How resilient is your company to future risks?

Imagine you have spent an exhausting day working in the garden, or walking the hills, chasing your children, and your aching body longs for a relaxing soak. You turn on both taps, pour in the bath salts, and nip out to find the Kindle.

But then you get distracted and caught up in another domestic drama. As the unwatched bath fills, it shifts from a future pleasure to a flood risk to an actual flood. And depending on how long the flood lasts, the greater the potential damage becomes. Once the system elements — indoor plumbing, water, bubbles, and container — hit a threshold, they transform into something destructive. Splashing across the bathroom floor, you wonder why you didn’t have a shower.

Our climate system is like an overflowing bath — both taps pumping out greenhouse gases with the plug in and overflow blocked. Turning down one tap a bit makes things less bad but still a problem. Switching off both taps stops it from getting worse and allows us to mop up a bit of the mess. But the bath is still too full, so we need to pull the plug and start draining the bath. However, we can’t let the bath run dry, as we need some warming effect or we will freeze to death, and many life forms need carbon to survive or flourish. Like many sustainability problems, climate change needs a goldilocks solution because we need to get the balance just right.

But in business, we are more likely to be incentivised to push things to the limit — squeezing in another meeting, signing up one new client, or shaving an extra 1% off a quote. And often it pays off. Yet sometimes your normal recipe for success backfires; you butcher your pitch because you weren’t properly prepared, and the credit check that should have been done before signing up the new client comes back with a big red flag.

These are examples of “it’s the last straw that breaks the camel’s back”, where a sequence of everyday actions crosses some threshold and triggers an unexpected catastrophic consequence. A routine response at the wrong time or place can trigger the dominos of doom, as one problem knocks into another, creating an unstoppable chain of events and uncovering previously unknown dependencies between parts of your business.

Knowing when and where these tipping points lie is critical for business and for sustainable development. This is of particular concern when the damage is irreversible or unintentional. For instance, when does the slow drip of legally sanctioned pollutants end up tipping a freshwater lake into a dead, toxic pool?

Accounting for resilience

Key to locating these tipping points is resilience assessment.

Resilience is best understood as the level of disturbance a system can absorb without shifting to a different configuration — or, to cite our earlier example, when the bath turns into a flood. A resilient system should continue to provide benefits to others while ensuring the stable supply of resources upon which it depends. Accounting for resilience will avoid a solution inadvertently compromising the integrity of bigger systems, in the same way inappropriate prescribing of antibiotics led to deadly new diseases.

At any point in time, each business will have to manage a unique configuration of dependencies, vulnerabilities, resource availability, positive outcomes, and negative external impacts. Accounting systems must reflect all elements of this configuration, and key to resilience accounting is the logic framework that underpins outcome-oriented accounting. This framework connects activities, resources, costs, outputs, and outcomes, mapping the relationships between what a business wants to do, what it is able to do, and how it can achieve its purpose.

Successful businesses will need to value and budget for these relationships. This may include estimating increased costs to ensure supplies of critical raw materials, providing for possible punitive damages, or implementing investment plans for new low-carbon products. Resilience accounting must meaningfully model the consequences of different decisions, including possible connected outcomes contained within future scenarios. An example is new product development evaluation in a net-zero world or a no-fossil-fuel world.

Working with these scenarios requires forward and backward chains of logics. This analysis needs to consider not only the impact on the sales and use of the product but also the likely impact on raw materials, transportation, processing, storing, distribution, and end-of-life disposal. Companies would need to consider predicted resource availability, logistical difficulties, pricing, costs, rationing, and other potential bottlenecks.

Sustainability scientists have developed a number of useful methods around thresholds, risks, and resilience, which could help inform businesses to do business better and to become more sustainable. For example, the resilience assessment workbook provides a solid comprehensive set of worksheets and tools that can be easily adapted into different business decision processes (see “Key Steps in Assessing Resilience” below).

Key steps in assessing resilience

Too often we overplay the power of the status quo. We assume what worked before will work again without considering the state of other systems. While the emissions of one heavy goods vehicle driving through a town centre is unlikely to constitute a health hazard, if it was one of ten lorries caught in a traffic jam, then it just might. Like passive smoking, any decision process or account that doesn’t fully consider the consequences will simply pass the problem somewhere else along the value chain. The risk of negative outcomes is increased when we silo decision processes or ignore the reaction of others.

Ignorance is not a clever business strategy

Imagine if your distinctive packaging were found in the stomach of a dead baby whale. How your business impacts the life of others is a major driver of business risks. If you don’t measure these impacts, how can you manage these risks?

Accounting needs to play a part in predicting future outcomes in order to avoid overstepping these boundaries of acceptable behaviour. This requires knowing where these limits are and how they affect business prospects. A sustainable business is one that works within the limits of resilient natural systems and contemporary social values. Accounting needs to respect these limits. This will require integrating social and environmental impacts into risk registers, monthly KPIs, quarterly scorecards, annual reports, and long-term strategic plans.

Budgets and targets will need to integrate new limiting factors such as greenhouse gas emissions or plastic waste. Businesses will need to be able to quickly and accurately respond to legitimate requests for information on their environmental impacts or face a possible consumer backlash.

Maintaining ignorance is not a clever business strategy. A business should be the expert on its business, and accountants are essential to producing and communicating that knowledge. Accountants need to master the key principles of resilience assessment and work with others to fully understand the connections between business and the rest of the world in order to measure and value those things that are essential for business success.

— Ian Thomson, ACMA, CGMA, is professor of accounting and sustainability and director of the Lloyds Banking Group Centre for Responsible Business at the University of Birmingham in the UK. To comment on this article or to suggest an idea for another article, contact Alexis See Tho, an FM magazine associate editor, at Alexis.SeeTho@aicpa-cima.com.