Relevance and activities
Of course, the finance director’s second difficulty or danger is of becoming Roger Irrelevant. At the Wolfson Foundation, the chairman taught the invaluable lesson that one shouldn’t manage the numbers (though they matter), one should manage the activity. The point here is that what constitutes the substance to the risk of not enough money varies across time and circumstance and must always be related to the real world. Further, financial numbers are frequently a lag indicator and are unlikely to catch the risk in time. In combination, this means that a perfect financial risk register won’t remain one for long and, forecasts aside, financial risk indicators probably won’t be of any use.

It’s helpful to try and think as if one had access to a space station, a helicopter and a microscope: risk arises on different scales and across different time frames. The space station corresponds to systemic risk: that the world as we know it has changed in a significant way. It doesn’t happen often, it’s often out of sight but when it happens it’s a triumph to meet the challenge.
 

Right now, a good example is shrinking government support in the years ahead as a knock-on effect of the financial crisis. A charity’s principal means of pursuing its goals may be in jeopardy and thus so might be the existence of the charity.

The helicopter corresponds to strategic risk: for instance the maturity and saturation of the fundraising market means future growth opportunities will be scarce for smaller charities. The microscope corresponds to the specific, operational risks of costs, income and reserves. A new risk might be your redundancy cost sharing terms with funders on a contract by contract basis as funding shrinks. An example of a risk driver that might have ceased to be prominent is that of having to fund the reserving of ever increasing activity.

 

Behaviours, cultures and processes
Financial risk isn’t just about strategies and numbers. It is very much about behaviours and the culture and processes that foster these. An organisation that doesn’t recognise the legitimacy of financial process and discipline vastly exacerbates all its financial risk elements. A culture that can’t allow difficult questions to be raised or won’t (occasionally) revisit the buried ‘obvious’ assumptions is doomed in the face of the unexpected.

Governance arises as an issue time and time again here. For example, the risk of complete melt down in financial systems was real only a year ago. How many charities moved their reserves into gold and other non-paper currency? How many charities responded to the worsening economic outlook and had all their deposits with banks likely to enjoy a government guarantee before Lehman Brother’s collapse? The unfortunate answer was: very few charities (though many have been wiser after the event). This is because either they had a touching faith in continuity or because their governance arrangements couldn’t respond in a timely and decisive manner. Charities were very lucky that, as long as they were able to be patient, Icelandic banks were about the extent of their likely losses.

And it’s not just about timeliness and decisiveness. At a very practical level, this is about the capacity of the stewards of risk and opportunity, particularly trustee boards and senior management. A risk, if it matters, should be acted upon – so there must be the management capacity to do this. As an example, it is absolutely understood that a rapid growth phase in a business generates different risks from steady growth in an established player. The same is true for charities: different skills are needed for different environments and different strategies. Does your charity link the risk register to the staff development budget and new skill set requirements in a clear way? Do management and trustee agendas shift focus because of risk? One of those actions might be cull the current agenda of the organisation: is that on your charity’s agenda? An example is NSPCC’s recent strategy of focusing on basics.

Elsewhere in this supplement, the point will doubtless have been made that financial risk is a spectrum from downside (risk) to upside (opportunity)[1]. I won’t labour the point again here, but it does lead me to the need to allow for pleasant surprises. This takes the practical form of budgeted contingency funds that allow additional resources to be released to meet new demands while existing resources are marshalled to take up the load, if required, in the longer term. It is terribly obvious, but worth restating, that risk often occurs because of change. If your world changes, do you have the mechanisms to respond effectively? See figure 1 for an example.

 

 

 

So far you will have seen some key axes (as in axis!) emerge: scale – from large to small; timeframe – from later today to 30 years away; and its accompaniments, frequency and duration; the buried risk to the obvious; the ‘soft’ risk to the hard; and opportunity to risk. The pressures of day-to-day working life mean that management teams are seldom as creative with these axes as they could be, yet constructing weird composite matrices can yield some interesting insights, some of which will change an organisation’s strategy.

 

What we are dealing with at the Childrens’ Society
All well and good. So, imperfect though they may be, what are The Children’s Society’s concerns at present? The easy bit is specific and much of our strategic risks. That is, it is easy to identify them but less easy to counter them.

1) Income and expenditure. We are wary of cost inflation from either taxation or traditional inflation. We continue to seek annual efficiencies of at least 1.5 per cent and would prefer to find 2.5 per cent. Within this we are explicitly addressing the duration of liabilities so, for instance, we ensure and benefit from past activity to include medium term tenant breaks in all our lease commitments. We are concerned about fundraising income risks in the year ahead because unemployment will probably go on rising, but see opportunity further out. We are very consciously diversifying income sources to spread further our fundraising risks.
2) Balance sheet. We are less paranoid about counterparty risk (credit risk and liquidity risk) but still deeply sceptical – our investment funds hold less gold and, along with a lot of indexed bonds, an increasing amount of real assets. We are exceptionally vigilant about our payment terms to suppliers and those of our customers. Our pension fund trustees’ governance, as for any charity with a defined benefit scheme, is something we are monitoring carefully.
3) Behaviour. We expect to have to cope with rapid change. So we have instituted
a major governance review to fit us for rapidly changing circumstances, refreshed forecasting behaviours and processes and launched
a series of organisational projects designed to give us better information and change behaviour so that we are more integrated in our thinking: a risk could be a hidden opportunity that will be more likely to be identified if we think about it more widely.
4) Government. The two key risks not mentioned to date relate to government. From what has gone before, you won’t be surprised to hear that they are ‘government cuts to our funding are significant’ and ‘government funders want different services’. A broad range of activity results from these including learning from the example above and looking carefully at a number of new business-model developments for our contract services. We are carefully auditing our risks to beneficiaries and to costs should funding streams cease, as well as modelling our working capital should payment terms change. We continue to invest in evaluation of
our work.
5) Contingency triggers. We have created overall trigger points for contingencies for the next three years, based on rolling projections rather than reported results. Buried within these risks is a lot of opportunity so we have attempted, as a minimum, to be symmetrical with our triggers around commissioning new (finite) activity as our hopes are realised. Because contingencies rest on confidence in the outlook, we will extend our rating of confidence levels for our income to our forecasting timetables throughout the year.

 

Application to your charity
So where does this take you as a finance manager or leader in your charity? You know your activities from a financial perspective better than anyone else. When it comes to risk, its management can seem like everyone’s and no one’s responsibility. So the first requirement is to own financial risk and then ensure that, through management and governance frameworks, everyone else understands their part in it.

Frequently, that part is not a sophisticated understanding of your processes and metrics, but the ability to comply with those processes, to help improve them and to talk openly about the challenges and opportunities of the activities and their environment. The financially trained can then relate this feedback to the financial picture and explain it in terms that any good steward of a family’s money can grasp. That in turn enables others to contribute the great obvious (in hindsight) question that engages them in continued interest and better management of your charity’s resources and opportunities. After all, the outcome of risk management is not risk analysis, it is more benefit for your charities’ beneficiaries than would otherwise have been achieved.
 

Author: Charles Nall

Charles Nall is corporate services director at The Children’s Society and chair of the Charity Finance Directors’ Group.

www.childrenssociety.org.uk

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