Why governance for SMEs?


When Joe or Alice opened a corner shop in the neighborhood they never thought of governance frameworks and policies. They knew they had to sell stuff at a price exceeding cost and make a living out of what is called profit.  They may have 

not known standard costing or absorption of fixed overheads nor understood variable cost, etc. They could have continued this way without any borrowings from financial institutions and being below the tax bracket. They may not need more employees and didn’t have the need to segregate duties to safeguard assets, etc. 

If Joe wants to scale up and become an SME or become even bigger he has to invest more, expand beyond a one man show and put processes to sustain long term success. Therefore, impact of other stakeholders like financiers, employees, society, government, etc will start to increase. If the corner shop becomes a medium sized company then, external directors and internal control processes and many other structures will be required. Good corporate governance will make it easy to bring in outside expertise, attract funding, and ensure long-term sustainability.  There are many researches and organizations like the OECD and IFC supporting this view. 

Joe’s corner shop nor any other business does not exist in a static state. All businesses are constantly evolving due to volatility and uncertainty in the business world. This requires the role of the owner or the board also to evolve over time. As the corner shop evolves into a SME and matures, there will be a greater need to bring in outside directors. Those external board members may initially be most valued for their complementary skills. Such external director’s role will be useful to improve governance practices and to manage future related party transactions and potential conflicts of interests. 

However there are many obstacles to implementing good governance measures in SMEs. These may include:

  • a lack of understanding of board room dynamics and roles
  • a lack of understanding of how independent non executive directors (NEDs) are supposed to work
  • difficulty in finding high-quality NEDs who are independent.
  • a distrust about the positive results of raising corporate governance standards in the business
  • failure to see the urgency of improving governance when compared with other pressing business issues, such as managing cash flow
  • a concern about the additional costs.

There are many challenges to understanding the role that corporate governance can play in helping SMEs to  grow. The biggest challenge is to make the owners of SMEs to take the time to understand what corporate governance means and how improving it could benefit the business. Another challenge is the belief that, in an economy characterised by widespread corruption or weak enforcement of laws and regulations, implementing corporate governance standards will lead to frustration and have limited impact.

Posted in Governance | Tagged | Leave a comment

Governance & Journalism in good Ole Lanka!


In contrast to Donald Trump’s war cry about “fake news”, a humble Barack Obama emphasized in one of his speeches to the African leaders that “good governance means everybody has a voice, that government is transparent and, thereby, accountable. And even though leaders don’t always like it, the media plays a crucial role in assuring people that they have the proper information to evaluate the policies that their leaders are pursuing.”

Unfortunately for us in Sri Lanka we’ve got camps of journalists, many of them not being a critical art of civil society respecting the right of the people to receive unbiased news. They’re in the business of cashing in sensational news. While Governments have respect the right of journalists to practice their trade as a critical part of civil society and a critical part of any democratic norm, journalists and news corporates need to reciprocate. 

Obama draws a connection between good governance and economic development. He said that “More and more countries are recognizing that in the absence of good governance, in the absence of accountability and transparency, that’s not only going to have an effect domestically on the legitimacy of a government, it’s going to have an effect on economic development and growth.” Unfortunate again for us in Sri Lanka only a minority of local leaders realize this aspect. Fraudsters think we don’t need ethical funding from IMF or any multilateral agency but can continue to borrow from China and enjoy life infinitely! The opponents of good governance know that economic independence of people will reduce the power and dependence on politicians, who act like demigods.

The US approach under Obama was stated as follows to the African leaders and it applied to our progress in the last few years. He said  “We will work with countries even though they’re not perfect on every issue. And we find that in some cases engaging a country that generally is a good partner but is not performing optimally when it comes to all of the various categories of human rights, that we can be effective by working with them on certain areas, and criticizing them and trying to elicit improvements in other areas.” Unfortunate for us again, our politicians want to put to test this statement and they may not face a challenge as the president of the US today is Trump. 

How does a third world country get out of this trap of geo politics, bad governance, selfish politicians & journalism and an ineffective civil society? Revolutions, terrorism and other unrest is not the answer. In developed countries politicians are treated as normal beings and held accountable. In undeveloped or developing countries politicians have created an aura of godlike image. What we need to do is;

Stop funding corrupt politicians, 

Stop asking for illegal/unethical favors from politicians, 

Sensible & fearless journalism

Corporates learn to compete on a level playing field

Stop worshipping politicians, 

Treat politicos like normal people who are elected to serve us and not like gods, to save us from this Unfortunate situation.

Posted in Governance | Tagged | Leave a comment

Audit Committee role in IT Governance


With increased automation of operations in companies, internet connectivity and reliance on IT the associated risks have also increased many folds. Questions have been raised regarding the role of the audit committee in monitoring increased IT risks. The audit committee seems to be in the best position to have oversight responsibility to monitor IT risks.  In many governance structures the board of directors is responsible for the strategic direction and decisions regarding IT. However, in the absence of a specific risk management or a similar committee, the audit committee should be responsible for the oversight of IT operations and risks. 

Oversight means to oversee someone or an activity. Oversee means for somebody/something to watch somebody/something and make sure that a job or an activity is done correctly.  Such definitions are sometimes confusing in the context of holding an audit committee responsible to oversee IT Governance. An audit committee has to achieve this purpose while performing an non executive function.

Simply put, the Audit Committee should ensure that Management is performing ongoing assessments of all IT risks and be satisfied that these risks are adequately addressed. The CFO and CIO along with the Internal Auditor should be held responsible to provide assurance regarding design & implementation of controls to mitigate all IT risks. 

How can the Audit Committee perform an ‘oversight’ role? 

  1. Define its scope within the Audit Committee charter
  2. Set in place a corporate culture that’s followed by IT staff who are trained to acknowledge what could go wrong, able to recruit control conscious people and encourage sharing as well as open and honest communication. 
  3. Ensure a proper framework like COBIT is used by the CIO and receive a comprehensive plan from the CIO comprising an assessment of the IT function, potential risks and  IT controls in place. ( COBIT -Control Objectives for Information and Related Technologies is a good-practice framework created by international professional association ISACA for information technology management and IT governance. )
  4. Use internal audit to support oversight. Internal audit should be equipped with IT knowledge and that should be used to assess effectiveness of IT controls and how they mitigate all key risks. 
  5. The Audit Committee may obtain an understanding of the extent of the IT-related testing and evaluation performed by external audit to get comfort on the IT risks affecting the financial reporting process.
  6. The audit committee may also use an independent external expert to critically review the IT risk assessment and the designated controls to ensure they’re sufficiently comprehensive and appropriate to provide the necessary assurance, based on good industry standards.

The audit committee should use all three i.e, the CIO, Internal Audit and External Audit to obtain assurance that IT is being managed and that IT risks are being mitigated properly. 

Posted in Governance | Tagged , | Leave a comment

Govern Artificial Intelligence or face Destruction


After reading the title, many well read corporate leaders and IT pundits must be wondering what’s wrong with me or thinking if I also need AI, which may have been useful considering the state of our political situation! Considering our local politicians’ ability to be happy and have eternal power without Any Intelligence (also “AI”) and without ethical values makes the book Homo Deus look like something of the past and not the future.  

In the book: “Homo Deus: A Brief History of Tomorrow” written by Israeli author Yuval Noah Harari, professor at the Hebrew University in Jerusalem, he speculates about the human ambition for happiness and power based on evidence from the past and present. Harari believes that humanism may push humans to search for immortality, happiness, and power and the inheritors of the present human race will be godlike.

My counter argument is if humans want to continue to be the dominant being, why would they invest so much in creating robots or super humans with AI who can potentially destroy their creators. Yeah, sounds like the story line in Terminator, Transformers, iRobot, the Avengers Age of Ultron or even the Matrix. Why not put that investment in cancer research, HIV control, improve life expectancy or even into ensuring food security of the human race? 

Technological developments have threatened the continued ability of humans to give meaning to their lives. Harari suggests the possilibity of the replacement of humankind with a Superman  or “homo deus” (human god) endowed with abilities such as eternal life. Therefore, if big data, algorithms and robotic processes are to dominate the human race in the future, whats the point in living. May sound like slavery in the past centuries. 

Considering the seriousness of the analysis in the book, Harari‘s himself closes with the following question addressed to the reader:”What will happen to society, politics and daily life when non-conscious but highly intelligent algorithms know us better than we know ourselves?”

Needless for me to present the enormous benefits of AI as we hear them on a daily basis. But we should remember the words of Max Tegmark, President of the Future of Life Institute; “Everything we love about civilization is a product of intelligence, so amplifying our human intelligence with artificial intelligence has the potential of helping civilization flourish like never before – as long as we manage to keep the technology beneficial.“

Posted in Governance | Tagged | Leave a comment

Boards should understand impact of IFRS on Debt covenants


What are Boards, CFOs and CEOs doing about potentially breaching bank covenants for debt and equity with the advent of new accounting standards? Many companies may inadvertently breach debt covenants because they’re not prepared for the changes coming through with new IFRSs. CFOs should be advising their boards to seek amendments to existing bank agreements to address implications of issues arising from the adoption of IFRSs. 

Boards need to realize that a breach of covenants will require reclassification of long term debts. CFOs who are facing refinancing of loans should be cognizant of the impact of new IFRS changes on covenant calculations when renegotiating covenants. Some of he key ratios affected include; earnings before interest, taxes, depreciation, and amortization (EBITDA), leverage ratios and fixed charge covenants. Some key drivers of change in critical ratios may include the following changes:

Financial instruments’ expected credit loss (ECL) model:

ECL estimates are likely to be material to many bank financial statements, reducing their equity. ECL estimation is complex and inherently judgemental. It is dependent on data about forward-looking estimates of key macro economic factors and other management’s assumptions. Non banking institutions also may see an impact of ECL provisions. These will affect earnings and equity in many industries though the most significantly affected will be the banks/finance industry. 

Revenue recognition:

IFRS 15 necessitates an evaluation of customer contracts to ensure that revenue is recognized when performance obligations are satisfied. Some revenues recognized over a period may become point in time contracts. This change will alter the timing of earnings and EBITDA in particular industries.

Lease accounting: 

The new lease accounting standard will result in some of the following changes:

– Operating lease being recorded on the balance sheet

– Lease rental expense will be replaced with depreciation/amortization and interest expense, impacting EBITDA

– As interest expense under the effective interest method plus depreciation will be higher in early years, compared to the current straight-line recognition of rental expense under an operating lease, profits will reduce in the early years. 

The increase in liability discounted using effective interest method whereas the related asset will be depreciated on straight line along with the impact on EBITDA needs to be considered when determining covenants. 

Insurance contracts:

Though this standard is applicable in 2021, the significant change made to accounting specifically for life insurance contracts will change the outlook of balance sheets and P&L of Insurance companies. Boards still don’t understand how to react to these changes. 

Boards and CFOs should have already considered the impact of the above accounting rules and negotiated amended bank agreements. CFOs may have convinced their lenders to calculate covenants using the GAAP rules in effect when the loan agreement was signed. Otherwise, it’s time to negotiate some flexibility to those loan agreements to manage the impact of these changes on the company’s compliance with its debt covenants. 

Posted in Governance | Tagged | Leave a comment

Politics and Trust a comical oxymoron.


In corporates and with politicians, politics and trust has the same opposite impact. People who are involved in organizational politics don’t acknowledge the oxymoronic~ self contradictory effect of the words. They play politics using trust placed on them and then want to be trusted! 

Desperation does seem to make strange bedfellows in politics. But it’s hard to trust when all you have from the past is evidence of why you shouldn’t be trusted. No one can associate the word trust with politicians. Many politicians think they can buy trust for money. Very few realize that ~ breaking someone’s trust is like crumpling up a piece of paper. Crooks think you can smoothen the paper or iron it over, not realizing it’s never going to be the same again. 

Therefore relying on someone who broke the trust placed cannot be expected to be trustworthy in a different situation. Trust is not situational. For example if a new recruit is willing to share confidential information from his/her previous employment, you can expect them to do the same thing and break your trust too. Many recruiters and managers fail to acknowledge that trust doesn’t come with a refill. Once it’s lost it cannot be refilled to make the person trustworthy again. 

Criminals and terrorists don’t break the  trust code. Because they realize that if they start selling each other everybody loses at the end. But politicians have survived by selling each other and so do managers in companies. May be because they’re in a position of authority and thieves and terrorists are fighting authorities? 

“To be contented human beings we need trust and friendship, which tends to develop much better once we realise that all beings have a right to happiness, just as we do.”~ Dalai Lama

Posted in Governance | Tagged | Leave a comment

Five tenets of good corporate governance


The corporate governance debate has come some way over the last decades, yet many still see it as a compliance exercise. Businesses need to realize the importance of a motivated and engaged workforce and positive relationship with their environment for long term prosperity. It’s time to shift the governance focus to outcomes from the processes and procedures from the current emphasis on compliance. ACCA’s publication on the ‘Five tenets of good corporate governance’ helps in shifting this debate to outcomes.

Society determines, in the long run, which businesses thrive, and how. ACCA, the global body of professional accountants, has a stake in this as the profession mediates between undigested data and the useful information on which society and businesses, equally, rely.

Five themes that are recurring in the corporate governance debate:
1. The relationship between companies and society -Aligning the vision of a company with that of society will help that company to prosper in the long term. Aiming to be part and fulfilling the needs of a society will help a company to navigate its challenges and uncertainties and create value from opportunities.
2. Diversity and balance- Diversity and balance in the composition of the workforce are important at all levels of the organisation. They are vital within leadership.
3. Enabling an effective board- Every board member should be accountable for enabling effective boardroom discussion, with the chair playing a critical role.
4. Executive remuneration- Any approach to the challenges related to executive remuneration must consider two discrete issues that underlie the pay debate. One of the issues is the mismatch between pay and performance. Executive pay has risen steadily over years, generally surpassing the rate of inaction where many employees have seen stagnant or failing wages in real terms. The second issue is the increasing sense of inequality. The general public observes a widening gap between the pay of executives and average employees.
5. Gatekeepers of corporate governance- The ‘gatekeeping’ of corporate governance involves more than just companies and their owners: the wider public and policymakers also play a role.

These themes, both individually and taken together, demonstrate that the long-term prosperity of society relies on businesses and vice versa. The tenets look at each in turn and set out ACCAs current thinking to help readers navigate the complex yet dynamic issues involved.

A recent trend in company law and corporate governance codes is to include the concept of a ‘ESG’ environment, society & governance as a license to operate a business. Indirectly implying that a company operating at odds with its environment & society would be rejected and ultimately fail. However, this has not always been the case in practice and many corporates continue to remain unpunished despite unsustainable activities.

Therefore, it is important that the public engages with the topic to maintain trust in business: it should help highlighting the better practice that some companies already strive to achieve and inspire the rest to meet the same standard.

Source: www. accaglobal.com

Posted in Governance | Tagged , | Leave a comment