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Risk-Taking | The Emergence of the New CFO

Generally speaking, financial-minded people are taught not to take risks. CEOs and sales-minded people are taught to take risks. This stark difference between the two roles (CFO and CEO) can cause friction if not addressed.

Risk can be expected within any organization, regardless of how much due diligence you do. Someone once described risk and uncertainty this way…

risk-takingYou are a football player and have the ball in your hands. You throw the ball to another player who is wide open. You’ve evaluated and concluded that this is the perfect opportunity to take a risk (letting the ball go) because it’s an open field with a clear path. But unexpectedly, a player from the opposing team comes between you and your teammate. Risk-taking is full of inevitable surprises.

With risk becoming a bigger conversation starter, there is a new role set emerging for CFOs and financial leaders alike.

Risk-Taking

Risk-taking and being a realist are not really compatible. Financial-minded people typically see themselves as realists and, consequently, tend to avoid risk.  The challenge is to combine the view through both of these lenses in order to decrease uncertainty from risk and increase opportunity.

Realists

A realist can be defined as someone who identifies things for what they really are. Most CPAs, financial analysts, financial leaders, and CFOs can easily relate to the “realist” role.  Realists tend to predict the future based upon past results.

Risk equates to uncertainty. Risk means making assumptions that may not be based upon reality, but on what could be.  Realists prefer to deal with the certainty of reality rather than the risk involved with dreaming.

Types of Risk Takers

Like it or not, risk is unavoidable.  Everything we do involves risk; whether you’re crossing a road or investing in a risky stock. Since you’re taking risks whether you know it or not, let’s investigate the type of risk taker you are.

Avoider

Have you ever met someone who tries to avoid all risk? This person likes to identify all outcomes and won’t make a decision unless it results in absolute certainty. They take the “cautious approach” too seriously.

The avoider is someone who truly believes that taking any action is the biggest risk. What they fail to see is that refusing to make a decision is a decision itself.  By not taking any action, they expose themselves to the whims of fate.

Think back to the emergence of the Internet. There were countless companies that assumed that going on the Internet was a risk because it was a new fad that would eventually go away.   Their decision not to take a risk definitely put them at the mercy of early adopters.  Avoiding the elephant in the room will not make it go away.

Mitigator

A mitigator typically does not take any risk unless he or she has compiled and vetted a significant amount of research to rule out any uncertainty. This type of risk-taker is only one step removed from the avoider, and is subject to the same consequences from their inaction.  But for those who do not have the experience or wherewithal to make a snap decision, this is may be their comfort zone.

Manager

Like any typical manager, a risk manager simply knows what’s going on.  What often separates the mitigator from the manager is experience.  Since they’ve had experience that the mitigator might not have, a risk manager is better equipped to make a quick judgement call when evaluating risk. They are a lot more comfortable in their decision-making and risk-taking roles.

Embracer

risk-takingSome people simply enjoy jumping out of airplanes, going all in at the poker table, or quitting their nine-to-five to start a company.  There’s a certain aura around entrepreneurs that just screams “RISK!” To financial leaders, risk means bad.

An embracer typically seeks high-risk for a high-return. They don’t do a whole lot of research before they act. The embracer can be compared to an adrenaline junkie, or someone who does crazy, dangerous things for the adrenaline rush.

The risk-embracer is at the extreme end of risk-taking.

helicopter-983979_960_720What type of risk-taker should I be?

As with everything, it’s important to find a balance between the two extremes. Do avoid dangerous risks. Do recognize that there is going to be uncertainty in your actions. Do embrace calculated risk-taking.

As a financial leader, your job is not to avoid all risk, but to help your CEO calculate risk, have their blind side and determine the best course of action. In short, it’s to be their wingman.  Learn more about how to guide your CEO as a trusted advisor by downloading your free guide on How to be a Wingman.

Enable Your CEO

Enabling your CEO is simply the most important part of your job as a wingmanCEOs generally like to take risks. CFOs generally avoid risks (which begs the question, can a CFO be a CEO?).  Your job is to help your CEO calculate the risks.  And I know you’re good at calculating…

Embracing risk isn’t always easy or comfortable, but creating a controlled environment will allow your CEO the creative freedom they need while still giving you a measure of certainty.

Risk Management and Control

So how do you create this “controlled environment”?  Through risk management and risk control.

Business Insider defined risk management as a practice of “creating economic value by the qualitative and quantitative identification and measurement of risk sources and the formulation of plans to address and manage these risks.” Risk-taking is an expected function that a financial leader has to manage.

They defined risk control as a “support function for financial risk takers and risk managers… [involving] the measuring and monitoring of risks versus pre-determined limits…”

In order to bridge the gap between the realist (You) and the risk-taker (your CEO), you need to re-examine your role.

The Emergence of a New CFO

brene-cc-880x1320Over the course of the past 25 years, I’ve spoken with hundreds, if not thousands, of CFOs, Controllers, and financial-minded people (financial analysts, accountants, bankers, CPAs, etc.). When I tell them that I work with entrepreneurial companies and that I’m an entrepreneur myself, they begin to get nervous. Why?

Dr. Brené Brown, research professor at the University of Houston, studies vulnerability, courage, worthiness, and shame within people, relationships, and organizations. She concisely puts it, “vulnerability is basically uncertainty, risk, and emotional exposure.” Taking risk in financial decisions or business decisions or even personal decisions is exposing yourself to uncertainty, more risk, and emotional exposure.

Today’s CFO cannot just be the person who always plays it safe. To stay relevant it’s important to become more than an number-crunching realist.

Manage and control the financial risk of your company by being a wingman to your CEO. If you’re interested in becoming the trusted advisor your CEO needs, download your free How to be a Wingman guide here

risk-taking

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Risk-Taking

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Work Breakdown Structure (WBS)

See Also:
Percentage Completion (POC) Method
Completed Contract Method
Capital Expenditures
Construction Accounting

Work Breakdown Structure Definition (WBS)

The Work Breakdown Structure definition is a technique or method of breaking out different components or pieces of a project. The work breakdown structure chart starts at the highest level of the project and then breaks down the different components.

Work Breakdown Structure (WBS) Explained

Allowed within the Work Breakdown Structure method, a project manager evaluates what is needed to be done initially to make it to the next level of a project. In a way, this allows the manager to start out at the basic level and move up to the more advanced stages. It also allows the project manager to prioritize the different components of the project. Project accountants also like the WBS template because it allows them to calculate the percentage complete if the project is being performed for revenue. Sometimes, you can use the Work Breakdown Structure method for something simple like job hiring for a position. Although, the main benefit from the WBS is that it breaks a large project down into manageable components.

Work Breakdown Structure Example

Now, let’s look at a work breakdown structure example. Tim is managing the construction of an airplane to be sold in the next year. First, Tim evaluates all the tasks he needs to perform. Then he writes them down. Check out the following list for the Work Breakdown structure:

  • Level 1 – Construction of Airplane
  • Level 2 – Construction of Fuselage, Wings, and Engines
  • (Fuselage) Level 3 – Construction of metal frame, purchase of seats, purchase of carpet, construction of cabinetry, and construction of cockpit
  • (Wings) Level 3 – Purchase of metal and construction of frame
  • (Engines) Level 3 – Purchase and installment of engines from company specializing in airplane engines

You can further break down all of the components in Level 3 into a Level 4, and then even further if required. The key to the Work Breakdown Structure is to make the project simplified and as manageable as possible.

work breakdown structure, Work Breakdown Structure Definition, Work Breakdown Structure example

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Cost Center

See also:
Cost Driver
Variable vs Fixed Cost
Sunk Costs
Activity Based Costing vs Traditional Costing
Removal Cost
Profit Center
Responsibility Center
Adding Value as a Financial Leader

Cost Center Definition

In accounting, a cost center is a type of responsibility center. A responsibility center is an organizational subunit the manager of which is responsible for certain financial and non-financial performance measures. For accounting purposes, consider a responsibility center – in this case a cost center – a distinct entity within the context of the larger organization.

Furthermore, a cost center is an organizational subunit that incurs cost but does not directly contribute to the company’s profits. In fact, a cost center may not generate any revenues at all. The manager in a cost center has the authority to incur costs related to normal business activities and operations. Furthermore, a cost center manager’s primary goal is to contain and control the subunit’s costs. As a result, the manager of a cost center is evaluated on the basis of cost containment and control.

Download the free Know Your Economics guide to monitor what’s happening in your business. 

Cost Centers and Discretionary Cost Centers

In addition, make a distinction between cost centers and discretionary cost centers. The difference is with the relation between inputs and outputs in the production process.

When there is a well-defined relation between inputs and outputs in the production process, the organizational subunit is a cost center. For example, a manufacturing process is a regular cost center because each unit of output requires a measurable input of raw materials and a measurable amount of direct labor time. Furthermore, in this type of process, it is easy to see the relationship between the cost-incurring inputs and the revenue-generating outputs.

When there is not a well-defined relation between inputs and outputs in a business activity, the organizational subunit is a discretionary cost center. A good example of a discretionary cost center is an administrative department where the work of the administrators is not clearly linked to any tangible or measurable output. It is not easy to see the relationship between the cost-incurring inputs and any type of revenue-generating outputs.

Examples

Cost centers are typical business units that incur costs but only indirectly contribute to revenue generation. For example, consider a company’s legal department, accounting department, research and development, advertising, marketing, and customer service a cost center. The managers in charge of these departments can control and contain costs – and they are evaluated on their ability to control and contain costs. But there is not much they can do to directly impact the company’s revenues. If you want to identify your cost centers and know how they fit within your economics, then download your free guide here.

cost center

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cost center

Sources:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

 

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