When it comes to setting financial reserves for your organization’s legacy environmental liabilities, uncertainty is the name of the game. Reserve too much, and you limit cash flow and risk stunting investment and growth in other business areas. Reserve too little, and you open yourself up to financial and reputational hardships if and/or when uncertainties become realities.
But what if I told you there was an opportunity to be more certain about uncertainty?
Too often, organizations lack a consistent approach to estimating environmental liability reserves, allowing uncertainty to run wild, stifling auditing efficiency, and inhibiting short- and long-term decision-making.
But developing an effective, consistent strategy for setting environmental liability reserves can be done to enhance certainty—and the business value can be proved up the internal value chain.
We’ve helped companies across the industry spectrum customize an approach to reserve setting. From our perspective, three core, strategic components need to be addressed if you want to develop an approach that maximizes business value creation—which we affectionately call “The Three Ps.”
1. Establishing Your Philosophy
Every organization’s risk tolerance is unique and nuanced. That’s precisely why developing a tailored approach to reserve setting is crucial—and it all starts by asking yourself one critical question:
How far do I want to go in assigning dollars to uncertainty?
Your answer to this question forms the philosophical foundation of your approach to reserve setting, serving as your guiding light to each of the subsequent steps. Essentially, your philosophy is your policy for how and under what circumstances you’ll reserve.
For example, if your company is typically more conservative and risk-averse, you may choose to reserve for ambiguous, highly improbable, or extreme uncertainties. If your company has a higher risk tolerance, you may decide you’ll only reserve for events with higher degrees of certainty.
But the thing to remember at this stage is that the reserve does not equal the liability, rather it’s a subset. This means effective cost modeling—where you use a cost and liability estimation hierarchy to assign numbers to hard-to-quantify business drivers—is an absolute must. Why?
For your internal stakeholders, this helps you confidently make the case for why and how you reserved for liabilities—and potentially helps you unearth savings that free up cash flow. As for the external, third-party auditors that regularly visit, you can show your reserves are data-backed and each has been scrutinized in the same way.
2. Developing Your Program Framework
Once you’ve defined your reserve setting philosophy, you need to establish a program framework to clearly outline:
- The stakeholders who can, will, or need to contribute to the process.
- The personnel and hardware and software tools you’ll need to execute.
- The frequency with which you’ll revisit existing liabilities and review new liabilities that come into the company fold.
Internally, this framework coupled with your philosophy ensure your reserve evaluation and setting needs and activities are accounted for. Externally, auditors can see you’ve put a thoughtful framework in place that ensures liabilities are consistently evaluated.
3. Defining Your Process Workflow
The process component brings your philosophy and program framework to life, establishing a detailed workflow for “who does what and when.” It also establishes a waterfall process for triggering events such as new acquisitions, operation shutdowns, or divestitures.
For your internal team and stakeholders, this is the nitty gritty that details how you’re going to accomplish reserve setting. For auditors, this piece provides a deeper look into your reserve setting practices, showing you’ve done your due diligence to meet federal requirements and protect your business interests.
Guard Against Liabilities. Unleash Cash Flow. Bolster Your Business.
Without a consistent approach to estimating and reserving for environmental remediation liabilities, you’re leaving business opportunity and value on the table—and opening yourself up auditing risk.
By nailing down how and under what circumstances you’ll reserve, you’ll be able to develop a program framework and process workflow that reasonably forecasts liabilities, frees up cash on your balance sheets, and streamlines the auditing process.
If you don’t have the expertise or in-house resources to redesign your reserve setting process, we’re here for you. We have specialized experience in environmental cost modeling, decision analysis, and stakeholder communication to help you evaluate and quantify risks, enhance the decision-making process, and put reserve dollars to liabilities.
