Section-D
RISK MANAGEMENT:
1. TYPE OF RISK:
· RISK:
A risk is any event or action that can even an organization from
achieving its objectives.
Risk is not the same as uncertainty
Uncertainty is not known or not defined.
· Benefits of risk management :
1.
Better objective control
2.
Fewer shocks and unwelcome surprise
3.
Better and more complete contingency planning
4.
Fewer disruptions to operations.
· Types of risk :
1. Strategic risk:
These are entity-level risks, that affect the whole organization
Examples: global marketing condition economy leadership risk,
the risk of customer needs change, reputation change, brand risk, and
political risk, etc.
2. Political risk:
Political risk arises when political conditions. In a given
country causes a company's investment is to cost value or worthless.
Examples: war, terrorist activity, civil unrest, expropriation,
nationalism, government regulations, corruption, tax regulations, etc.
3. Financial risk:
These are connected to the financial health of the company
= EBIT ÷ interest = financial risk
Financial risk can also arise from the volatility of the foreign currency,
interest rate, or commodity price.[input].
4. Horizontal risk:
These are risk events that can be insured against such as natural
disasters with proper insurance.
Death of key employee [ with life insurance]
Or personal injury on the business premises [ with liability
insurance ]
5. Operational risk:
It results from adequate or filed internal processes people or
systems.
It includes legal risk and compliance risks.
· Legal risk: it arises from uncertainty related to legal action>
·
Compliance risk: its current or future risk to
profit or to the company's asset as a result of a violation of or nonperformance with loss rules and regulations etc.
Note: risk is investing as the potential for either a
positive or negative event whereas another type of risk has the potential only
for a negative event.
Volatility and time impact the risk.
6. Internal risk:
Within the organization
Controllable
Example:
infrastructure risk: such as changes to the organization or its
policies
internal technological risk: such as introducing new software.
External risk: such as out of the organization.
process-related risk; such as a changes in the manufacturing process
Examples; are political risk, competition action, regulations,
market changes, etc.
STUDY UNIT TO RISK MANAGEMENT PROCESS:
Steps in risk management are
1. Risk identification
2. Risk assessment [ qualitative and quantitative]
3. Risk prioritization
4. Response planning
5. Risk monitoring
Ø RISK IDENTIFICATION:
Management analyses the company's internal and external environment to identify all possible risk events that might adversely impact or otherwise prevent the company from achieving its objectives.
Risk arises from,
- 1. Internal event
- 2. External event
Ø Internal event: for example, a personal event such as employee fraud, work stoppage, or less of a key employee, technological change, etc.
Ø External event: example: competitive action, natural disaster, political event, etc.
Event identification techniques :
1. Brainstorming sessions:
These are meetings in which employees, management, and all staff members are invited to discuss the risk and develop solutions through idea sharing.
2. SWOT analysis: [ strength weakness opportunity threat ]
It is used for formulating a strategy
SWOT stands for strength weakness opportunity and threat.
Strength and weakness are internal
Opportunities and threats are external.
3. Scenario analysis:
Managers consider various scenarios that could occur and how they would impact the business.
4. Facilitate workshops:
For example, the financial controller might conduct a workshop with the accounting terms to identify events that could have an impact on the entity's external financial reporting.
5. Interview and self-assessment:
Each unit assesses its risk management capability and submits its self-assessment to the risk management co-ordination.
The coordination follows up with interviews to clarify the issue.
6. Risk questionnaire and risk services:
It helps to identify potential risks by providing a list of questions related to specific risks.
Risk service may be used instead of the questionnaire.
7. Event inventories and loss event data;
Event inventories are detailed listings of potential events common to companies within a particular inventory.
Loss event data could be a database of actual loss events that have taken place for a specific industry.
8. Process mapping:
It’s a process of mapping each process of the organization.
RISK MANAGEMENT STEPS
Step 2-RISK ASSESSMENT :
It is a process of analyzing and qualifying identified risks.
Risk assessment focuses on two kinds of risk.
1. Inherent risk:
It is a level of risk before management takes mitigation action.
It is a risk related to the nature of the activities the companies undertake.
2. Residual risk;
The level of risk that remains after management has taken action to mitigate the risk.
Residual risk = inherent risk – risk mitigation activities
3. Loss frequency:
It measures how often the loss occurs [probability].
Example: the probability of sale of loss.
4. Loss severity :
It is a measure of a loss in terms of cost at the time it occurs.
For example: if a fire occurs in a company the cost will be $500000
Ø Qualitative risk assessment tools:
It is used to consider qualitative factors.
Qualitative risk can be assessed with a risk map or risk map heat map.
Ø Quantitative risk assessment tool:
1. Value at risk:
It measures the potential loss in value of the risky assets as a result of a specific risk event over a defined period or certain period for a given confidential internal.
For example: if the VAR on an asset is $100M at a 95% confidence level, there s only a 5% chance that the value of the asset will drop more than 100% over any given period.
VAR is the maximum loss within a certain period at a given level of confidence.
2. Benchmarking :
It compares the company's risk profiles and the impact of risk potential with the dose of similar companies.
3. EPS distribution:
It is a graphical representation of the probability distribution of various potential amounts of EPS.
4. Earnings distributions:
It is a graphical distribution of the probability distribution of various potential levels o return.
5. Cash flow at risk:
It measures likely hood that cash flow will drop by more than a certain amount over a given period.
6. Earnings at risk:
It measures the confidence initially for a fall in earnings during a specific period.