to challenge assumptions. Think critically, play devil's advocate. Yeah. So if someone presents a forecast that looks a little too good to be true, don't just take it at face value. Exactly. Dig a little deeper, ask some tough questions, make sure those risks have been carefully considered. That's right. And this applies to every stage of the financial planning process, from budgeting and forecasting to analyzing investments and evaluating performance. Okay, so let's get into the nitty gritty.

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What are some practical steps that finance professionals, especially those in FPNA roles, can take to really make risk management part of their daily routine? One crucial step is incorporating risk assessments into your financial models. Okay. Move beyond those deterministic forecasts that rely on a single fixed outcome. Right. Embrace probabilistic modeling, which allows you to explore a range of possibilities. So instead of saying we project revenue will grow by 10% next year, you'd say something like there's a 60% chance revenue will grow between 8% and 12%. But there's also a 10% chance that it could actually decline. That's a great example. By acknowledging that inherent uncertainty in any forecast, you're painting a much more realistic and nuanced picture of what the future might hold. And that leads to better decision making. It allows you to assess those potential downside risks, understand the range of potential outcomes, and ultimately make more strategic decisions about resource allocation investments, even pricing strategies. Okay, so that's financial modeling. We also talked about scenario planning. How can FP&A teams make this a more regular part of their workflow? So scenario planning shouldn't be confined to that annual budgeting process. Okay. It should be an ongoing activity that informs decision making throughout the year. So regularly revisiting those best case, base case, worst case scenarios that we talked about. Exactly. And don't be afraid to get creative with your scenarios. Think about potential disruptions specific to your industry, your company, even your individual projects. So a manufacturing company might develop a scenario around a major supplier going bankrupt, while a software company might focus on a scenario where a new competitor disrupts the market with some groundbreaking product.

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It's about challenging your assumptions, thinking critically about what could go wrong, and don't just focus on external risks. Internal risks like operational failures or cybersecurity breaches can be just as damaging. Yeah, like we said, sometimes the most dangerous risks are the ones that are right under our noses. Absolutely. So it's important to have that holistic view of risk that encompasses both the internal and external environment. Okay. And so scenario planning isn't just about identifying risks though. It's about actually developing concrete action plans. That's right. What steps will you take if a particular scenario actually plays out who's going to be responsible? What resources will you need? Exactly. It's like having a playbook ready to go. Right. And then you're off guard when something unexpected happens. And that level of preparedness can make all the difference. You really can, especially in today's world. Okay. We can't talk about modern risk management without talking about data and technology. It's everywhere. It seems like they're playing a really vital role. What are your thoughts on that? I think it's undeniable. We live in a world that's overflowing with data, and finance professionals have access to more information than ever before. Right. The key is knowing how to harness that data effectively to actually inform your risk management decisions. So it's not just about having data. It's about knowing what to do with it. Exactly. And that's where technology comes in. We're seeing these advanced analytics platforms, machine learning algorithms, even artificial intelligence being used to sift through massive amounts of data, identify patterns, predict potential risks. It's like having a high tech crystal ball. Well, maybe not quite a crystal ball, but these technologies can definitely augment your risk management capabilities and support more informed decision making. Technology is a huge help, but we also can't forget about the human element of risk management. What are some of the essential skills and qualities that finance professionals really need to cultivate to become effective risk managers? Well, the technical skills are crucial.

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Of course, you need a solid understanding of financial modeling data analysis and the fundamental principles of risk management. But the SARF skills are equally important things like communication collaboration, critical thinking, problem solving. So it's not just about crunching the numbers. It's about being able to effectively communicate those insights to others, collaborating across teams, making sound judgments under pressure. You're hitting all the key points. Risk management is ultimately a team sport. It requires diverse perspectives, open communication, and a willingness to challenge the status quo. And it's about fostering that culture of risk awareness throughout the organization. Absolutely. Everyone from the CEO to the newest employee needs to understand their role in managing risk. Right. It's about creating that environment where people feel comfortable speaking up about potential risks, asking tough questions, challenging assumptions. That's the most effective risk management strategies are built on a foundation of transparency, accountability, and continuous improvement. This has been a really fascinating deep dive into the world of risk management. We covered a lot of ground today from identifying the different types of risk to exploring a whole bunch of practical strategies and even peering into the future of risk management with data and technology. And we've really underscored how important it is to embed that culture of risk awareness throughout an organization. So as we wrap up, I want to leave everyone with a final thought. The ability to manage risks effectively is becoming a defining characteristic of successful companies in this uncertain world. It's no longer enough to just be good at what you do. You also need to be good at anticipating what could go wrong and having a plan to address it. The companies that thrive in the future will be the ones that view risk management not as a burden, but as a strategic opportunity to build resilience, adaptability, and long-term value. Well said. I think that's a great note to end on. So to everyone listening, keep learning, keep challenging yourselves, and keep striving to become more effective risk managers. It's an investment that will pay dividends for both your company and your career. Thanks for joining us on the Deep Dive.