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  • Antoine Fonfreyde

How can you factor climate risk into your cash flow?

Climate change is no longer a distant hypothesis, but a reality that is already affecting businesses. Faced with extreme weather events, rising raw material and energy costs, changing regulations, and changing customer expectations, entrepreneurs need to integrate climate risk into their cash flow management. How can they do this? What tools and best practices should you adopt? Here are a few tips to help you.

Climate risk is defined as all the negative consequences of climate change on economic and financial activity. It can be broken down into two categories: physical risk, linked to material and human damage caused by climatic hazards (droughts, floods, heatwaves, fires, etc.), and transition risk, linked to the need for companies to adapt to new environmental standards and changes in markets and behaviour (carbon taxes, technological innovations, green demand, etc.).

These risks can have a direct or indirect impact on companies' cash flow, affecting their sales, production costs, investments, financing, and reputation. According to the AMRAE (“Association for Enterprise Risk and Insurance Management") 2022 barometer, 88% of companies surveyed say they are exposed to the risks of heatwaves, 74% to droughts, and 88% to rising temperatures. Furthermore, 90% of the risk managers surveyed identified the rising cost of raw materials and energy as a risk that would have an impact on their business.

Faced with these challenges, entrepreneurs need to anticipate and manage climate risk in their cash flow, in order to safeguard their profitability and long-term survival. But how do they go about it? What are the tools and best practices to adopt? Here are a few suggestions.

Identifying and assessing climate risk

The first step is to identify and assess the climate risk to which the company is exposed, taking into account its sector of activity, geographical location, value chain, customers, and suppliers. This involves analysing possible climate change scenarios and their potential impact on the company's cash flow, in terms of both probability and severity.

There are several tools available for this purpose:

  • IPCC (Intergovernmental Panel on Climate Change) reports, which provide scientific information on the causes, consequences, and solutions of climate change.

  • The scenarios of the TCFD (Task Force on Climate-related Financial Disclosures), which propose four prospective scenarios based on different levels of greenhouse gas emissions and climate policies.

  • Climate risk assessment tools developed by public or private bodies, such as Carbone 4 (Carbon Risk Assessment for Sovereigns), Acclimatise (Physical Climate Risk Application), or Atradius (Climate Change Risk Assessment Tool).

These tools provide a global view of the climate risk faced by a company, and can also be broken down by activity, geographical area, product, or customer. They help to identify sources of vulnerability and opportunities for resilience.

Adapting your strategy and cash flow plan

Once the climate risk has been identified and assessed, the company must adapt its strategy and cash flow plan accordingly. This means setting targets for reducing greenhouse gas emissions, controlling energy costs, optimising resources, and promoting green innovation. It also involves forecasting the financing needs and sources associated with these objectives, taking into account regulatory changes, investor requirements, and market opportunities.

There are several possible levers for action:

  • Reducing the company's carbon footprint, by improving energy efficiency, using renewable energies, limiting travel, or offsetting residual emissions.

  • Physical risk management, by strengthening infrastructure security, taking out appropriate insurance, diversifying supply sources, and implementing business continuity plans.

  • The transition to a low-carbon economy, by developing environmentally-friendly products and services, meeting the expectations of green customers, seizing the growth opportunities offered by new technologies, and accessing green sources of funding.

These levers for action must be incorporated into the company's cash flow plan, which must be updated regularly to reflect changes in the climate. The cash flow plan must therefore reflect the impact of climate risk on forecast cash flows, as well as on short- and long-term financing needs and sources.

Communicating climate performance

The final stage involves communicating climate performance to internal and external stakeholders. This involves reporting on the actions taken by the company to integrate climate risk into its cash flow, as well as the results achieved in terms of greenhouse gas emissions, energy savings, green innovation, and resilience in the face of climatic hazards.

There are several reference frameworks:

  • The recommendations of the TCFD (Task Force on Climate-related Financial Disclosures), which propose a harmonised framework for financial communication on climate risk, based on four pillars: governance, strategy, risk management, and indicators.

  • International non-financial reporting standards, such as the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB), which provide guidelines for communication on the environmental, social, and governance (ESG) aspects of a company.

  • Environmental labels and certifications, such as the low-carbon label, the ISO 14001 standard, or the B Corp label, which attest to a company's compliance with demanding environmental criteria.

These reference frameworks enable the company to promote its climate performance to its internal stakeholders (management, employees, etc.) and external stakeholders (customers, suppliers, investors, etc.). In this way, they help to strengthen the company's credibility, reputation, and competitiveness in the marketplace.

Climate risk is a major challenge for companies, which need to integrate it into their cash management. To do this, they need to identify and assess this risk, adapt their strategy and cash flow plan accordingly, and communicate on their climate performance. By doing so, they can not only reduce their vulnerability to climate hazards, but also seize the opportunities offered by the ecological transition.

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