Risk and reward
Effective risk management involves making strategic decisions at all levels of an organization to reduce the likelihood and impact of threats while enhancing the chances of seizing opportunities.
Setting realistic objectives is the foundation of any successful change initiative. To enhance the effectiveness of the indirect tax function, it’s essential to establish SMART objectives. For example, we can ask:
Is achieving full VAT compliance a realistic goal?
The ability to define, predict, and manage risks while creating strategic insights is crucial for driving operational excellence. This means identifying high-return initiatives, allocating resources efficiently, and measuring the ultimate return on investment (ROI).
Effectiveness is determined by how well an organization meets its objectives. For the tax function, effectiveness is achieved when all risks are appropriately managed and opportunities are recognized and acted upon. Efficiency, on the other hand, refers to the optimal use of time, effort, or costs in reaching these objectives.
Given that indirect tax resources are often limited, it is vital to utilize time effectively and efficiently. Mismanagement of all risks incurs unnecessary costs and negatively impacts efficiency beyond just indirect tax (e.g., by consuming time within the finance department for VAT-related issues). It ultimately comes down to making the right choices.
To allocate resources effectively in risk and cost-saving areas, it is essential to establish the company's risk appetite. This clarity allows for proper prioritization in resource deployment. When acceptable levels of risk are defined, resources can be focused on significant risks rather than further mitigating risks that are already within an acceptable range. It’s about striking the right balance between taking appropriate risks.
Resource allocation and budgeting should align with the outcomes of risk assessments, emphasizing high-risk areas. The efficiency and effectiveness of the indirect tax function should be periodically evaluated against financial and operational KPIs. These evaluations are discussed in review meetings, where corrective actions can be identified when necessary.
In practice, metrics are often employed to demonstrate the perceived level of control. The well-known 80-20 rule is one example, as is the claim that "95% of our transactions are compliant." However, these figures can create misconceptions at the senior management level, leading to the false impression that the company is fully in control.
Consider the potential impact of such error rates on "Earnings Before Interest, Taxes, Depreciation, and Amortization" (EBITDA) through the VAT throughput calculation.
What does the statement, "Addressing master data can contribute to achieving over 80% VAT compliance for invoices," convey about risk management?
If 80% of these invoices fall within a low-risk category while 20% surpass the company's acceptable risk threshold, the strategy may facilitate efficient employee deployment but fail to meet the overall risk management objectives.
It is critical to note that this example assumes the 20% is classified as high risk. In practice, this classification should be thoroughly investigated and measured to be truly effective from a management perspective.
Increase workforce efficiency, avoid rework, decrease 'material' risk exposures, realize savings, increased visibility and awareness by which the tax function can set the right priorities.
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Structuring the Tax Function
For large companies, the challenge often lies not in the availability of skills but in the focus and capacity of skilled team members, as well as their access to the necessary information for effective planning.
Frequently, tax functions find themselves preoccupied with compliance and reporting tasks, as well as gathering and revising the information required for planning and forecasting. To succeed, the indirect tax department must have an adequate number of personnel with the appropriate skills and capabilities. To fulfill the mission statement outlined in the title of this section, it is essential to evaluate the following factors to determine whether the established objectives can be achieved.
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