A Road Map to Risk Management: CPAs Can Help Companies Manage Risk to Create Value. (Consulting)

By Bodine, Stephen W.; Pugliese, Anthony et al. | Journal of Accountancy, December 2001 | Go to article overview

A Road Map to Risk Management: CPAs Can Help Companies Manage Risk to Create Value. (Consulting)


Bodine, Stephen W., Pugliese, Anthony, Walker, Paul L., Journal of Accountancy


Successful businesses take calculated risks to achieve objectives. Globalization, deregulation, Web-based services, complicated financial instruments and contracts, emerging markets--all contain tremendous potential advantages for companies and carry the danger of huge mistakes or unexpected developments. Businesses must measure these risks, try to minimize them and--if possible---use them to their advantage. The CPA is the professional best suited to help them manage risk. CPAs--as internal or external advisers--have the skills and competencies required to help companies evaluate and address risk.

This article describes a generic framework or set of steps for risk management--based on current best practices--that is applicable to any size or type of organization. The AICPA risk advisory services task force created the framework as a resource for CPAs advising clients or employers in an increasingly complex business environment.

STEP BY STEP

Although each business may have its own unique approach to risk management, current best practices suggest following these steps:

* Establish the context; look carefully at an organization's strategy, stakeholders and environment.

* Identify situations that can affect the business objectives.

* Analyze and assess the risks.

* Design strategies for managing risks.

* Implement and integrate management processes.

* Measure and monitor the business' efficiency, profitability and vulnerability.

* Report the data to the executives who are in charge.

ESTABLISH THE CONTEXT

Risk management can succeed only when it works within the context of a company's environment, goals, objectives and strategies. Organizations may differ greatly in their risk tolerance and management styles. Deposit-taking institutions necessarily place a high value on solvency and the preservation of capital. Their investors and customers expect a good return with little risk. Companies that prospect for minerals or develop high-tech products focus on big rewards in exchange for big risks. Their investors typically understand this tradeoff and the significance of such an organization's appetite and capacity for risk. CPAs will want to examine a company's business environment and risk tolerance as a first step in risk advisory services.

How do these ideas work in practice? The Medicines Co. (TMC), a pharmaceutical developer in Cambridge, Massachusetts, has been able to minimize risk because it not only understands the market but also knows how to leverage its strengths. According to a report on TMC by Stan Davis and Christopher Meyer in Future Wealth, developing a drug can cost as much as $300 million, and the process entails several distinct stages--from creating the chemical or biological compound to winning approval from the Food and Drug Administration. Pharmaceutical companies take a risk that the huge investment will pay off in the hope of producing a billion-dollar seller such as Zantac or Viagra.

TMC understands that drug development involves a sequence of very different risks. A product can fail for several reasons at any stage, but the rigors of the approval process can kill it late in the game. The later the failure, the more expensive it is.

TMC recognized which risks it managed well--for example, the potential for failure during clinical trials. It had recognized it was weak in the beginning stages--basic research--and at the end of the process--marketing drugs to physicians. Accordingly, the company buys the rights to proven chemical and biological compounds, develops them into drugs and then sells them to other pharmaceutical organizations to bring to market. Having successfully found its niche, TCM bears risk only in the areas where it is strongest.

Once a company understands the risks of an undertaking, the owners or management can develop a strategy for containing them.

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A Road Map to Risk Management: CPAs Can Help Companies Manage Risk to Create Value. (Consulting)
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