Explore this subject further: How are climate scenarios useful?; Five steps to a confident start on climate reporting.
Every business depends on conditions it does not fully control. A manufacturer needs reliable energy and materials. A distributor depends on accessible roads, warehouses and customer demand. A service business depends on its people, technology and the continuity of its customers' operations.
Climate change can alter these conditions through physical events and longer-term shifts in technology, markets and policy. The financial consequences depend on how the business earns revenue, incurs costs, uses assets and finances its activities.
For CEOs, CFOs and risk leaders, the important question is not simply which climate risks exist. It is which changes could affect enterprise value, how significant those effects might be, and which management decisions can influence the outcome.
Climate analysis helps management investigate those changes. AASB S2 uses two broad risk categories:
- Physical risks arise from changing climate conditions and events.
- Transition risks arise as policy, technology, markets and expectations change in the move towards a lower carbon economy.
Both can affect operations, suppliers and customers, with consequences for financial performance, assets and cash flow.
Start with what creates value
A climate hazard or market change does not have the same consequences for every company. Its significance depends on the business model and the value drivers it affects.
Management can begin with four questions:
- What creates value? Which products, customers, assets, capabilities and relationships sustain revenue, margins and future growth?
- What could change? Which physical or transition developments could affect those value drivers, directly or through suppliers and customers?
- What are the financial pathways? Could the change affect sales, operating costs, capital expenditure, asset values, working capital or financing?
- What can management influence? Which responses might protect existing value or create a new advantage, and what would they cost?
These questions help distinguish a climate issue that warrants monitoring from one that requires further investigation, financial analysis or a management decision.
Physical risks affect the conditions in which you operate
Physical risks are commonly classified as
- acute risks associated with events such as storms and floods, or
- chronic risks associated with longer term shifts such as rising average temperatures and sea levels. The effect on a company depends on its exposure, vulnerability and capacity to respond.
The following hypothetical examples illustrate relationships to investigate in your own business; they do not predict the financial consequences for any particular company.
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| Category and risk example | Possible business impact | Possible financial consequences | Response and related opportunity |
|---|---|---|---|
| Acute - flood affects a distribution centre | Stock damage, interrupted deliveries and customers switching suppliers. | Lost sales, inventory write offs, repair expenses and additional freight costs. | Compare site protection, alternative locations and distribution capacity. Reliable service during disruption could help retain or attract customers. |
| Acute - severe heatwave affects outdoor work | Reduced safe working hours, lower productivity and delayed projects. | Higher labour costs per unit, delayed revenue and potential contract penalties. | Review scheduling, work methods and equipment. Solutions that maintain safe productivity may also become products or services for customers facing similar conditions. |
| Chronic - rising temperatures increase cooling demand | Equipment operates less efficiently and premises require more cooling. | Higher energy and maintenance expenses, with additional capital expenditure. | Coordinate efficiency upgrades with asset replacement. Test whether lower running costs justify investment and whether improved conditions support reliable output. |
| Chronic - sustained changes in rainfall reduce water availability | Production constraints, input shortages or changes in product quality. | Lower revenue, higher water and input costs, and possible asset impairment. | Evaluate water efficiency, reuse and alternative supply. Water saving capability may support growth or become part of a differentiated offer. |
An insured loss may cover part of the damage while leaving the company exposed to deductibles, delays, customer losses or higher renewal costs. Assess the costs and recovery assumptions that apply to the particular business.
Illustration: What could a flood interruption cost Junction Freight Services?
Junction Freight Services
This fictional Australian freight and warehousing business earns its revenue from moving and storing goods. Its enterprise value depends on reliable deliveries, warehouse utilisation, customer retention and the margins it earns from moving and storing goods. Imagine that flooding interrupts access to one of its distribution centres for four working days. Stock is largely undamaged, but vehicles cannot enter the site and some customers need alternative arrangements.
The leadership team begins with an illustrative estimate of the financial consequences.
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| Assumption | Illustrative amount |
|---|---|
| Revenue normally serviced through the affected site | $120,000 per working day |
| Days of disruption | 4 |
| Revenue affected during disruption | $480,000 |
| Proportion of affected revenue recovered through delayed deliveries or alternative arrangements | 50% |
| Revenue not recovered | $240,000 |
| Contribution margin on unrecovered revenue | 30% |
| Lost contribution | $72,000 |
| Additional freight and temporary operating costs | $55,000 |
| Clean-up, inspection and minor repairs | $20,000 |
| Illustrative adverse operating earnings effect | $147,000 |
The $480,000 of affected revenue is not the financial loss. Some work is recovered, and costs associated with sales that do not occur may be avoided. Using the assumed contribution margin, the estimated lost contribution is $72,000. Adding $75,000 of incremental costs produces an illustrative adverse operating earnings effect of $147,000.
This is not a forecast or a complete financial assessment. It assumes the additional costs are not already included in the contribution margin calculation and excludes insurance recoveries, customer penalties, tax effects, longer-term customer losses and any material asset impairment.
The management discussion
- Operations: Which deliveries can be redirected, and how much additional capacity is available?
- Finance: Which losses represent reduced contribution, additional expenditure or delayed cash receipts? What might insurance recover?
- Risk: How exposed are the site and access routes, and what operating history and analysis support the assumed disruption period?
- Executive management: Would alternative capacity, site protection or network redesign justify the investment?
The team might compare three responses: maintain current arrangements with stronger recovery procedures; invest in protecting the existing site and access; or establish alternative distribution capacity.
Each response has different costs, dependencies and potential benefits. Before choosing, management needs information about the likelihood and duration of disruption, recovery capability, customer behaviour and the cost of each response.
The value of the exercise is not the apparent precision of $147,000. It is that the leadership team can see which assumptions drive the result, what information is missing and which decisions deserve further analysis.
All figures are fictional and illustrative. They describe one hypothetical disruption, not an annual expected loss, scenario projection or valuation of Junction Freight Services.
Transition risks affect the economics of doing business
The established Taskforce for Climate related Financial Disclosures (TCFD) categories are policy and legal, technology, market and reputation. They help leaders identify different sources of change and connect them to financial consequences.
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| Category and risk example | Possible business impact | Possible financial consequences | Response and related opportunity |
|---|---|---|---|
| Policy and legal - tighter emissions requirements or carbon costs | Higher compliance costs or a need to change production. Unsupported environmental claims may also expose the company to disputes or enforcement. | Higher operating expenses, legal costs and capital requirements. | Compare production options and substantiate claims. Lower emissions capability may help meet purchasing requirements or improve cost competitiveness. |
| Technology - a lower emissions substitute becomes commercially competitive | Existing equipment or products lose competitiveness before their planned retirement. | Reduced margins, stranded development expenditure, shorter asset lives or impairment. | Test upgrade, partnership and replacement options. New technology may support a better product, lower operating costs or a new service model. |
| Market - customers change specifications or suppliers change prices | Demand shifts between products, while energy and material costs change. | Revenue changes, margin pressure and additional working capital needs. | Validate customer demand and adapt the offer. Resource efficiency, alternative materials or circular business models may improve the commercial proposition. |
| Reputation - stakeholders challenge a company’s claims or conduct | Loss of trust affects purchasing, recruitment or relationships. | Lost sales, additional recruitment costs and expenditure to address concerns. | Align statements with evidence and delivery. Demonstrable product performance and credible communication may strengthen customer relationships. |
These are possible pathways. A risk category does not establish a financial impact. A customer’s stated preference needs to be tested against purchasing behaviour before you assume it will change revenue.
Use the analysis within enterprise risk management
Frameworks such as ISO 31000 and COSO ERM are established processes for assessing uncertainty, setting responsibilities and monitoring responses. Climate analysis can inform strategic, operational, financial and compliance risks already managed through those processes and introduce new risks or increase likelihood and impact assessments.
AASB S2 requires reporting entities to disclose how climate risk processes are integrated into overall risk management. APRA’s CPG 229 addresses integration for APRA regulated institutions, while also identifying liability risk explicitly.
In the register, describe the cause, event and consequence clearly. Junction Freight might record:
This gives Operations, Finance and Risk a shared starting point. Operations can test disruption and recovery assumptions; Finance can identify the relevant financial effects; and Risk can assess exposure, existing controls and residual risk.
The register should distinguish observed business experience from hypothetical estimates and future projections. A plausible financial pathway is a reason to investigate, not proof that the impact will occur.
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| Register field | What to capture |
|---|---|
| Risk and affected objective | Describe the cause, event and consequence. Identify the value driver, asset, operation or customer commitment affected. |
| Classification and connections | Record the physical or transition category and link it to existing enterprise risks, including supply chain and infrastructure dependencies. |
| Sources, observations and assumptions | Identify sources, past events, observed effects and gaps. Separate company experience from projections and estimates. |
| Assessment | Record likelihood and consequence using the company’s criteria. Where relevant, show how the assessment changes by scenario and time horizon. |
| Controls and ownership | Identify existing controls, records of control effectiveness, the accountable owner and residual exposure. |
| Financial implications | Identify affected revenue, costs, assets, liabilities and cash flows. Include ranges and uncertainty where appropriate. |
| Responses and monitoring | Record proposed actions, costs, responsibilities, dependencies, indicators and review triggers. Link opportunities to the relevant business case. |
Check for overlap when aggregating impacts. The same disrupted sale may appear in a site, supply chain and customer risk assessment.
Connect risk responses with value creation
The Taskforce for Climate related Financial Disclosures opportunity categories cover resource efficiency, energy sources, products and services, markets and resilience. These provide prompts for exploring how a company could respond.
The Climate Value Framework© starts with how the enterprise creates value, investigates relevant risks and opportunities, tests company evidence and assesses future financial consequences. Management can then compare responses by their value, cost, feasibility, dependencies and timing.
Consider Junction Freight's response options. Protecting its existing distribution centre may reduce disruption costs and help preserve customer relationships. Establishing alternative distribution capacity may provide greater flexibility and create opportunities to serve new customers or markets.
The first response is principally about protecting value already created. The second could protect value while creating additional revenue opportunities.
Neither is automatically the better investment. Management needs to compare the cost of each response, its likely effectiveness, the operational dependencies and the customer and market information supporting additional demand.
The commercial question is not simply how much risk can be reduced, but which response creates the strongest overall enterprise value proposition.
What should management do next?
Choose one climate-related risk already identified by your business. Bring together the people responsible for the affected operations, financial performance and risk management.
Ask them to establish:
- Which enterprise value drivers could be affected.
- What do we know about the exposure and its consequences?
- Which revenue, cost, asset, cash flow or financing outcomes could change.
- Which assumptions remain untested.
- Which management responses warrant comparison.
The initial result may be a qualitative assessment, an indicative financial range or a decision to collect more information. It need not be a precise estimate. Where disclosure is required, management must separately assess the applicable reporting requirements and the basis for any quantitative or qualitative information.
Sightlines Advisory helps businesses connect climate risks and opportunities with their existing risk management, financial planning and investment decisions. We work with management to identify what matters, test the available information and assumptions and determine where further analysis could create value.
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