Over the last decade, the CFO’s role has seen a lot of changes. In the past, CFOs focused on mitigating the risks that threatened a company’s financial stability. Their financial risk management strategies now branch into other areas of business, such as legal compliance and tech. This, in turn, has changed the way CFOs work with others to ensure risk management.
What Is the Traditional vs Modern-Day Role of a CFO?
A CFO’s role has traditionally centered on financial risks. However, the modern-day role of a CFO is much more complex. These are some of the tasks modern CFOs now tackle:
- Financial planning and analysis
- Investor relations
- Corporate finance
- Risk management
- Compliance
Many of these tasks are essential for a company’s success in the current business environment. They also require a collaborative effort with other department heads to ensure consistent growth.
What Are the Main Types of Financial Business Risks?
Before implementing financial risk management techniques, a good CFO thoroughly assesses the internal and external risks the company faces. This requires a team effort to ensure the CFO gets in-depth information beyond quantitative data. Consider these main types of financial risk.
Credit Risk
Credit risk is the possibility that a borrower will not repay a loan or debt obligation. It takes two forms: the credit risk of the company and that of customers that owe the company money. Credit risk can affect the value of investments, such as bonds.
Equity Risk
Equity risk is the possibility that the value of a company’s stock will fall. This type of risk is often caused by changes in the overall market, management decisions or by specific events, such as a natural disaster.
Interest Rate Risk
Interest rate risk is the possibility that the company will not be able to meet its debt obligations because of a change in financing rates. Government policies, market changes and a company’s credit profile can affect the interest rates offered.
Inflation Risk
Inflation risk is the possibility that the company will not be able to meet its debt obligations because of price increases. The same factors affecting interest risks tend to affect inflation risks. In fact, the U.S. government uses interest rates to manage inflation.
Liquidity Risk
This refers to the risk of running out of liquid assets — or cash — to cover the cost of financial obligations. This can happen when a company takes on too much debt or has difficulty collecting payments from customers.
Market Risk
Market risk is the chance that a security’s price will change due to fluctuations in the market. This includes risks from political and economic events, as well as natural disasters. For example, a company’s stock price can fall drastically during a recession or during fears of a recession.
Currency Risk
Currency risk is the chance that a company will experience price hikes or might not be able to meet its debt obligations because of a change in the exchange rate. This type of risk is often caused by international market changes, government policies and the decisions of big hedge fund companies.
What Are Some Common Financial Risk Management Strategies?
Each of these strategies has its own risks and benefits, so CFOs need to carefully consider which ones are best for their company. Additionally, they need to continually monitor the market conditions and make adjustments as needed.
Diversification
Companies can use diversification strategies to hedge their bets against market changes. For example, when in-person shopping declined in 2020, many retail stores finally took advantage of e-commerce options.
Hedging
This technique involves taking out insurance policies or entering into contracts that will protect the company from potential losses. Companies that trade across national borders also often rely on foreign exchange hedges to reduce risks associated with fluctuations.
Liquidity Management
This technique involves ensuring that the company has enough cash on hand to cover its expenses. CFOs achieve this by maintaining a strong cash position, leveraging short-term debt, or using credit lines.
Asset Management
This technique involves managing the company’s assets in a way that reduces the risk of losses. For example, a company may invest in assets that are not as susceptible to market changes. Asset management in retail can also take the form of implementing steps to reduce theft.
Credit management
To accomplish this, the AR team must properly monitor the creditworthiness of customers and suppliers to maintain a steady cash flow. The CFO must also take steps to ensure the creditworthiness of the company by overseeing and improving accounts payable procedures.
Process Automation
This technique involves the use of tech to reduce the chances of human error. For example, a company may use software to automate its invoicing and order fulfillment processes. Automation software can also improve or ensure CFO compliance.
How Can CFOs Use Technology to Mitigate Financial Risks?
CFOs have no shortage of software and tools to assist in their efforts to mitigate risk. Consider these examples:
- Enterprise risk management software identifies and assesses the risks a company faces.
- Data analytics helps CFOs track financial data and trends.
- Financial forecasting software helps CFOs predict future financial risks.
- Budgeting and planning software helps CFOs create and manage budgets.
- Reporting and CFO compliance software helps the financial team meet regulatory requirements.
What Are Some Risks of Incorporating Technology Into Risk Management Solutions?
While technology can be a valuable tool for managing financial risk, technology also introduces its own risks. CFOs need to be aware of these risks and take steps to mitigate them:
- Data Security: Financial data is sensitive information. CFOs need to ensure that the systems they use are secure and that only authorized personnel have access to the data.
- System Downtime: If the technology systems are down, CFOs will not be able to access critical data or perform necessary tasks. Reliability is key when choosing a software or network provider.
- Human Error: Even with the best technology, human error can still occur. CFOs need to have procedures in place to prevent, detect and correct errors.
Over the past few decades, financial risks have evolved into more complex problems. Smart CFOs leverage technology to lessen their workloads while also creating contingency plans to tackle technical risks.
