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Rethinking supply chain resilience in the age of cost volatility

By Peter Spence, Associate Technical Director — MA, Association of International Certified Professional Accountants

It’s no secret to accounting and finance professionals that Chief Executives value certainty. Yet, in the past two years alone, they have had to grapple with a lot of change and uncertainty. In Europe, business leaders are dealing with the implications of Brexit and, globally, with the effects of COVID-19 on their companies.

As geopolitical threats become more apparent (e.g., energy crunch, labour and skills gap, inflation, rising interest rates, and new environmental regulations), businesses are increasingly thinking about supplier concentration and related risks.

Whether your supply chain spans currency borders or not, trying to predict the reliability of your extended supply chains is a risky move, remember that there’s no such thing as price certainty. Accounting and finance professionals must get to grips with increasingly complex risks in our volatile and uncertain environment – staying in business means managing effectively risks. So what steps do you need to take?

Firstly, if you haven’t recently reviewed risks across your business and operating model now might be a good time to do so. The Osterwalder Business Model Canvas is a useful tactical tool that will help you to do so. Once you understand what your risks are, you need to categorise them as follows “can be avoided altogether”, “fully accepted”, “reduced”, “shared”, or “shifted” and consider when they might occur. You can use the CGMA Horizon Scanner to help you with this scenario planning exercise. Finally, you need to reflect on the costs (financial and non-financial) vs. the benefits of your risk mitigation strategy…and then start to mitigate.

Here are a few options to consider:

  • Risk reduction – hedging

Some commodities can be hedged, as can many currencies and some interest rates on loans.  If your business is exposed to commodity price or foreign exchange risk, or holds interest-bearing loans, you could discuss how to best mitigate these risks with your bank or financial adviser. The simplest, and most generic instruments used for hedging commodity price and foreign exchange risk are futures and options, and for loans, swaps and caps.

Risk

Instrument

Description

Commodity or currency

Future

A contract to buy or sell a commodity or currency at a pre-agreed price in the future.  The two most basic types are American and European. Usually cheaper than options, so great if you can forecast accurately.

Forward

A custom contract between two (usually) parties to buy or sell a commodity at an agreed price in the future (e.g. gas). It’s sometimes possible to agree to this via reverse auction.

Option

A contract that gives a buyer or seller the option (not the obligation) to buy or sell a commodity or currency at a pre-agreed price in the future. It usually comes with a fee premium to futures. It is a good choice if your future volumes are uncertain, or the spot price moves to your advantage, as you are not compelled to exercise.

Interest rate

Swap

A contract to swap floating interest rate payments with fixed interest rate payments for an agreed principal, or vice versa.

Cap

A contract to fix the maximum interest rate payable on a loan.

 

There are other variants or combinations of instruments, which might provide better value for your business, or allow you to tailor the level of exposure. If you are willing to expose your business to some unhedged trade, you don’t have to aim to hedge 100% of your exposure

However, you must also remember that these instruments are broadly classified as “derivatives” by regulators and can significantly impact on your reported profit and loss (P&L) and balance sheet, depending on your reporting jurisdiction and applicable reporting standards. If you are unsure of the possible impact to your statutory P&L and balance sheet, you should consult with your auditor and incorporate regulatory requirements into your management information to ensure that business leaders can consider their impacts, make informed decisions, and forecast accurately.

  • Risk reduction – gearing, or leverage

A more strategic consideration is the “shape” of your balance sheet. Leaving aside market forces dividends are optional, but bond interest (coupon) payments and redemptions are not unless lenders agree to waive, defer, or exchange. During periods where interest rates are trending either up or down, or where business performance is such that the balance between debt and equity (gearing, or leverage) no longer looks optimal, it might be worth modelling options for changing the balance between the two and discussing them with a corporate finance specialist.

  • Risk shifting – insurance

Insurance allows you to shift the risk of some facets of your business onto insurers.  However, bear in mind that remedy usually takes the form of financial compensation – not operational fixes.

  • Risk shifting – outsourcing

Outsourcing of non-strategic or non-core activities and processes can be a way of reducing cost and shifting the risk of future cost increases to third-party specialist providers, or centres of excellence. However, you should not underestimate the challenges associated with setting up and effectively managing such relationships. As business conditions change there is a risk that such arrangements could themselves adversely impact the ability of your business to prosper. You should not take a “fire-and-forget” approach to outsourcing and you must ensure that your business continuity plans allow for possible shocks to these arrangements.

As accounting and finance professionals we must ensure that our businesses remain resilient and responsive, especially in these volatile, unpredictable, and complex times. I hope this blog gave you a clear overview of your options and encourages you to consider, or rather consider afresh, the risks across your organisations’ business and operating models, including within your extended supply chains.