How do you monitor financial uncertainty and risk?

Sensitivity analysis and scenario analysis should be part of a Modeler’s tool kit. For example, in a P&L forecast, you should focus on the “main” drivers e.g. Revenue growth, COGS/Expense growth rate, etc.

Use data analysis, scenario planning, stress testing, diversification, real-time monitoring, regulatory compliance, risk metrics, and contingency planning.

Monitoring financial uncertainty and risk is crucial to make informed decisions and mitigate potential financial challenges. Here are steps and strategies to effectively monitor financial uncertainty and risk: 1. Identify Key Risk Factors 2. Risk Assessment 3. Financial Statements Analysis 4. Scenario Analysis 5. Stress Testing 6. Market Research 7. Credit Risk Management 8. Diversification 9. Insurance 10. Financial Models and Forecasts 11. Regular Reporting and Dashboards 12. Risk Management Committee 13. Regulatory Compliance 14. External Audits 15. Contingency Planning 16. Regular Reviews. I believe implementing and continuously monitoring these strategies can respond to financial challenges, enhancing their stability and resilience.

Identify 2 to 3 leading indicators that have a direct impact on your market and/or product. These indicators may be macro in nature such as the Fed Funds rate or more micro as the future pricing of a key raw material that is used in your production process. Or the indicator may be market specific that signals changes in market demand or requirements. The key is to validate these indicators based on past historical performance to determine the timing of the change to the impact on your financial results. By tracking these indicators over time, it will provide insight into potential future risk or uncertainty.

To monitor financial uncertainty and risk effectively, assess potential risks, measure their magnitude, monitor them continuously, plan scenarios, stay informed about market conditions, conduct stress tests, implement mitigation strategies, ensure regulatory compliance, foster open communication, and periodically review and adjust risk management processes.

Assumptions and scenarios are a great and practical way of being prepared for facing challenges. Even though that I do not fully agree with the statement that "assumptions are the key variables and drivers that inflluence your financial performance", for sure they are the basis of creating a realistic model to examine what can go wrong.

Define Key Variables: Identify and document key financial drivers like sales volume, price, and cost. Develop Assumption Sets: Create sets of assumptions based on these variables for accurate forecasting. Construct Scenarios: Develop best case, worst case, and base case scenarios using these assumptions. Justify Your Choices: Ensure all assumptions and scenarios are well-reasoned and documented. Integrate External Data: Include relevant market and industry data to support your assumptions. Regularly Review and Update: Continuously update your scenarios and assumptions with new data. Use Scenarios for Decision Making: Apply these scenarios to guide financial planning and strategic decisions.

Para estabelecer um processo de orçamento e previsão eficaz, é essencial definir premissas e cenários com base nas fontes de incerteza e risco identificadas anteriormente. As premissas são as variáveis principais que impactam o desempenho financeiro, como volume de vendas, preço, custo, margem ou taxa de crescimento. Os cenários representam os resultados alternativos que podem surgir de diferentes combinações de suposições, incluindo casos melhor, pior ou base. É fundamental documentar e justificar essas suposições e cenários, atualizando-os regularmente à medida que novas informações se tornam disponíveis. Isso permite uma tomada de decisão mais informada e adaptação às mudanças nas condições do mercado e no ambiente empresarial.

An example of flexible and dynamic modeling is to use Simulation and Game Theory methodology to incorporate any challenges that may rise.

When working on dynamic models, I recommend using 2 (maximum 3) drivers which you will play with. That helps you focus on the main drivers of the business but also uncertainty. More than that and you get a complex model that will not react hollistically at each change.

Monte Carlo Simulation: This model uses probability distributions to simulate a wide range of possible outcomes, making it valuable for assessing risk and uncertainty. Sensitivity Analysis: Helps in understanding how different values of an independent variable affect a particular dependent variable under a given set of assumptions. Scenario Planning Models: These allow for the testing of different scenarios (like best case, worst case) to see how changes in key variables impact outcomes. Real Options Analysis: Forecasting Models: Dynamic Financial Analysis (DFA): Spreadsheet Models: Business Intelligence Tools: Enterprise Resource Planning (ERP) Systems:

Para monitorar e gerenciar a incerteza e o risco de forma eficaz, é fundamental utilizar modelos flexíveis e dinâmicos que possam se adaptar às mudanças nas suposições e cenários. Isso pode ser alcançado por meio de diversas ferramentas e técnicas, como planilhas, softwares específicos ou plataformas baseadas em nuvem. Esses modelos devem ser precisos, confiáveis, consistentes e transparentes, alinhados com os objetivos estratégicos e operacionais da empresa. Ao atualizar regularmente esses modelos, é possível refletir o impacto das mudanças nas demonstrações financeiras e nos indicadores-chave de desempenho, permitindo uma tomada de decisão mais informada e ágil.

The continuous review and stress testing of forecasts are crucial. It's important to consistently incorporate scenario planning for all key attributes into the forecasting process. Startups, in particular, are advised to maintain a "doomsday" scenario at all times. This scenario assumes a complete halt in revenue, providing an opportunity to assess priorities and essentially conduct a preparedness drill. This strategy is invaluable in the unlikely event that it needs to be executed. It ensures that the company is ready to respond effectively to severe financial challenges.

Most entrepreneurs tend to think very positive thoughts. Sometimes they feel that "doomsday " can not happen to them because their business idea is sound and fool-proof. Positive thoughts are always great but the stress test is a key in developing a high level of comfort in forecasts. Forecasts, by nature, are based on the know facts on hand but they must also recognize the unknowns to the extent possible. Our experience during COVID was totally out of our hands and it devastated so many small businesses. Key is stress test and do it often.

Risk management is an ongoing, dynamic process, not a static undertaking. Contingency and mitigation plans are crucial for navigating identified risks. Contingency plans are safety nets, while mitigation plans proactively reduce the likelihood or impact of these risks. As companies evolve, so do the risks they face. Therefore, it is essential to monitor this process closely and adapt both contingency and mitigation plans to align with the ever-changing world. Both plans should be regularly communicated to all stakeholders to ensure awareness of the changes.

Mitigating Risk and developing alternatives strategies and approaches to address risks is an ongoing process. Some factors are controllable and some are uncontrollable. In both cases continuous monitoring and keeping the risk at minimal is essential. This helps organizations to be focused and effectively focused on the task/ objectives set for them.

In brief, efficient risk management relies mostly on decision-making about risk mitigating actions. These actions can be categorized in interventions to reduce vulnerability and interventions to improve resilience. By adding 3 Risk dimensions, namely Impact, Likelihood and Ability to Control, you can match and apply the right measure to each challenge.

A learning loop during the process of implementing mitigating actions and strategies, can provide valuable assistance in adapting to changes and efficiently facing future challenges.

Sometimes, less is more. So, a simple list of risks with updated figures and a percentage of realisation will do a better job than a complex model. I realised that, in these exercises, collaboration with other department is paramount so try to make it accessible for them.

In my opinion, regular internal review with the finance team using presentation as a tool to present the risk is helpful and useful. Additionally, designing and developing an internal tool to monitor the risk is workable and updating the same keeps the finance team up to the task.