CHAPTER 7

RISK MANAGEMENT
 RISK MANAGEMENT DEFINED

• Risk management is the process of measuring or assessing

risk and developing strategies to manage it. Risk management
is a systematic approach in identifying, analyzing and
controlling areas or events with a potential for causing
unwanted change.
 BASIC PRINCIPLES OF RISK MANAGEMENT
Risk management should:
1. Create value
2. Address uncertainty and assumptions
3. Be an integral part of the organizational processes and decision making
4. Be dynamic, iterative, transparent, tailorable, and responsive to change
5. Create capability of continual improvement and enhancement considering the
best available information and human factors
6. Be systematic, structured and continually or periodically reassessed
Process of Risk Management
1. Establishing the context
2. Identification of potential risks
3. Risk Assessment
Relevant Risk Terminologies
1. Risks Associated With Investments
a. Business risk refers to the uncertainty about the rate of return caused
by the nature of the business.
b. b. Default risk is related to the probability that some or all of the
initial investment will not be returned.
c. Financial risk the firm capital structure or sources of financing
determine financial risk.
d. Interest rate risk because money has time value, fluctuations in interest
rates will cause the value of an investment to fluctuate also.
e. Liquidity risk is associated with the uncertainty created by the inability
to sell the investment quickly for cash.
f. Management risk decisions made by a firm’s management and board of
directors materiality affect the risk faced by investors.
g. Purchasing power risk is perhaps, more difficult to recognize than the
other types of risk.
 2. Risks Associated With Manufacturing, Trading and Service
Concerns
a. Market Risk
b. Operational Risk
c. Product Risk
d. Competitor Risk
STEPS IN THE RISK MANAGEMENT PROCESS
1. Set up a separate risk management committee chaired by a board member
2. Ensure that a formal comprehensive risk management system is in place
3. Assess whether the formal system processes the necessary elements
4. Evaluate the effectiveness of the various steps in the assessment of the
comprehensive risks faced by the business firm
5. Assess if management has developed and implemented the suitable risk
management strategies and evaluate their effectiveness
6. Evaluate if management has designed and implemented risk
management capabilities
7. Assess management’s efforts to monitor overall company risk
management performance and to improve continuously the firm’s
capabilities
8. See to it that best practices as well as mistakes are shared by all
9. Assess regularly the level of sophistication of the firm’s risk
management system
10.Hire experts when needed.
 AREAS OF RISK MANAGEMENT

1. Enterprise risk management

2. Risk management activities as applied to project management
3. Risk management for megaprojects
4. Risk management of information technology
5. Risk management techniques in petroleum and natural gas
PRACTICAL GUIDELINES IN REDUCING AND
MANAGING BUSINESS RISKS

Practical guidelines in managing and reducing

enterprise wide risk inherent in business activity is best
achieved by applying the principles and techniques
appropriate to the situation.
• Understand the Nature of Risk
The willingness and readiness to take personal and financial risks is a
defining characteristic of the entrepreneurial decision-maker.
• Identify and Prioritize Risks
Identification of significant risks both within and outside the
organization is crucial and allows to make informed decisions.
• Consider the Acceptable Level of Risks
As earlier mentioned, the usual first step is to determine the nature and
extent of risks the business will accept.
• Understand and Why Risks Become Reality
Once risks are identified they can be ranked according to their
potential impact and the likelihood of them occurring.
 THE FIVE MOST SIGNIFICANT TYPES OF RISK
CATALYST ARE AS FOLLOWS:
a. Technology
b. Organizational change
c. Processes
d. People
e. External factors
Apply a Simple Risk Management Process
a. Risk assessment and analysis
b. Risk management and control
c. Controlling and monitoring enterprise-wide risk
Practical Considerations in Managing and Reducing Financial Risk
1. Variance analysis
2. Assessment or market entry and exit barriers
3. Break even analysis
4. Controlling costs
a. Focus on the big items of expenditure
b. Be cost aware
c. Maintain a balance between costs and quality
d. Use budgets for dynamic financial management
e. Develop a positive attitude to budgeting f. Eliminate waste
 PRACTICAL TECHNIQUES TO IMPROVE
PROFITABILITY
1. Focus decision making on the most profitable areas.
2. Decide how to treat the least profitable products
3. Make sure new products enhance overall profitability
4. Manage development and production decisions
5. Set the buying policy
6. Consider how to create greater value from existing customers and products to
enhance profitability
7. Consider how to increase profitability by managing people