CFOs are spending more time with their boards readying for quick strategic course changes as thorny economic conditions set in for the year ahead. 

    As we hurtle towards FY25, few CFOs are expecting much relief from the prevailing blustery economic headwinds. The economic scene looks set for more of the same — a thorny combination of sticky inflation and high interest rates elevating input costs and dampening consumer spending, overshadowed by the unsettling influence of intensifying global conflicts, trade tensions and cyber threats. It’s a mix that’s already hitting bottom lines, with analysis of S&P/ASX 200 companies’ earnings showing this year’s interim profits were down on the long-term average.

    No wonder CFOs’ risk appetites have ebbed to record lows, according to Deloitte’s latest CFO Sentiment Report.

    “There’s no doubt COVID-19 introduced a level of uncertainty none of us had ever seen, but the current uncertainty around the financial future is at an all-time high and that’s affecting the investment decisions that CFOs and boards are making,” says Joanne Gorton MAICD, managing partner of audit and assurance at Deloitte.

    Consequently, many CFOs are spending much more time with their boards on scenario analyses, readying their organisations for quick course changes to avoid threats and seize opportunities.

    Energetic stress testing

    For AGL CFO Gary Brown GAICD, the issue that tops the pile is undoubtedly the race to decarbonise the Australian economy. Indeed, Brown was appointed CFO after leading the review of the strategy of Australia’s largest electricity generator and emitter, resulting in the 2022 unveiling of a fresh direction. The new headline plans include an earlier than expected exit from coal- fired power generation by the end of 2034–35, while delivering 12GW of renewable generation and firming capacity.

    “We know it will be a bumpy transition to a green future for Australia and the transition does not come without risk and cost,” says Brown, also a director of Tilt Renewables and previously in CFO and senior finance roles at ENGIE, Viva Energy, Shell and BHP. “Our strategy at AGL is to play a significant role in helping the country decarbonise, and we’re very focused on navigating the hurdles and opportunities that come out of that.”

    The multitude of unknowns in the energy transition — from potential supply chain bottlenecks and competitive tensions to the cost of procurement and speed of regulatory approvals — mean AGL’s board and management are more regularly stress testing various risk scenarios, says Brown. “What if things go faster? What if they go slower? What if procurement prices go up, or come down? What if EV uptake is higher, or lower? We don’t have all the answers, so we spend a lot more time in discussions around the different scenarios that could play out, and constantly evolve, where possible, to future-proof ourselves.”

    Brown notes it also means getting comfortable with potentially taking on more risk than historically palatable, for example when assessing a renewable or firming generation asset investment.

    “In the past, you might have had all your various approvals in line before you ultimately proceeded, whereas going forward, we may be willing to take more risk in certain areas of the development asset up front to give us more options going forward,” he says. “There’s a little bit of tension between our stringent core risk management and making sure we allow sufficient risk or opportunity into some of those growth areas, but in a very calculated and transparent manner. We’re certainly going into it with our eyes wide open.”

    Pulling more levers

    Operating with a very different risk register, the CFO of global online real estate advertising company REA Group, Janelle Hopkins GAICD, feels “overall net-optimistic” despite all the moving parts. “For a business like ours, predominantly in residential listings, we earn our revenue when people list their properties to sell. So, it’s all about consumer confidence, and for us I’d say the market is pretty good,” says Hopkins, previously CFO at Australia Post before joining REA in 2019.

    “Interest rates are more stable, we’ve got net migration, which means more people demanding housing, and we’re seeing a pretty good balance of supply and demand from a listings perspective in the housing market — although the chronic undersupply of houses is a different challenge that needs to be addressed.”

    Yet, Hopkins is keenly aware that, while the outlook seems solid today, the world could change substantially within months. A big lesson to come out of the COVID-19 era, she says, has been the need to plan for scenarios with multitudes of outcomes and to be prepared to tweak plans quicker than ever.

    “Take the past two years, for example, when we had 13 interest rate rises,” says Hopkins. “One or two you can cope with, but 13 had a massive impact from a revenue perspective. We were running multitudes of scenarios — considering how bad it could get and what levers we’d pull under each scenario. It seems the scale of possible outcomes for different scenarios is bigger than what we saw in the five or six years pre-COVID, when we had a more buoyant economy and not as many shocks.”

    To manage it, she works with her board to set a benchmark for investments in line with REA’s “positive operating jaws” approach and keeps a steady watch over which investments to quickly dial up or down. “If the market turns against us, we’ll say, ‘These are the three things we would stop doing or where we’ll slow our investment’, but if the market is ahead and we can see a pipeline of future revenue, we might say, ‘Now’s the time to accelerate our execution and look to the next three things’.”

    However, it’s important to avoid underinvesting simply to satisfy a short-term blip in the market, says Hopkins. “REA Group’s risk appetite is expansionary. We absolutely want to continue investing for the long-term growth of the company, so making sure not to short-term the business is super-critical.”

    Reinvention imperative

    Dr Saranne Cooke FAICD, chair of Racing NSW finds that scenario planning potential causes of organisational collapse can be a useful way to lift companies’ propensity to shift their business models to generate revenue from new products and services. PwC’s most recent Annual Global CEO Survey found that 85 per cent of Australian CEOs say their business would still be viable 10 years from now even if they were to stay on the same path, compared to 53 per cent globally.

    It also found that Australian chief executives have high expectations of revenue growth in the next three years, mostly from existing products and services, inferring a lack of urgency around future-proofing. Yet many experts agree companies face a reinvention imperative given the uncertainty ahead and as generative AI and other technologies accelerate the pace of transformation.

    “You can’t simply coast along when the world is changing so much,” says Cooke. “You need to be re-testing assumptions, talking about tolerances, putting in guardrails so the CFO knows which levers they can pull — and how far.”

    Communication is key

    To successfully navigate uncertain terrain, Cooke says a culture that enables open, honest and frank discussions among board and management, which encourages the tabling of difficult discussions without fear of negative reaction, is vital.

    “The CFO and the CEO need to feel free to air their concerns or make admissions that perhaps past assumptions were wrong, or things are not panning out how we thought,” she says. “Because I’d much rather know unsettling news now, so we can frame up the next agenda to deal with it.”

    In addition to open communication in which the CFO must be the “truth teller” — giving the board the “warts and all” view of performance — Hopkins says CFOs should not hesitate to leverage the experience around the board table.

    “We have members of our board who sit on other boards in different industries, and therefore can share what they’re hearing, which is valuable for us as we think about our top risks — such as, are we being too pessimistic? Are we being too optimistic? Some board members have seen a few different cycles and have very diverse experiences. Particularly for newer CFOs, that insight and knowledge can be extremely valuable.”

    Brown adds that CFOs must accept they will not always have all the answers. “Particularly as we’re entering a period of greater uncertainty, where we don’t always know what’s ahead, we need to make sure we’re having open, transparent dialogue as early as possible with the board — and it may mean we’re workshopping some of the issues and the risks and opportunities together.”

    Gorton, with three decades of experience in auditing and assurance with Deloitte and PwC, observes that this type of collaborative approach between the board and management has become far more common in the past decade, whereas previously much of the decision-making power rested with management. It’s a shift she says is likely leading to better risk management outcomes.

    “The C-suite will know their organisation in a level of detail that a board member doesn’t, and that’s to be expected, but the amount of experience around any board table is huge,” says Gorton. “At the end of the day, managing risk is about judgement. Without the benefit of hindsight, there is technically no right or wrong answer. Therefore, having rigorous debate, with different views and experiences around the table is essential for the organisation to have a good feel for their risks and how best they can manage those risks.”

    Rising above the chaos

    Boards should be prepared to pull back, rethink and reset organisational strategy when required.

    Board director and chair Dr Saranne Cooke FAICD has concerns that not enough Australian boards have the agility to be able to pause and rethink strategy, despite the fast-shifting operating landscape. “You can no longer necessarily wait until budget time or until the strategy is due for reset,” says Cooke, whose roles include chair of Racing NSW, deputy chancellor of Charles Sturt University and chair of the Royal Flying Doctor Service (South Eastern Section).

    “Boards should be willing to say, ‘Let’s stop, rise above the chaos, and rethink what we’re doing here’, because strategy is, after all, supposed to be a living thing.”

    Risk registers are helpful in the discussion, says Cooke, but only if used properly. “If you have a risk laundry list 20 pages-long that’s ticked and flicked, it’s a waste of time.”

    Instead, Cooke uses a couple of techniques to better govern the risk levers that really matter, including a regular practice of “deep diving” into one or two risks at every risk committee meeting. She also holds sessions with her boards and management teams where she asks everyone to imagine they’ve been handed a crystal ball that shows the company no longer exists in a decade.

    “I ask everyone to think about what might be the top three things that could have wiped out the company 10 years into the future,” she says. “Then we’ll really think those things through and what we should be doing about it. It’s a healthy practice that gets better engagement in your risk discussions.”

    This article first appeared under the headline 'Holding the Bottom Line’ in the June 2024 issue of Company Director magazine.

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