Have You Got the Risk Right? On Risk Appetite, Strategic Planning, and a Truly Holistic Approach to Risk Management

Abstract

A company’s overall risk profile is in no small measure determined by how much liquidity it has available to meet unforeseen cash outflows, and by how much debt leverage it has in its balance sheet, which may limit its access to new funding. In addition, the overall risk profile is clearly also a function of the risks identified in the “risk register” , the list of key risks which is typically an output of Enterprise Risk Management (ERM) programs. However, the ERM process is often detached from the analytical work of predicting and managing the company’s financial position. Enterprise Risk Budgeting (ERB) is about creating an interface between these processes. At the heart of this lies a risk-adjusted financial planning model that is capable of utilizing the knowledge about risk contained in the risk register, and of expressing overall risk in terms of well-recognized financial bottom lines, such as earnings, cash, or key financial ratios. The goal of ERB is that the risk-return profile of various strategic and financial policies (such as investment budgets, strategic plans, capital structure, and so on) can be reliably addressed to ensure that risk is within the company’s risk appetite. When Enterprise Risk Budgeting is applied, ERM, financial management, and strategic decision-making become integrated processes.