In the third and the final part of our three-part ‘Accounting Blunders’ series, we are narrowing down our focus to risk assessment. The final part of our series is distinct from the previous parts since risk assessment concepts are not as simplistic as, say, bookkeeping concepts. That being said, we have simplified the concepts in order to suit a casual reader.
This is the period after the financial crisis of 2008, and the global economic system didn’t sufficiently insulate itself from effects of the crisis based on previously established risk assessment models. The complexity of the economic system makes it essential for us to adopt newer approaches to risk assessment. Our principal focus is on reducing the impact of high-risk events that can’t be accurately predicted. And, to do so, let us start with the elimination of common risk assessment blunders businesses have been making.
Here’s the basic principle applicable to companies just as it is applicable to humans in general. The “what we should not do” is often more important than “what we should do”. We need only consider the repeatedly neglected instruction provided to banks before the financial crisis that would have saved them from insolvency. The banks were warned against the accumulation of large exposures in the place of low profitability. The reason why it’s important to pay more heed to the “what not to do” is that it’s centered around the principle of preservation of the dollar, as opposed to say, finding ways to fetch an additional dollar. While veterans who have regularly conducted risk assessment audits over the years adhere to the principle of “the dollar you save is a dollar you earn”, at a time when your primary competitors are losing their dollars, the value of the dollar not lost is enhanced further.
Modern experts on the subject believe we waste too much time in our attempts to predict less-likely, high-risk ‘Black Swan’ events. By doing so, we are making ourselves more vulnerable than necessary to the milder uncertainties in life. This is not to mean that the high-risk events shouldn’t be prepared and accounted for. The prediction of these events may just be a fruitless activity, but not sufficiently preparing for them is a potentially fatal move. If companies think in terms of when, than in terms of if, they are better prepared to withstand the ramifications of the eventuality of a high-risk event. Companies must look to ask themselves how a potentially high-risk event might hamper their business interests. After they have determined the manner in which they are likely to get affected, the focus must be based around efficient-damage control with preparatory measures brought in. Companies must understand that risk assessment audit is akin to a preparatory measure that is not an option by any means; it’s an essential, similar to insurance.
Now, we’re bringing a more technical point that most risk assessment teams or departments are unaware about. Most companies – especially from the financial background – have adopted standard deviation as a metric of measuring risk. This use of standard deviation as a means to measure risk is hard to understand as most experts, let alone the average risk assessment team, don’t really have a decent understanding of standard deviation as a concept. The root of the problem with standard deviation remains the fact that standard deviation does not correspond to the square root of just the average variation, it simply corresponds to the square root of the average squared variations. Risk assessment teams must understand the problems associated with measures that relate to standard deviation, which include regression models.
While they say those who don’t pay attention to history are doomed to repeat it, we believe that, that notion mustn’t be taken to an unhealthy extreme, especially for the sake of ‘risk assessment audit’. Economics is a source of great laughter for many experts because of its unpredictability. Major economic events that leave experts scratching their heads in its fallout generally don’t have a pattern. And, it is for this precise reason that we intend to break away from the traditional approach of paying special heed to past events. Companies must pay attention to the forces that actually make a difference in the world – statistical randomness and socioeconomic randomness. Companies can better account for the randomness they can derive from the many economic variables that are often a result of changing policies, changing investment patterns, and changing prices.
We understand modern day risk-management functions are complicated as a result of a globalized economy, where economies over the world are more intertwined. This volatility of our economy makes the anticipation of high-impact events doubly difficult. At the core of our efforts to safeguard ourselves from the many uncertainties of the free market, we intend to strengthen your capacity to withstand these fluctuations in economic conditions, rather than strengthening our capacity to predict what is inherently unpredictable. Alongside our core accounting services, we extend our risk assessment services for your benefit. Contact us at Altitude Accounting to learn more about the nature of our services, the center at which lie our tax shelter accountants who ensure you breeze through the filing process of your tax returns.
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