Page 514 - COSO Guidance

4 | Developing Key Risk Indicators to Strengthen Enterprise Risk Management | Thought Leadership in ERM

As an illustration, let’s assume that management is concerned But, only monitoring KRIs tied to intermediate events allows
about the risk that the organization may breach covenants less time for management to proactively manage the
associated with its outstanding debt. In this example, a emerging risk event than would be the case if management
covenant breach would represent the risk event that is of had access to KRIs related to earlier root cause events
concern. In developing effective KRIs to help management that often precede intermediate events. In this example,
monitor the risk of default, they may look backwards to external data, such as customer industry reports and
identify potential intermediate events that may arise before economic indicators, combined with internal data, such as
the organization reaches the point of a covenant breach. input pricing trends, labor issues, plant capacity, key staff
For example, an intermediate event preceding a possible turnover, among other KRIs may provide useful leading
covenant breach might involve decreases in sales in recent indicators of conditions that may likely initiate events, such
months (i.e., covenants based on net income or interest as future drops in sales or future cash shortages that will
coverage). Additionally, shortages of cash or increases in the lead to an intermediate event and ultimately to the actual
need for short-term borrowings or draws under existing risk event of covenant default. In addition, these key risk
lines-of-credit may provide early warning signs that a indicators may highlight potential opportunities to increase
covenant breach may be looming in the near term. Key risk sales or improve operations that management may wish to
indicators that help monitor these intermediate events put capture.
management in a better position to implement potential
mitigation strategies, such as earlier discussions with key The following figure illustrates the linkage of KRIs to both
lenders before an actual covenant breach has occurred. root cause events and intermediate events.

KRIs to Inform About Risk of Debt Covenant Default
Example
KRIs to Inform About Risk of Debt Covenant Default

Potential
Risk

Risk Event
Debt covenant breach
Intermediate Event
Leading KRIs might include sales trends, cash on hand,
changes in short-term borrowings, etc.
Root Cause Event
Leading KRIs might include customer financial reports, industry reports,
economic conditions, pricing trends, labor issues, plant capacity, etc.

KRIs provide Opportunities for proactive Strategic Risk Management

A well-designed ERM system provides information that allows stakeholders. As illustrated by the figure on the next page,
management to understand whether key strategic objectives management selects initial strategies at a point in time. As
are being met and to identify opportunities to adjust strategies time goes by, the range of uncertainty begins to increase,
and tactics to take advantage of shifts in the environment that threatening the successful execution of those strategies.
might be exploited for the benefit of the organization and its

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