Risk management that keeps you one step ahead

The coronavirus has compelled CFOs to build up resistance — not just to COVID-19 disruption but to other external risks such as cyber attacks, tariff wars and climate change.

The pandemic underscored to CFOs the vulnerability of their companies to the broadest range of external risks in decades, according to financial executives and experts in business technology.

CFOs face the possible spread of COVID-19 variants, fragile supply chains, rising pressure for disclosures on sustainability and extreme weather such as the recent winter storms in Texas. They also need to watch for signs of financial instability from high levels of federal and corporate debt and record fiscal and monetary stimulus.

“We’re in uncharted waters with respect to the size of the risks we face,” according to Barry Keating, co-author of Forecasting and Predictive Analytics, now in its seventh edition. Companies that fail to forecast external threats based on analysis of near- or real-time data “are going to be the ones who don’t exist in the future,” said Keating, a professor at Notre Dame’s Mendoza College of Business.

During the pandemic CFOs have used advanced data analytics to cut costs, tighten cash management and safeguard supplies. For example, detailed analysis of consumer demand and economic growth in several countries is helping automakers adjust their just-in-time production to a severe shortage of semiconductors.

CFOs who most effectively manage risk today have discarded old forecasting methods that primarily relied on spreadsheets and backward-looking historical data. They have adopted advanced analytics that track external and internal risks based on high volumes of near- or real-time data, according to CFOs and experts in business technology.

Using cloud computing and data analytics, a CFO can perform the detailed econometric modeling that for decades many companies rejected as too costly, according to Prevedere CEO Richard Wagner. “It’s like having an army of economists in a box,” he said.

CFOs will sooner move on from traditional forecasting to advanced data analytics after recognizing that just 15% of the variables that shape business performance reside within a company, Wagner said.

The remaining 85% of factors — such as political unrest, recession, social turmoil and regulatory changes — influence a company from the outside, beyond a financial executive’s control.

Casting a wide net

A CFO can gather details on external risks from news reports, social media, regulatory announcements, quarterly earnings calls by industry leaders and other sources, according to Jérôme Basdevant, chief technology officer at Datamaran, a provider of software analytics. They can analyze the findings based on likelihood and potential business impact.

Financial executives with such information can identify and measure emerging risks, such as the reliability of suppliers in countries struggling with COVID-19 or the impact of lockdowns and other coronavirus stresses on the wellbeing of new company hires. 

“You can transform something that was unstructured and difficult to assess into something that you can start to compare with your other risks,” Basdevant said.

Using a dynamic data dashboard, a CFO can alter the degree and balance of risks based on a range of scenarios and build a strategy for risk management that is comprehensive, forward-looking and timely.

“You need to be able to look at what’s actually going on” across the full landscape of risks, rather than rely on expectations based on internal historical data, according to Sharon Daniels, CEO at Arria NLG, a provider of artificial intelligence that turns structured data into natural language. When it comes to identifying and measuring risks, “there is just no room to be any further behind.”

CFOs who disregard outside threats may face greater regulatory and conduct risk. Pressure from regulators and investors will probably compel businesses to disclose more about external risks related to public health, climate and workforce diversity, The Conference Board and Datamaran said in a study.

“The events of 2020 brought risks related to climate change, social justice issues and public health to the forefront of public consciousness,” they said, noting that U.S. and European companies currently give limited attention to those issues in public statements.

“Now is the time for companies to examine whether their financial disclosures adequately acknowledge systemic risks,” The Conference Board and Datamaran said.

The Securities and Exchange Commission has already started such an examination. It is considering ways that companies should provide detailed disclosures on environmental, social and governance (ESG) risks.

Most CFOs foresee obstacles as they ramp up advanced data analytics this year, Gartner found. Eighty-two percent of financial executives have made adoption of such technology a top priority and 78% expect difficulties in reaching their goals, according to a Gartner survey of 173 CFOs.

Similarly, 99% of CFOs want to use real-time data to navigate risks but only 16% say they tap data at the needed scale, according to an Accenture survey of 450 financial executives at companies with at least $1 billion in revenue.

Thirty-four percent of CFOs rate real-time scenario planning as their highest priority for 2021, while 24% have made gaining real-time insights the No. 1 goal of their finance function.

Other benefits

Financial executives who launch near- or real-time data analytics often gain more than insights into external risks, the CFOs and experts in business technology said. For example, they benefit from more frequent and timely predictions.

Many CFOs at the start of the pandemic began meeting with their leadership teams on a daily or weekly basis rather than monthly, Wagner said. They “now have to do ‘now-casting’” rather than forecasting, he said, “so they know what’s going on this week and next week.”

Advanced analytics shared on a data dashboard prompts structural improvements within a company by spurring communication and collaboration, the CFOs and business technology experts said.

“Risk has to be perceived and discussed in a collaborative manner,” OneStream Software CFO Bill Koefoed said. Given the variety and rapid evolution of external risk, “everybody has to have visibility into it, everybody has to be talking about it.”

A data dashboard shared throughout a company breaks down organizational silos and opens the way for “self-serve analytics,” Daniels said. “Your IT department is basically democratizing data.”

Advanced data analytics reveals opportunities as well as risks, the CFOs and experts in business technology said.

“You could say that those are new risks or new challenges, but actually think of them more as opportunities to strengthen your company,” Dun & Bradstreet CFO Bryan Hipsher said.

For example, a technology company could view social media describing a lack of diversity in its industry as an opportunity to refocus hiring on a broader demographic and stand out from rival companies, Basdevant said.

Using advanced data analytics, “you identify where you have the best opportunity to not only contribute to society, but also to differentiate yourself” from competitors, he said.

Mining data pays off

Insights from advanced data analytics can boost the bottom line.

A beverage company that was determined to dominate the space on store shelves in China knew it was overproducing and holding excessive inventory but lacked accurate estimates of future demand. It aimed to improve forecast accuracy by at least 3% and save $9 million by reducing inventory, Wagner said.

The company analyzed several consumer indices — including online spending, retail sales and spending on luxury goods, gasoline and travel — and improved its forecast for beverage demand four weeks in the future by 18%. It cut inventory with confidence and met its cost savings goals, Wagner said.

AT&T sought through data analytics to more effectively identify ESG concerns, improve communication with stakeholders and gain insights for its decisions on reporting and strategy, Basdevant said. AT&T’s usual surveys lacked the nuanced, qualitative insights that it needed.

The company used software to automate information gathering from social media, regulatory notices, peer reports and traditional media. It also surveyed 26,000 stakeholders across several groups, including investors, business customers and consumers, expanding its reach well beyond prior research.

Using its findings, AT&T plotted several issues on a chart — including work/life balance, company water use and network security — based on relevance to company performance and importance to consumers and stakeholders. The resulting scatter plot helped rank priorities and clarify company strategy, Basdevant said.

Monitoring external risks

CFOs today identify several major external risks, all of which can be tracked around the clock by advanced data analytics. For example, the increase in the yield on the 10-year Treasury note from 0.917% on Jan. 4 to more than 1.5% on March 5 has pushed up corporate borrowing costs. With analytics, a CFO can monitor in depth the real-time impact on markets and company cash and investments.

Rising interest rates is a major concern for 49% percent of the respondents to the Accenture survey. The trend threatens to undermine Federal Reserve stimulus. At the outset of the pandemic, the central bank cut the benchmark interest rate to a record low and began buying $120 billion in bonds each month.

“Whenever there is cheap money, that has come to an end — not always in a good way,” Koefoed said.  

Record monetary stimulus and a $1.9 trillion coronavirus rescue package headed toward congressional approval have fueled concerns the economy will overheat and stoke inflation.

The surge in federal spending “is going to heat up the economy like putting a blowtorch to a pan on your stove,” Keating said.

Forty-seven percent of survey respondents flagged further pandemic disruption and the possibility of recession as leading concerns, while 42% identified hiring and retaining talent.

Even in the face of an unprecedented range of external risks, many financial executives still use just internal data and outdated technology to build their business strategy, the CFOs and experts in business technology said.

“I’m afraid a lot of firms today do their forecasting on the back of an envelope,” Keating said. “The use of predictive analytics is a very important way to compete.”

Just as CFOs are guiding their companies out of the pandemic, they face a new peril to their profits — rising inflation.

The Federal Reserve’s preferred inflation measure — the core personal consumption expenditures price index —increased 3.1% in April from a year earlier, well above the central bank’s 2% inflation target. Prices are surging for a broad variety of products, from used cars and homes to commodities such as copper, steel, iron ore, oil and lumber.

The Fed will likely add more fuel to the fire. The central bank is on track by 2023 to expand its record balance sheet 14% to $9 trillion from $7.9 trillion today, further increasing the U.S. money supply, the central bank has said, citing expectations of financial market participants.

Months of record monetary and fiscal stimulus aimed at offsetting COVID-19 pushed up household expectations for inflation in May to the highest level in a decade, according to a University of Michigan survey of consumers.

“The public is no fool,” according to Charles Calomiris, a Columbia Business School professor. “The surveys are showing a dramatic increase in the public’s expectations for inflation — we haven’t seen anything like this for 30 years.”

To many CFOs under 50, rapidly rising prices are a relic from their parents’ past, as quaint and unfamiliar as sideburns and bell bottoms. They may have only heard vague references about how double-digit inflation repeatedly savaged U.S. companies from 1974 until 1981.

“Current business managers haven’t lived through an inflationary period,” according to Barry Keating, a professor at Notre Dame’s Mendoza College of Business. “It’s not that they’ve forgotten the bad effects from rising prices, they didn’t learn about them in the first place.”

Even CFOs who doubt that an inflationary wildfire is approaching would do well, as part of scenario planning, to consider ways to limit the harm from rising prices, according to economists and financial executives. Such steps range from issuing debt, to building inventories, to hedging against a depreciating dollar.

This too shall pass

For their part, Fed policy makers predict that accelerating inflation is just a passing phase in the post-pandemic recovery. Price gains will eventually slow as pent-up demand fades and supply bottlenecks ease.

Instead of fighting inflation, policy makers favor letting it exceed their 2% target to make up for past shortfalls and reduce unemployment, now at 6.1%.

Some economists say that the central bank stoked high inflation during the past several months by holding down the benchmark interest rate at 0.25% and pumping up its balance sheet with $120 billion in monthly purchases of Treasury and mortgage bonds.

“The inflation rate over the next two or three years is already baked into the cake,” according to Steve Hanke, a professor of applied economics at Johns Hopkins University. He predicts 5% to 6% inflation next year and in 2023.

Rapidly rising prices torpedo strategic planning and upset relationships between a company and its suppliers, employees, customers, lenders and other stakeholders.

“It’s like taking out the mortar from between the bricks of the economy,” Keating said, warning that “inflation is going to get a lot worse.”

“CFOs lose the power to accurately predict what will happen in the near-term and long-term future,” he said, adding that “business relationships that have been constant for 40 or 50 years are going to change."

Faced with rising prices, many businesses hunker down and reduce investment. Borrowers gain at the expense of lenders. Economic growth may slow, the real value of savings falls and a depreciating dollar reduces the purchasing power of companies buying goods and services from abroad. 

In an effort to limit damage, companies may make bad decisions such as excessive overstocking or committing to long-term agreements on services.

“Businesses will lock in to long-term contracts that can turn out to be very foolish,” Keating said. “They will have a tendency to do things that they really know nothing about, and that can be really dangerous.”

Persistent high inflation can fuel a “wage-price spiral” as employees, confronting higher prices, demand higher pay. Companies, facing higher payroll and input costs, raise product prices.

A disruptive period of rising prices often ends in a bust. Eventually, a central bank will try to curb inflationary damage by raising interest rates, risking a recession and widespread unemployment.

Economists say that CFOs can blunt inflation’s edge by taking five steps:

1. Issue debt

With the benchmark 10-year Treasury note today yielding about 1.6%, CFOs should take advantage of low borrowing costs and sell debt, economists said.

“This is a good time to lengthen the maturity of your debt as much as possible and to think about issuing debt,” Calomiris said. After all, inflation over time will reduce real servicing costs.

“It doesn’t mean you go crazy and issue debt you can’t repay,” he said. “But it does mean you cross a little bit more in the direction of selling more debt of longer maturity.”

2. Buy goods and services at today’s prices

With inflation eroding purchasing power, CFOs should consider buying now the goods and services that they anticipate needing in the future.

“You want to be long inventories, long commodities, long goods and processes,” Hanke said. “That’s the smartest thing to do.”

A CFO needs to weigh the expected price increase against the cost of financing and carrying extra inventory. Such a strategy flouts a decades-long emphasis at many companies in slimming inventories in order to free up cash.

Still, “it’s a sure bet,” Hanke said. “If you anticipate the price is going to be up in the next three of four months by 10% or more, you better be long.”

3. Hedge against a falling dollar

CFOs at companies that heavily depend on imports may want to consider using a currency swap or similar financial tool to limit losses from depreciation of the dollar, the economists said.

A financial executive would need to take into account transaction costs and ensure the second currency is also not vulnerable to inflation.

“It’s not cheap,” Calomiris said, and “you’ll also have to know that those countries aren’t themselves subject to similar kinds of risks” as the U.S.

4. Cushion your company’s portfolio

CFOs should weigh moving a portion of their company investment portfolios into inflation buffers such as gold, Treasury inflation-protected securities (TIPS) and funds that track the prices of a basket of commodities, the economists said.

Financial executives should remember that no investment is a perfect inflation hedge, they said. Gold pays no yield and the prices of oil and other commodities can be highly volatile and vulnerable to geopolitical tensions. Diversification is essential.

First movers in hedging gain an advantage. “We can’t all be short the market,” Calormiris said. “There has to be somebody on the other side of the trade.”

Also, “if the economy is in the tank, then nobody is a winner” — some companies just limit their losses better than others, he said.

5. Learn from the pandemic

During a pandemic, bouts of inflation and other times of instability CFOs should exemplify “agile absorption,” or the ability to quickly seize opportunities while maintaining structural strengths such as a solid balance sheet, Hanke said, citing The Upside of Turbulence by Donald Sull of the MIT Sloan School of Management. 

“It’s a great way to think when you get into turbulence because most people just freeze up,” he said.

The sudden, unexpected onset of COVID-19 underscored to CFOs the value of agility — an essential trait when prices surge, the economists and financial executives said.

“The pandemic made companies much more agile,” Keating said.

Many CFOs used high volumes of near- and real-time data and data analytics to cut costs, tighten cash management and safeguard supplies. They discarded forecasting methods that primarily relied on spreadsheets and backward-looking historical data.

“Inflation brings massive change so you need to make your short-term forecasts very accurate,” Keating said. “You’ll need to track short-term indicators to keep your finger on what’s going to change.”

Hot Florida market

During the past century many Florida real estate developers discovered the value of agility as they grew familiar with a pattern of boom and bust. Still, the market of the past several months has seemed especially jarring to Amicon CEO Adam Mopsick.

Amicon, a Miami developer and project manager with more than $1 billion in assets under management, began 2020 anticipating a record year, Mopsick said.

The pandemic quickly blew up such expectations as clients en masse put projects on hold, he said. “There were a lot of scared people.”

Today, business is booming like never before, fueled by record-low borrowing costs, rebounding economic growth, pent-up demand for real estate, widespread vaccination and a flood of buyers from California, Illinois and other high-tax states, Mopsick said. Demand for luxury residential construction and other markets “is unlike anything we’ve ever seen.”

At the same time, prices are soaring for steel, copper, aluminum, glass, lumber and other materials, Mopsick said. Labor costs are also rising, with qualified subcontractors in short supply.

Amicon has had to mark up the cost of some projects by 20% during the past 12 months, and write in higher escalation contingencies to offset inflation, he said.

“We don’t want to budget on yesterday’s pricing,” he said. “We want to budget on the pricing that would be the worst case by the end of the project.”

Amicon is also ordering in advance materials that it will need during the next 12 months, including steel, piping, lighting materials, glass and glazing. “When we have an opportunity to lock in today’s pricing, we’re doing that.”

“I don’t know that we can maintain the level that we’re at right now,” Mopsick said, referring to the Miami real estate market. “A little bit of a pullback wouldn’t be the worst thing in the world.”

Overheated Tennessee

Speaking at a May 19 hearing of the House Financial Services Committee, Rep. David Kustoff, R-Tenn., delivered a similar message of moderation to Federal Reserve Vice Chairman Randal Quarles, a leading advocate of the idea that inflation will eventually subside.

Kustoff told Quarles that homebuilders and real estate agents in his west Tennessee district faced a “red hot” market beset by labor shortages and lumber prices rising at a 300% annual rate, making “it almost prohibitive to build homes.”

“How much longer can we expect that to continue and at what point does the Fed need to say, ‘Enough is enough’?” Kustoff said.

Quarles replied that on a few occasions during the past decade the Fed reduced stimulus to rein in inflation and prematurely throttled growth. “If we were to try now to stay ahead of the inflation curve, we could end up significantly constraining the recovery.”

Having determined that it repeatedly acted too early in quashing inflation, the central bank may now wait too long before trying to control prices, Keating said. “They may err on the side of inflation until it may be too late to easily stop.”

Companies that fail to make progress on environmental, social and governance (ESG) goals may end up excluded from consideration by many investors, Larry Wieseneck, Cowen co-president, told an online conference for CFOs sponsored by the American Institute of CPAs.

“If you’re not moving forward on things like the environment, you’ll be uninvestable in certain parts of the investor universe,” Wieseneck said, predicting that all Wall Street research within 12 months will include “an ESG score — it’s just becoming too important to investors.” 

“We think ESG is bigger than anyone realizes,” he said, adding that during “the last few years it’s accelerated enormously quickly."

Corporate reporting and disclosure on ESG metrics has surged during the past decade, according to the Governance & Accountability Institute.

Nine out of 10 companies in the Standard & Poor’s 500 released sustainability reports in 2019 compared with just two out of 10 in 2011, the Institute said.

“Corporate reporting now has permanently expanded to include” ESG performance, Robert Hirth, co-vice chair of the Sustainability Accounting Standards Board, told the conference for CFOs.

“There’s absolutely an increased demand for this reporting,” Hirth said, predicting that eventually “every publicly listed company will more than likely report some form of ESG information.”

The Securities and Exchange Commission (SEC) and regulators in many countries are urging more disclosure. Since the start of the Biden administration in January, the SEC has sharpened its focus on ESG matters across its oversight and operations.

The SEC examinations division mentioned climate-related risks first in its description of priorities for 2021, and the agency's corporation finance division plans to give more attention to climate-related disclosure.

The SEC's enforcement division in March announced the creation of a climate and ESG task force made up of 22 members from SEC headquarters, including the whistleblower's office, as well as regional offices and “specialized units” within the division.

Strong ESG performance can reduce a company’s cost of capital, improve operations and boost share valuation, Hirth said, urging executives “not to look at this as a cost.”

“You’ve got to tell your story at the end of the day to attract your investors and satisfy your individual stakeholders,’” he said. “This is a way to focus on some factors that make you a better company, that reduce risk, that make you more attractive to customers, more attractive to employees and gives you a better supply chain.”

Most executives either haven't started thinking about moving away from LIBOR or are just now doing so even though the transition is approaching and unlikely to get pushed back because of the pandemic, according to a webcast by global advisory firm Duff & Phelps. 

U.S. and European Union regulators are replacing the London Inter-bank Offered Rate (LIBOR) at the end of 2021, a move that creates administrative and potential liability headaches for businesses across the board.

Since the mid-1980s, LIBOR has been the go-to rate for most commercial and consumer loans, structured products, contractual agreements, derivatives, corporate securities, floating rate instruments, and benchmarked instruments. 

Regulators called for a transition away from the index after the 2008 financial meltdown because of increasing problems with the credibility of the rates it was based on. In the U.S., regulators are expected to support what's known as SOFR, or the Secured Overnight Financing Rate, as its replacement. In the E.U., the preferred replacement is expected to be SONIA, the Sterling Over Night Index Average. 

The transition puts businesses under the gun to look at their investments, loans, hedges, contracts and other potential exposure points. They must assess which changes, if any, are needed to account for the end of LIBOR, something that was never contemplated when many of these instruments were created. 

For most businesses, the transition burden falls on CFOs, an informal poll conducted during the webcast shows. Almost half of the attendees named the CFO as the point person; no other executive came close. 

Expensive exposure

Even for mid-sized companies, potential exposure to the transition can be large. One Duff & Phelps client, a real estate operating company — though not considered an especially large enterprise — has tens of thousands of financial instruments, contracts, and governing documents that must be sorted through to see if they have relevant LIBOR clauses and, if they do, if they need amending. 

In some cases, the terms of the LIBOR reference end before the transition, so no action is needed. In other cases, the terms already include language governing what to do if an alternative to LIBOR is needed. In these cases, the language needs to be checked to ensure it remains appropriate for a final cessation of LIBOR. In other cases, there's no applicable language; it must be added in. 

Getting ready for the change involves three steps:

1. Check your instruments and documents for LIBOR references
2. Replace terms where needed
3. Get buy-in from counterparties

For companies with hundreds of instruments and documents, just finding and identifying those with potential exposure is a big task best done using an internal steering committee with representatives from all relevant divisions, including finance, procurement, legal, IT, and others, depending on your business. 

"Large enterprise or small, a lot of the time they're not even aware of where all the contracts are and who's in control of them," Rich Vestuto, managing director of information governance at Duff & Phelps, said.

For a company he worked with that had tens of thousands of documents to assess, Vestuto's team used artificial intelligence-assisted natural language processing (NLP) software to speed up the search process. By using contract attorneys to review how well the software identified relevant documents, the team was able to define the search parameters over time until the results were close to what they wanted.

"We'd tweak the NLP application, look at the output, and do it again until we were really satisfied we were capturing everything," Vestuto said. 

The team worked with counsel to draft new contract language as well as two or three fallback clauses to replace the LIBOR references. 

In most cases, the team was able to get the counterparties — those on the other side of the transaction or contract — to okay the proposed revised language or one of the fallback clauses, typically by email, without much difficulty. 

"If we can get three quarters of them done that way, they saved a ton of money and effort," Vestuto said. 

The cases in which counterparties tend to push back are those where the transition to an alternative index results in materially higher costs or lower returns for them. 

"As the contracts change, there are going to be winners and losers," said Charles Parekh, Duff & Phelps managing director of the firm's disputes consulting practice. "If the losses are large enough on one side, it often ends up in a lawsuit in which they're trying to blame someone or recoup some of those losses."

The pandemic is compounding the problem because of the financial turmoil it's causing some companies.

"What is due to bad act and what is due just to bad luck?" Parekh said. "All of this requires having financial experts, damages experts, and securities and LIBOR experts on hand."

Financial modeling

In addition to the contractual changes, companies must model financial impacts based on revised rates under the new indices. 

"Valuation and risk models potentially will need changing to take into account new conventions involved in the rates," said Marcus Morton, Duff & Phelps managing director of valuation services.

"You have to make sure the financial modeling with that fallback language still makes sense," Vestuto said. 

Modeling valuations is particularly challenging for hedging instruments. 

"It's hard to model hedging requirements until you have a picture of your whole portfolio," Mark Turner, managing director for regulatory consulting at Duff & Phelps, said. 

Even though the transition is looming, companies are often still using LIBOR to model a forward-pointing curve because of limited data from other indices. 

"SOFR is backwards-looking right now," Jennifer Press, Duff & Phelps' managing director of alternative asset advisory, said. "The forward-curve SOFR is still being developed."

Governance, communication key

The steering committee will want to keep executives and the board updated on the transition's progress. Especially for larger companies with thousands of exposure points, it's important the process not be allowed to backslide. 

"It really calls for good project governance," Vestuto said. "Normally, you have a meeting and you decide on something, come up with a plan. Then everybody goes back to their day jobs and you meet two weeks later and nothing has moved forward."

Vestuto said it can help to bring in an outside firm to manage the process. "They're going to carry the ball forward between meetings," he said.

Good communication has to carry to the counterparties as well. Depending on the side of the transaction you're on — as a lender or a borrower, for example — you don't want to wait until you're contacted about an instrument. It's better to take the initiative and get the agreement that's needed to change the terms.

"Firms shouldn't sit back and wait, and if they're not getting communications, assume they're clear from counterparties and lenders," Turner said. Instead, you should let counterparties know you want to take action, telling them you need more from them and expect their support.

CFOs are reexamining just-in-time production after the pandemic left many businesses unable to meet customer demand because of supply shortages.

Until some form of equilibrium is once again reached, CFOs should rethink how just-in-time is used, says Debbie Fogel-Monnissen, CFO of the Institute for Supply Management. The pandemic made clear the total cost of the supply chain, which includes safety stock to increase resiliency, is more important than just short-term gains for maximum elimination of inventory.  

Companies that don’t have a resilient supply chain, she says, even as the economy recovers, might miss growth opportunities or even suffer permanent damage to brand loyalty if consumers can’t get what they want, when they want it.

“The pandemic caused rapid changes in demand and supply — a shock to the global supply chain ecosystem that threw the prior equilibrium out of balance, Fogel-Monnissen says. “Just-in-time by its nature requires some predictability and the pandemic interrupted that cycle.”

Stockpiles advised

The consulting firm of BDO urged manufacturers to reevaluate their just-in-time inventory strategies and consider developing alternative sources of supplies or stockpiles of critical materials or products.

“The manufacturing industry is at a crossroads,” BDO says in a manufacturing report released in March. “On one end are the continued headwinds that manufacturers will face due to the pandemic recession. On the other are emerging opportunities for growth and innovation that organizations cannot afford to ignore. 2021 will be a balancing act between mitigating risk, navigating continued uncertainty and seizing new opportunities.”

The authors say the keys for CFOs at manufacturing companies are to balance investments that increase connectivity and resiliency to mitigate disruption with longer-term plans for transformation to meet changing customer expectations.

3D printing

Looking at how his company is changing its approach to just-in-time, 3D metal and carbon fiber printer manufacturer Markforged CFO Mark Schwartz says for years just-in-time has dominated, thanks to its ability to keep firms nimble and capital free from being tied up in inventory.

However, he says, companies have found over the last year and a half how fragile just-in-time operations can be, with broken supply lines and other supply chain problems.

Going forward, Schwartz says, he sees promise in a new generation of just-in-time operations that leverage the kind of manufacturing his company specializes in, 3D printing.

“Enabled by 3D printing, this new approach brings operations closer to home and avoids potential delays by printing parts directly at the site where they are needed,” he says. “Not only does this significantly reduce stress on companies’ inventory, but it can drive down supply chain costs and reduce the amount of time required to get the part you need, all while avoiding the need to tie up capital by stockpiling inventory in warehouses."

Near-shoring

Rene Ho, CFO for Taulia, a supply chain solutions company, says just-in-time disruptions caused a domino effect throughout the manufacturing and sales process.

“To overcome some of these challenges more companies are exploring near-shoring options, maintaining greater stock levels and using innovative inventory management solutions to make sure production isn’t disrupted and maintain their competitiveness,” the executive says.

The CFO is finding a shift in the relative negotiating power of buyers and suppliers globally. This, coupled with components that are either more expensive to produce or come with higher storage costs as inventory levels increase, is making CFOs think differently.

“Essentially, working capital is being tied up in the supply-chain for longer,” the CFO says.

Quick problem detection

The thinking that just-in-time created problems in the pandemic that CFOs have to resolve in the aftermath is not universal.

While shortages occur quicker in just-in-time, problems are also detected faster, says Thomas Roemer, senior lecturer of operations management at the MIT Sloan School of Management and executive director of the MIT Leaders for Global Operations program. One of the principal purposes of keeping low inventory and relying on just-in-time has always been to find, and resolve, problems faster, he says. 

“I doubt that conventional inventory heavy systems would have had enough usable inventory in the system to bridge extended periods of shortages,” he says. In any case, “that heavy inventory burden would have rendered them uncompetitive a long time ago.” 

The MIT expert contends long lead times and non-transparent supply chains, with layers of outsourcing and offshoring, are much more to blame for the pandemic shortages than just-in-time per se.

“After all, things worked for so long without ‘wasting’ time on collaborating with sub-suppliers,” he says.  

In other words, although outsourcing has been associated with just-in-time, it’s not a necessary part of it.

CFOs have to realize, he says, outsourcing and offshoring are strategic decisions in which procurement costs are only one factor. 

“Factors such as flexibility, responsiveness, transparency and sundry other factors must be considered” as well, he says. 

The good news out of this, says Roemer, is that this keeps the job of the CFO both interesting and secure. After all, automation can easily make decisions based solely on costs. What it can’t do is the kind of strategic CFO thinking that looks at factors other than costs when designing supply chains.

CFOs whose finance and accounting functions are built on legacy computer systems got a stark reminder last week from the Colonial pipeline hacking of what’s at stake if their system is breached.

The hack to Colonial’s system led to widespread gas shortages throughout the East and reportedly forced the company to pay $5 million in ransomware to get the instructions for reclaiming its data. 

“For finance departments, the cybersecurity risk is huge,” Samir Jaipati, a finance solutions leader with EY Americas, told CFO Dive in an email. “Something built on outdated technology won’t be able to keep hackers out.” 

Security specialists generally agree legacy, on-premises systems starting from about 10 years ago typically have solid cybersecurity features built in, but those that are older might require significant upgrades if they’re going to stand a chance against today’s sophisticated hackers.

The risk for CFOs who must manage their processes on an outdated system is they’ll try to get by with short-term fixes that won’t solve the systemic problems they face. 

“These temporary fixes aren’t as dependable and in the long-term may cost more,” said Jaipati.

Best effort

For CFOs who don’t have the time or budget to implement the system overhaul they need or to transfer their processes to a more secure on-premises system or to a cloud-based system, the best step is to do a comprehensive review of their end-to-end finance processes to audit for consistency and reliability, said Steve Adams, Gartner finance director. 

He suggested reviewing the organization’s record-to-report process from start to finish to understand where non-secure platforms are used, whether there are audit trails that don’t exist, and if exogenous data is incorporated. By eliminating these and other red flags, CFOs can go a significant way to clean up their processes and reduce risk without making system changes, Adams said. 

CFOs taking this approach should first engage their IT business partner and ask for a full audit of the cybersecurity capabilities of the suite of financial applications and to use that review as a starting point to making improvements, he said. 

Wider integration

Legacy systems pose a broader problem than just security risk; they can impede company growth because CFOs aren’t generating the data or producing the analytics that can help them identify ways to make more money or reduce costs in the same way they can get from sophisticated cloud-based solutions. 

Nor can legacy systems be expected to be as good at integrating data throughout the organization in the same way as cloud systems.

For CFOs who can do it, switching from an old on-premises system to the cloud can be a game-changer, said Manish Sharma, an Accenture operations group executive.

“CFOs that are agile and able to overcome these restrictions by scaling digital and cloud-powered technologies have been able to break down data silos and siloed ways of working to support the ever-evolving business strategy with speed and flexibility,” he said. 

The importance of using up-to-date IT was emphasized in a recent Accenture report that found “future-ready” leaders are emerging ahead of the pack with higher efficiency and profitability by scaling digital capabilities in ways to improve operational maturity.

“These leaders use better, more diverse data to inform decision-making as part of a cloud-powered continuous feedback loop,” said Sharma.

Flexible categorization

Another benefit of moving to the cloud or a hybrid cloud-on-premises arrangement is cost flexibility. 

On average, the cost of managing an outdated IT system can cost a business around $3.61 per line of code or over $1 million for an application with 300,000 lines of code, said Kevin Shuler, owner and CEO of the Quandary Consulting Group, a Denver-based IT firm. 

“It accounts for customizations, maintenance, reporting, server and hardware, etc.,” he said. 

While replacing the old with the new might appear to be prohibitively expensive at first glance, Shuler noted what can put a CFO more at ease is the costs are more transparent than maintaining a legacy system.

“Better, they can be categorized as either an operating expense or a capital expense since a lot of software is classified as a service rather than software,” he said. 

This gives flexibility to the CFO’s finances and forecasting. It also means more resources can be available for modernized systems. 

“That means you can get superior resources at a lower cost than trying to pull from a pool of highly specialized and competitive contractors who work mainly with legacy systems,” he said.

Financial fraud increased steadily over 2020 and is expected to keep rising this year, the Association of Certified Fraud Examiners (ACFE) said in a report.

“There is little doubt that the effects of COVID-19 will linger well into 2021,” said the report, which compiles input from internal and external fraud examiners. “Factors stemming from the global pandemic have altered organizations’ fraud risks and anti-fraud programs.” 

In May 2020, 25% of examiners reported a significant increase in fraud. That figure grew to 34% by August and then to 38% by the end of the year. When moderate increases in fraud were included, the numbers jumped substantially more. By the end of last year, 79% had seen fraud go up. 

The shift to remote work and the financial pressure on pandemic-hit companies and individuals are a recipe for increased fraud, Julie Bell Lindsay, executive director of the Center for Audit Quality, told CFO Dive earlier this year. Lindsay’s organization wasn’t involved in the ACFE report. 

"You certainly can see pressure,” Lindsay said. 

Security experts look for what they call a fraud triangle — a convergence of pressure, opportunity and rationalization — that typically signals a rise in illegal activity even among people who wouldn’t otherwise commit fraud. 

"This is where all of this comes to a head," she said. 

Remote audit

The biggest challenge for preventing problems is the travel restrictions companies faced, the ACFE report found. By August, 43% of fraud prevention specialists cited that. 

In place of on-site meetings and oversight, staff have been forced to conduct interviews remotely, with limited access to evidence.

On the positive side, 41% said anti-fraud budgets increased over the year and 38% hired more people to fight the problem.  

Of 12 types of fraud the report tracked, all rose, with cyber fraud rising the most. By the end of last year, 52% of examiners said it had risen significantly. Payment fraud also saw a jump, with 35% saying it went up significantly.

This year isn’t expected to be much better: 57% expect cyber fraud to rise significantly and 43% say the same of payments fraud.

The Federal Trade Commission is scrutinizing the booming usage of subscription pricing, key to the typical software-as-a-service (SaaS) platform, a Washington Post report finds. 

After a rash of complaints by subscribers on the consumer side of the business, the FTC is taking a look at whether the way many companies structure their billing — known as a negative option, because it equates subscriber silence to renewal consent — is being abused.

“The commission is trying to figure out how best to respond to this problem and, in doing so, is looking at all its tools,” James Kohn, an FTC associate director, told the Washington Post.

The FTC has limited authority, tools and resources to tackle the problem. 

The last law enacted to address subscription issues, the “Restore Online Shoppers’ Confidence Act (ROSCA),” was in 2010. Among other things, it requires companies that use the negative-option billing model to provide a simple mechanism for subscribers to cancel recurring charges, but because of ambiguity over what constitutes a simple mechanism, the law hasn’t done much to hold companies accountable for abuses. 

“Companies will say, well, you can call us, but the issue is you can never get through or you’re on hold for hours,” Bonnie Patten, executive director of Truth in Advertising, told the Post. 

Potential B2B impact

Although the FTC scrutiny is focused on the consumer side of subscription pricing, it could have implications for the business-to-business side of the model. The agency could create principles that courts and other regulators could apply in a non-consumer context.  

Especially for technology companies, subscription-based recurring revenue is key to attracting capital; investors like it because it gives them confidence the company has a stable source of revenue.

“Volatility in revenues … is just so hard to sell to an investor," one CFO said last year in a podcast. 

Technology CFOs across the board say annual recurring revenue is integral to their growth plans. 

One CFO equated the company’s annual recurring revenue (ARR) model to a snowball, because as subscribers are added on, company revenue expands like a snowball.

An industry survey conducted two years ago found subscriptions increase incremental spend by 60% and that 83% of retail leaders view recurring customers as integral to their strategy.

Negative-option abuse

The FTC’s interest in the issue isn’t over subscription pricing as a practice; it’s over companies that abuse the negative billing option by signing up consumers using deceptive or ambiguous procedures or making it hard or confusing to cancel and, if necessary, get a refund. 

The agency in 2019 said it wanted to tighten up its rules on negative-option billing but it hasn’t taken steps to do that yet, according to the Post report. 

That might change under the Biden administration; the rule is one of about two dozen the agency said it has put under review. 

In the courts, the few big cases to be litigated have been on the consumer side. A 2015 case, for instance, involved DirectTV, which the FTC said was tricking consumers with automatic charges and imposing onerous cancellation fees, but that case was dismissed. 

Other cases have had mixed results, although last year the FTC negotiated a $10 million settlement with education company ABCmouse for allegedly unfairly billing consumers and making it hard to cancel. 

Bottom line: To the extent the FTC ramps up subscription pricing scrutiny, it’s focus will likely be on consumer models but it could end up having ramifications for business-to-business models as well. 

Policyholders aren't getting hundreds of millions of dollars in premium rebates each year because health insurers are overestimating claims costs to avoid paying refunds, an academic study published in the Accounting Review has found.

The finding could impact companies whose benefits package includes paying all or a portion of their employees’ health insurance premiums.

“The more likely companies were to be forced to issue refunds to policyholders, the more likely those companies were to overestimate forthcoming costs – which would allow them to reduce or avoid paying the refunds,” Andrew Van Buskirk, co-author of the study and an associate professor of accounting at Ohio State University, said.

The Affordable Care Act includes a provision requiring insurers that don’t spend at least 80% of the premiums they collect on medical claims to rebate the difference between the premiums and the claims to policyholders. 

The provision is intended to give insurers an incentive to direct more of their expenditures to benefit policyholders and help lower insurance costs.

To meet the requirement, insurers calculate the percentage of premiums they spend on claims based on a rolling three-year average that mixes actual costs with estimates.

The estimates in the calculation give insurers flexibility in reporting their claim-expense ratio, opening the door to overestimations that enable insurers to keep more of the premiums, the researchers said. 

“We estimate that about 14% of insurers engage in strategic overestimation, costing policyholders hundreds of millions of dollars in unpaid rebates,” said Evan Eastman, co-author of the study and an assistant professor of risk management and insurance at Florida State University.

The key variable is what’s called the medical loss ratio (MLR), a measure of claims to premiums. The number should be more accurate in the first year of the three-year rolling average, since insurers can include a higher ratio of actual costs to estimates compared to years two and three. 

As they replace estimated costs with actual costs, the three-year average should get more accurate over time, but that doesn’t always happen. 

Instead, the researchers found, insurers’ estimates were consistently overstated in situations where more accurate estimates would have triggered higher rebate payments.

“If you create an incentive, companies are going to respond to that incentive,” David Eckles, co-author of the study and a professor of risk management and insurance at the University of Georgia, said. “In this case, that means overestimating costs to avoid paying rebates.”

Regulators could limit misaligned incentives by changing the rules to focus solely on paid costs each year, Eckles said, or by incorporating a clawback provision to account for previously overestimated costs.

The Biden administration’s “Made in America” tax plan would increase taxes on U.S. multinational corporations in 2022 by 81%, to $104 billion, and by 72% over the next decade, to $1.2 trillion, according to a Tax Foundation study.

Tax rates on domestic income would rise more than on foreign income, resulting in a net increase in profit shifting by U.S. companies outside the country and a reduction in their U.S. tax liabilities by $75.5 billion over 10 years, the Tax Foundation said.

The Biden plan would impose a 9.4% average surtax on foreign activities by U.S. multinational companies above the taxes that they pay abroad, putting them at a competitive disadvantage and “perhaps forcing U.S. firms to sell their foreign subsidiaries,” according to the analysis.

The Tax Foundation study collides with points the Biden administration has made while trying to gain public and congressional support for its tax proposal. Biden would raise the corporate tax rate to 28% from 21% and the minimum tax on the foreign profits of U.S. companies to 21% from 10.5%.

The Treasury Department, citing data from the Joint Committee on Taxation, notes that in 2018 the effective tax rate on profits of U.S. multinationals was just 7.8% compared with an average of 8.7% and 18.1% among the European Union and the top 10 U.S. trading partners, respectively.

The U.S. collects less in corporate taxes as a share of gross domestic product (GDP) than most other advanced economies in the Organization for Economic Co-Operation and Development, according to the Treasury. Since the approval of a tax cut package in December 2017, corporate tax revenues have fallen to 1% of GDP from 2%.

Also, U.S. and foreign corporations have incentives to report profits in low-tax countries rather than in the U.S., and “the latest data suggest that such profit shifting remains at record levels,” the Treasury said.

Finally, a U.S. company that invests in a physical asset abroad pays no U.S. tax on the first 10% return on foreign investment.

Biden’s tax proposal aims “to make American companies and workers more competitive by eliminating incentives to offshore investment, substantially reducing profit shifting, countering tax competition on corporate rates and providing tax preferences for clean energy production,” the Treasury said.

The plan over a 15-year period would fully pay for Biden’s $2 trillion in proposed infrastructure spending, known as the American Jobs Plan, according to the White House.

Treasury Secretary Janet Yellen this month called for a global minimum corporate tax rate, pledging to work with other countries “to end the pressures of tax competition and corporate tax base erosion.”

Yellen said in a speech that Treasury seeks in talks with G-20 nations to achieve a minimum corporate tax rate that ensures “the global economy thrives based on a more level playing field in the taxation of multinational corporations, and spurs innovation, growth, and prosperity.”

As it stands, Biden’s tax plan would erode U.S. competitiveness, the Tax Foundation said.

“The high U.S. taxes on foreign activities of U.S. multinationals under the proposal would put U.S. MNEs [multinational enterprises] at a disadvantage relative to non-U.S. corporations,” the Tax Foundation said. “This disadvantage would be sizable, potentially resulting in substantial restructuring of foreign ownership and activities of U.S. multinationals.”