When you prepare budgets for submission to the Trustees or Board of Directors, do you include a line anywhere in your Profit and Loss Accounts for Risk? I’m guessing like us, you don’t. But should you?
As CEO of Utility Aid, I regularly sit with our Board of Directors reviewing our management accounts. I also sit with our Leadership Team every month to compare budget versus actual, to make sure we are meeting targets, and not overspending. I do this, not only because it’s part of my job but also because I hate curveballs. I dislike having an expense charged to our accounts that I haven’t approved or been made aware of. When it happens and it does of course, I take it personally. I feel somewhat embarrassed because I take pride in accurate forecasting and am responsible for when it’s not. I wonder if these feelings resonate with those of you with a fiscal responsibility for your own organisation.
If the unbudgeted charge to the P&L is small, it might not matter too much. And to an extent, we could say things like these are simply a cost of doing business. But what happens when the unexpected charge is big. So big in fact, it could bring the organisation to its knees? This is what happened to one of our customers.
In May, an education charity declined to renew their energy contract because they faced a £5k annual increase on a £232k annual spend. They chose not to renew in the hope that markets would drop prior to their contract end date of 1st October. Unfortunately, they didn’t and despite us repeatedly advising them to renew in between times, they put off doing so – again in the eternal hope that markets would drop. They didn’t, they actually went through the roof. So, today the charity faces an absolutely horrific choice of either renewing at a staggering £132k annual increase or remaining on Out of Contract rates incurring hundreds of thousands in excess charges, whilst hoping for the market to drop. Or, some hybrid agreement in between. None are satisfactory and any one is financially disastrous.
There is no question that the FD did what he believed to be right at the time. However, by not setting a ceiling on the rates at which point he had to trigger an action, his inaction has potentially crippled the charity financially. Moreover, if he hasn’t flagged the risk to the trust, he may have blindsided the Trustees/Board. It doesn’t bear thinking about, does it? So, the question is this. Could it have been avoided?
In this instance, the charity had an annual spend of £232k, the FD might have theoretically budgeted for £250k, but also have advised the Trustees/Board that if rates increased significantly then he would automatically sign the contract, if and when the spend equated to £280k. This action would therefore have mitigated any further risk to the organisation and protected it from unknown costs. Should the markets have subsequently dropped, then at least the organisation would have gained price certainty for the length of the contract. The Risk charged to the budget would then have been the difference between the two i.e. £280k – £250k = £30k.
The benefit of doing so, is three-fold. Firstly, by having the risk in the budget signed-off, the FD would then have the advance authority of the Trustees or Board to act should market conditions dictate. Secondly, by publishing the risk the Board and Trustees would be aware of the amount of exposure and thirdly the call to action would have acted as a “fail-safe” for the Trustees/Board and not left them exposed as they are today.
I can only imagine that right now the FD feels sick to his stomach. My heart goes out to him. Best intentions and all that. He cannot possibly have budgeted for such huge increases, as who in all fairness could have guessed that energy rates would have gone through the roof to the extent they have? The truth is, no one. But he could’ve budgeted for the risk, and de facto got approval at budget sign-off to have a plan of action should markets get out of control as they have done.
The moral of the story is that risk can be an unknown quantity and if a charitable organisation operates with a material element of risk in its day-to-day operations, then surely the Trustees/Board should be made aware of what that potential risk could be and then mitigate for it? By doing so, they are aligning with accounting convention following the conventions of disclosure, conservatism and materiality. So, I ask again, should we include Risk as a heading within our P&L’s?
The energy market is in very choppy seas. If you are out of contract, or shortly to be so, you need to take some form of action sooner rather than later. Unfortunately, there is no pain-free solution, but we can talk you through the various options available.