The Role and Possible Methods of Mitigating Financial Risks in Planning

Abstract

The focus of our study is on the description and management of financial risks, which are of crucial importance in planning. Risk management is a major focus, as its conscious and optimal management ensures the successful survival and development of enterprises. At both operational and strategic levels, we take account of the types of risks that businesses face. The need to adopt an agile approach to financial planning will be described, as well as the role of dynamic financial planning. Finally, it is pointed out that enterprises face different decision situations in planning and implementation at different stages of their life cycle.

Introduction

There are many different ideas about risk in general public understanding, it is easy to formulate in broad terms. One general formulation is that risk is the uncertainty surrounding the occurrence of an event, which can be reduced by providing information. The formulation refers to uncertainty and its reduction. The reader may miss the steps taken to mitigate the negative effects of consequences, such as a system of bank guarantees. Although there might be some truth in this idea, the fact is that risk mitigation is about the occurrence of an adverse event, about avoiding it. There several methods described in the literature for measuring the severity and impact of risks, but there is little uniform guidance that can be applied to all economic situations. According to Kovács (2018), when measuring risks and their impact, it is appropriate to consider the impact on assets, liabilities, wealth and liquidity in addition to the probability of an adverse event occurring. For an entity, the above factors are essential elements to ensure sustainable operations (Bethlendi-Lentner, 2018; Lentner, 2015). In the following, we will examine the types of risk, the impact of each adverse event and the options for ‘protection’.

The importance of corporate risk management

The importance and relevance of the corporate risk management toolkit is quite well documented; thus, it is not surprising that several authors (Krauss et al., 2005; Songling et al., 2018; Wegner et al., 2017; Tóth et al., 2022a,b) highlight the benefits of risk management in the SME sector. For a company, any factor that can negatively change the company’s performance and management is a risk, so identifying the source of risks, conscious risk management and risk-aware decision-making are particularly important (Olah et al., 2019). In today’s turbulent, often unpredictable economic world, it is a must for entrepreneurs and managers to focus on managing risks and consciously managing them (Jaka et al., 2019; Lentner 2013,2019). The economic (financial and controlling) managers of SMEs must do their utmost to be able to manage the risks they face effectively in order to ensure the survival of their organisation (Cressy, 2006; Jaka et al., 2019; Jaroslav et al., 2014; Grable and Lytton, 1999; Goswami et al., 2017). This also means that businesses must manage the risks they face for effective operation. While a group of firms tries to manage their financial risks passively, others may try to gain a competitive advantage by consciously increasing and managing them. Díez-Esteban et al. (2017) conducted research and found that there is a very strong link between a firm’s risk management (attitudes, awareness) and a firm’s performance and effectiveness, and recommend that managers implement firm-specific risk mitigation strategies as soon as possible. Their research also shows that risk management tools are positively and significantly related to corporate performance. Humaira and Sagoro (2018) also have similar results, while also finding that a significant relationship between corporate financial literacy and financial risk management can be demonstrated. Reversing the previous logic, Adi and Salina (2021) argue in their study that lack of corporate financial awareness causes poor risk management in firms, and thus, their performance deteriorates.

Grouping of risks

Risks have been grouped according to their origin and their impact on the management of the business.

To work through the topic, let’s start from the objectives of the planning work, its process and the risk of the activity. Planning is the process by which an enterprise determines its objectives, the means to achieve them and matches means to objectives. Another task in risk management is the mapping of risks, in which we will look at two aspects. The first step is to identify the potential adverse event, determine the probability of its occurrence and the negative impact of its occurrence. In the assessment, we weight the events and focus mainly on those with a high economic impact and a high probability of occurrence. We may decide to omit the economic operation. A simple example would be to stop truck deliveries to a war zone, where the probability of physical damage or looting is high and their economic impact is significant.

Taking the time factor into account, risks can be divided into two classes: there are operational and strategic risks.

Risks affecting operations

– Financial risks: we need to organise our work around operational tasks, have a solvent demand that is able and willing to buy our products and services at the price we envisage and is prepared to pay the bills. To mitigate risks, market research and market analysis is carried out. Before we organise products and services and start production, we find out whether the necessary market demand exists. This can be done through market research and analysis of potential partners. To assess potential partners, most commonly their annual accounts and company court records should be analysed. In the analysis of short-term risks, we examine the expected value of the operating cash flow. The question may arise: why is cash flow included in the operational group? This question is answered by the content of the statement. The content of the operating cash flow lines is linked to the operational activity. Without being exhaustive, we can mention the profit and loss, current liabilities, current receivables, inventories, etc. All these items are the result of intra-year activity. The summary indicator for financial risks is the operating cash flow.

– Operational risks: it is important to remember that the primary management process is real, of which financial processes are the economic dimension. It is only natural that financial processes – collection of trade receivables, liquidity management, etc. – have an impact on real processes, where disruptions can also occur if they are insufficient. There is a close link between the two activities and no order of priority can be established. The risks of operational disruption are reflected in the operability of assets, the supply of materials and energy, the provision of labour, the disruption of IT system operations, possible insurance events, etc. Any disruption of operations will affect short-term profitability and efficiency. The above classification includes the change in costs as a long-term risk, but it should be noted that due to the global economic trends – of the summer of 2022 –, it will also be included among the short-term risks. Why is that? Supply chain disruptions due to the pandemic are detectable in the short term, and energy security and energy prices due to the Russia – Ukraine war have emerged as a significant influencing factor affecting short term operations.
Risks can be mitigated by work organization and larger stocks. Two examples of risk measurement are.

– The risk of labor shortages and the continuous rise in labor costs can be countered by mechanization and automation, in addition to effective HR work.

– We can avoid disruptions in material supply by higher stock levels and taking on the rising inventory costs.

Strategic risks

In strategic planning, in the long term, trying to define the conditions of operation and the circumstances and results of operations several years in advance. The timeframe means that the risks are different. We do not consider it necessary to list them all. Still, we can think about market movements and relate our plans to the evolution of the product life cycle, technological and technical developments, market changes, exchange rate fluctuations, etc. The risks can be estimated by analyzing macroeconomic flows. Means of mitigating risks include the consistent and accurate preparation of long-term plans, the conclusion of long-term contracts with the inclusion of guarantees, and the taking out of insurance against certain events.

The following flow chart illustrates our thoughts on risk and its management.

The agile approach to design

The need for flexibility and adaptability has increased because of the constant challenges and unexpected impacts in the broader and narrower business environment. Agility and forward-thinking using design tools can be behind the success of ‘surviving’ businesses. „An iterative and incremental approach characterizes agile design. This principle, coupled with the realization that innovative (riskier, more uncertain) tasks (projects) cannot, in principle, be planned for the longer term, gives rise to the need for a relatively short (months) planning cycle (Klimkó, 2014:91).” The author refers to the declining importance of strategic planning over a more extended planning period. In our view, it is precisely in such an environment that strategic thinking can be a compass for stable operations. Strategic planning is necessary to avoid ad hoc decision-making and hectic, haphazard processes. At the same time, however, the demand for flexibility and reducing the strategic timeframe are becoming increasingly stringent. This means that the objectives and planning figures of strategic plans must be constantly monitored and measured. If justified, they must be revised and rethought (rolling planning approach). Close cooperation between strategic, tactical, and operational plans is essential, and changed strategic objectives must be broken down immediately into action plans and monthly or weekly operational plans.

The so-called Agile Manifesto (Beck et al., 2001), produced and published in 2001, was the first to summarise the core values and basic principles of agile thinking and thinking, which were first formulated in the field of software development but are now the core values to be considered and applied in the design process.

The general objectives of agility are to achieve efficiency, improve productivity and product/service quality, increase customer satisfaction, and reduce operating costs (Fernandez – Fernandez, 2009). Therefore, the traditional design method must be revised, incorporating agile design tools such as lean or Kanban (Szóka, 2019). In addition to conventional ‘hard data,’ it contains soft information, human intuition, market testing, and listening to customers and employees (Di Fiore, 2018).

The global economic crisis has spilled over into our country, which calls for a rethinking and redesigning of existing corporate budgets and those already approved for future operations. Cost planning in this economic environment has led to a structural transformation of direct and indirect operations costs, resulting in a radical reduction of – typically – corporate overheads, which are fixed and regularly incurred. In such operating conditions, maintaining liquidity is particularly difficult, reinforcing the role of financial planning.

The essence of financial planning is the continuous review and regular comparison of the plan with the actuals to forecast payment problems promptly. This planning can cover short, medium, and long-term forecasts. A further aspect of planning is static (traditional) and dynamic (modern) analysis (Szijártó et al., 2017). The main principles of active financial planning are illustrated in the figure below.

In the context of dynamic financial planning, it is essential to mention the so-called rolling financial planning, which helps to avoid economic contingencies and is, therefore, indispensable for all businesses. Rolling financial planning, therefore, falls into the category of dynamic planning. The two main strengths of its application are: firstly, the continuous updating activity, which allows the implementation of necessary interventions based on comparing the plan and actual data (Nagy, 2013).

Although this means additional management tasks, it can achieve financially demonstrable results. On the other hand, proactive behavior and management create opportunities to understand better and manage environmental change. Rolling planning has other advantages over static financial planning, such as adapting better to economic realities and reducing the variance of planning forecasts.

An agile approach enables organizations to promptly adapt to dynamic market environments and confront business challenges with agility. Integrating agile design and risk management is gaining traction within corporate entities. Several companies have effectively implemented agile methodologies in risk management. The collection below contains a comprehensive list of agile tools that are frequently employed by enterprises when it comes to agile risk management.

– Backlog Management Tools aid teams in prioritizing and organizing their work items, which may include user stories, tasks, and features. Some of examples are Jira, Trello, Azure Boards, and Asana.
– Agile boards monitor task progress and enhance team transparency through visual representation, typically grounded on Kanban principles. Digital Kanban boards are provided by various tools such as Trello, Kanbanize, and Monday.com.
– Agile project management software encompasses functionalities that facilitate sprint planning, task monitoring, and team cooperation. Some software tools commonly used in project management are Jira, Microsoft Project, Rally, and VersionOne.
– Collaboration and communication tools enable efficient communication and collaboration among agile teams. Instances of such platforms comprise Slack, Microsoft Teams, and Atlassian Confluence.
– Test Management Tools encompass testing and validating solutions by utilizing test management tools. Test management software applications such as TestRail, Zephyr, and qTest facilitate the process of organizing, monitoring, and documenting testing procedures for teams.
– Automating software builds, testing, and deployment is critical to agile risk management. The subject matter pertains to the tools utilized for Continuous Integration and Deployment (CI/CD) Tools. Jenkins, GitLab CI/CD, and CircleCI are among the commonly used CI/CD tools.
– Version Control Systems are software tools that facilitate managing and monitoring modifications made to a team’s codebase. The utilization of Git and its associated platforms, namely GitHub and Bitbucket, is prevalent in version control.
– Implementing Analytics and Monitoring Tools is crucial for data-driven risk management, as it enables the monitoring and analyzing of system performance and user behavior. Various software applications such as Google Analytics, New Relic, and Datadog offer valuable insights for risk assessment.
– Retrospective tools are utilized to promote ongoing enhancement by enabling team dialogues regarding successful and unsuccessful practices and devising strategies for improvement. Illustrative instances comprise Retrium, FunRetro, and Trello’s retrospective templates.
– Risk management software offers specialized tools, such as RiskyProject, LogicManager, and Risk Cloud, that identify, evaluate, and reduce risks at every stage of a project’s development.

The tools above facilitate agile risk management by augmentation of collaborative efforts, monitoring advancements, automating procedures, and providing discerning perspectives for informed decision-making. Various organizations may blend these instruments depending on their particular requirements and inclinations.

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Dr. Róbert Tóth, Senior Lecturer,
Institute of Economics and Management
Faculty of Law of the Károli Gáspár University
of the Reformed Church in Hungary

Prof. Dr. László Ungvári
Technische Hochschule Wildau

Dr. Imre Túróczi, College associate professor
University of Debrecen,

Dr. Ibolya Szentesi, Senior Lecturer,
College associate professor
University of Debrecen

Dr. habil. Richárd Kása
Faculty of Finance and Accountancy,
Department of Management, Budapest Business School,