Cost and risk management

The persisting economic scenario is a major global concern, more so to the managers of commercial enterprises. Providing quality products and services at affordable prices in a fierce competitive environment is yet another entrepreneurial challenge. Dr V. Krishnamurthy, Chairman of National Manufacturing Competitiveness Council (NMCC), and a member on various committees of the Prime Minister, observed, “Contribution of manufacturing sector to the GDP has stagnated during the last two decades, and one of the major reasons for this has been the inability of India to build competitiveness needed to meet the global challenges as well as to develop a larger domestic market through low cost production.” He elaborated, “India has the potential to emerge as a major manufacturing hub for the global market. This can happen only with improved competitiveness of its industry apart from innovation and productivity.”

In this context it is essential to address the two vital aspects: cost management and risk management. Cost management is not a one-time ad hoc exercise of cost reduction (which might have long-term repercussions) in losing talented work force and a sacrifice in maintaining quality.

The Gujarat Chief Minister, Mr Narendra Modi said cost management is the systematic approach to provide such a framework which can control and reduce operational cost activity-wise, and the challenge lies in convergence of diverse aspects of cost and risk management.

Mr Sudhir Vasudeva, Chairman, ONGC Group, exhorted, “The lesson learnt from the severe economic recession in 2008-09, which has not yet ceased, is for establishing a comprehensive and robust system of cost and risk management in every facet of financial activities and to lay the emphasis on inculcating a culture of cost consciousness, so that each individual is aware of the cost implications of his activities on the bottom line of the company.”

NEWER APPROACHES

Against this backdrop, the role of the financial professionals moves from book-keeper and reporter towards a strategic partnership with corporate leaders. The framework for convergence of diverse functions relating to managing costs and mitigating risks against all odds is being developed by various bodies of accountants, including the world body of accountants, International Federation of Accountants.

Like any other technological revolutions, quick developments are taking place in the approaches of cost and management accountants. From traditional cost-accounting systems (like marginal costing for pricing, standard costing for control of costs, throughput accounting, etc.) new approaches (like activity-based costing, total cost management, lean accounting, etc.) have been developed. Activity-based costing is a special costing model that identifies activities in an organisation and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. Total cost management is a company-wide systematic and structured approach, which provides a holistic framework to control, reduce and eliminate costs throughout the value chain. This process of managing the financial outcome of activities encompasses all operations — internal and external.

Nevertheless, technical words of the accountants, like “gross margin”, “overhead absorption”, etc, are not generally understood within most organisations. This may be acceptable when financial reports are restricted to senior managers. But in today's context, they should be simple and understandable so that people can readily use the reports for improvements and decision-making. Income statements written in plain language are easy to use. When used in meetings, lucid financial statements change the question from “what does this mean” to “what should we do”. Thus, the new approach of lean accounting has emerged.

The Ministry of Corporate affairs formed an expert group in 2008 to study and suggest suitable changes to cost accounting or audit into a framework that would facilitate the competitive regime and also protect stakeholders. Based on these recommendations, the Company Law Board recently issued circulars and orders about changes in the cost audit and compliance report. The performance report that has to be submitted to the management, and forms part of the cost audit reports, also includes risk management, apart from other areas critical and sensitive to improve enterprise resource management.

The International Standard for Risk Management (ISO 31000) published on November 13, 2009, defined risk management as “the identification, assessment and prioritisation of risks as the effect of uncertainty on objectives, whether positive or negative, followed by coordinated and economical application of resources to minimise, monitor and control the probability and/or impact of unfortunate events or to maximise the realisation of opportunities.” According to ISO Guideline 73, in ideal risk management, a prioritisation process is followed where risks with the greater loss (or impact) and greater probability are handled first.

In short, the two major responsibilities of corporate boards are cost management and risk management, while adhering to the requirements of corporate governance that involve practices in business that are designed to ensure that transactions and corporate affairs are handled ethically and are financially sound, resulting in creation of value to the shareholders, employees and other stakeholders. Integrated reporting imbibing corporate social responsibility is part of the shift in business responsibility. However, integrating reporting for the sake of integrating is set to fail and disappoint stakeholders. In view of the same, companies with a profound connection of their sustainability efforts with their strategy and the management cycle should start taking steps towards integrated reporting.

(The author is advisor and senior faculty member, Institute of Public Enterprise,Osmania University campus, Hyderabad.)